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April 2017 Policy Study, Number 17-7

   

A Commentary on Property and Taxation

   

Part 6

   

 

Perhaps a real-world example would be in order.  Let’s put some raw product into the economic stream.  We’ll quarry some sand from the earth.  The basis for all wealth is natural resources.  To create wealth we apply our intellectual talent and labor to a portion of earth.  The difference in value between what the original portion of earth was worth before we applied our intellectual talent and labor and what it becomes worth after we apply our intellectual talent and labor is created wealth.  It is improper to suggest that resources in their natural state have no value; but they really don’t have very much value.  By way of explanation, consider society before it developed to the current state with which you are familiar.  What would an apple tree be worth to a hunter-gatherer?  It would be worth its sustenance, a mere meal as he made his rounds.  It certainly holds more value for today’s orchard owner, but why?

 

Consider iron ore.  What would it be worth to the hunter-gatherer?  It would be worth even less than the apple tree because he probably didn’t recognize it as raw product.  It was merely a pile of rocks.  At most, it was material to build a shelter or ammunition to repel an enemy.  But we know that when we apply our intellectual talent and labor, it can be worth a great deal more.  That is created wealth.  Although resources have value in their natural state, the point is that wealth just doesn’t exist in the state of nature.  It is created.

 

We are very much like Rumpelstiltskin.  He was the character of legend that could spin straw into gold.  Of course, we cannot turn straw directly into gold as he purportedly was able to do, but through the application of our intellectual talent and labor, we do exactly this in a very real sense.  We create value, and that created value is wealth.

 

(This is another of those paragraphs that is slightly off topic at present; but I would like you to keep the question posed herein in the back of your mind as we proceed.  We would probably all agree at this point that the act of wealth creation is a good thing.  We also would all probably agree that when there is an incentive for an action, you will get more of it, but when there is a disincentive for an action, you will get less.  We would all probably further agree that a tax placed on an action is a disincentive.  The VAT is just such a tax.  It tries to levy an economic cost to the producer at the point of wealth creation.  Why do we impose an economic disincentive on an action of which we desire more?)

 

This is what we want to do with our sand.  We want to turn it into gold.  How do we go about doing that?  First, we must purchase some real estate that contains the type of sand for which we have a market, the heavy equipment needed to extract our raw material from the earth, and the machinery used to transport it to our client.  We will also be financially liable for a host of licenses, professional fees, fuel, utilities, maintenance, insurance, interest, depreciation, other sundry costs, and, not to be forgotten, property tax.

 

We must still add our wage and salary costs to the prior list.  I’ve probably forgotten something important, but you get the idea.  For the purpose at hand, we will consider all these costs added together as our cost of production, or breakeven point if you wish.  It stands to reason that a load of sand delivered to a location where someone desires it is worth more than that same sand sitting in a hole where nobody really cares.  Because this is the starting point in our economic chain of events.  The amount the customer is willing to pay over and above all of the aforementioned costs of production (the profit of the producer), plus the actual costs of production, is our incremental increase in value.  A value-added tax is computed as a percentage of this figure, and it is then added to the customer’s invoice.

 

As it turns out, our customer operates in Silicon Valley, and the sand is of a type of silica that is used to make computer chips.  To this high-tech company, sand is a minor cost but a vital component in its production.  This company has its own set of fixed and variable costs of production to which are added the total costs of the sand, which includes the VAT.  They compute their cost of production in the same manner as the first company, add as much of a profit margin as the market will bear, as well as their VAT, and ship both the chip and the bill to the company that assembles parts into salable personal computers.

 

Assembled computers being worth more than computer parts, computers shipped to a retailer being worth more than a computer sitting in an assembler’s warehouse, etc.  I suspect that by this time you’re way ahead of me.  You’ve concluded that this same process travels through the entire economic chain of events of production and terminates when, and only when, the economic chain switches from production to consumption.  I am in total agreement.  The retail buyer is the end consumer in the final economic transaction and therefore cannot escape the tax consequences by passing them on to someone else.

 

Even though each producer in the economic chain of events leading up to the consumer was liable for and did pay the VAT tax, it is also quite clear to me that each producer will also recapture the VAT expense incurred.  He does this by including that expense in the price of the finished product he ships to the next entity in the economic chain of events.  Adam Smith agrees with our reasoning.  He writes:

 

When the tax upon a commodity is so moderate as not to encourage smuggling, the merchant who deals in it, though he advances, does not properly pay the tax, as he gets it back in the price of the commodity.  The tax is finally paid by the last purchaser or consumer.  (Emphasis added).  (The Wealth of Nations, Book IV, Chapter IV,).

 

Because this element is absolutely critical to the making of my argument, I will restate the point.  The aggregate burden, of all compiled VAT taxes from every step in the chain of economic production is contained in the finished product that sits on the retailer’s shelf.  And this, plus any tax incurred by the retailer, is passed to the final consumer at the point of purchase for consumption — without fail.

 

   

 

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