Dear Godfrey

I attach a note of the principles that any policy designed to reform our insane tax system should ideally incorporate.

This has nothing in common with the waffle on the EU’s “harmonisation” aspirations, but for UKIP that is a blessing rather than an obstacle.

The paper I have attached is confined to principles – a discussion on the detail and problems with implementation would be most welcome.

We have, of course, many taxes in the UK. The merits (few) and the failings (many) of each need to be separately considered by reference to certain overarching criteria. There are many taxes I haven’t referred to (obvious omissions are capital gains tax, inheritance tax and stamp duty). This is because (i) these taxes, in the scheme of things, raise relatively little tax; (ii) their origins are politically motivated rather than principled; and (iii) once you get the main tax reform programme on the way, in the right direction, the spotlight will tend to focus on the reforms that have the most impact – both in terms of revenue and the public perception.

To illustrate the importance of understanding principles, allow me to briefly relate the story of how I was, quite fortuitously, able to deal with the question of VAT when visiting the USA in 1980:

In that year I was awarded the Author’s Prize by the University of Hartford (Connecticut) Business School. At the celebratory lunch I was seated next to the Hon. Al Ullman, Chairman of the House of Representatives Ways and Means Committee. He was there to receive the Award for Taxation Services (!), and had just introduced a Tax Restructuring Bill which the House was about to consider, and whose main purpose was to impose VAT as a federal tax applicable to the USA as a whole.

At lunch he quizzed me politely on the experience of VAT in the UK over the 8 years or so since its introduction (to replace the old Purchase Tax). I had no reason to hold back. Basically I told him that VAT is an insidious and regressive tax that is indiscriminate in its incidence. It is inherently inflationary as it goes straight into consumer prices. Governments always introduce it at  a low rate (8% in the UK) but it never stays there. Every increase inflates prices further at each production stage. Governments love it because it is easily absorbed into the public consciousness and people get used to its existence. Businesses learn to accept their role as the Exchequer’s tax collector and its true incidence is hidden by the practice of simply passing it on in stages down the production chain.

Furthermore, the prices on which VAT is calculated include a host of other imposts, duties and levies. So you get a tax-on-tax escalation in pricing which has nothing to do with the true costs of production. It also spawns a sub-economy of fraudulent abuse, and the different rates of VAT represent a classical example of  government’s obsession with interfering in people’s normal spending preferences.

After explaining all this, Al Ullman was thoughtful and invited me to Washington to discuss the whole question with his “think-tank” of young academic economists who were guiding the proposed Bill through to legislation. (“If you can persuade them, they’ll persuade me!”). Naturally, I accepted. I battled solo with his team one morning, while Al was at a meeting with Jimmy Carter and the Prime Minister of Japan. Al’s team was a formidable group who were thoroughly familiar with the mechanics of how VAT works. They were good talkers on amelioration and masking of effects, but they had missed the principle: VAT is not a tax on value added. Although calculated by reference to inputs and outputs, the effect of passing it on down the production chain results in it being borne by the only party that adds no value – the final consumer. I explained that to distinguish good from bad taxes it is essential to recognise the difference between the mechanics of a tax and its incidence (ie who finally bears it).

I pointed out that a genuine tax on differential added value, which reflects taxable capacity, is what they should have been introducing: it is neutral regarding employment, which it treats as a “share” of added value rather than a cost of production.

To their credit they dropped their defensiveness and explained it all to Al when he returned to the office at midday. He was obviously able to grasp the principles because, to my astonishment, he took up his copy of the Bill, lifted it above his head saying “This is an important day. America will be saved from VAT – I always knew there was something wrong with that tax!  and ripped it in half before dropping it in the waste basket. To this day, there has been no VAT in USA.

One of the reasons Al lost his seat in the next election is that he was already tainted as the promoter of introducing VAT as a federal tax!

I hope that you enjoy reading the attachment, and of course I would welcome a discussion.