Budget VAT Change Did Not Cost €700 million

The lead story in today’s Sunday Independent carries the headline “Lenihan admits VAT error cost us €700m”. It states that the Minister “has admitted that his decision to increase the VAT rate in last October’s budget was a “serious mistake” which has cost the state over €700m in lost trade to the North.” Without doubt, this story will further fuel the media’s intense (but misplaced) focus on cross-border shopping as a major source of our fiscal problems. Unfortunately, however, the story is highly misleading and clearly relies on a misinterpretation of the Minister’s comments.

The key part of the story is as follows:

Addressing the Howth, Sutton, Baldoyle Chamber of Commerce at the Marine Hotel at Sutton Cross, the minister said: “If I have one act of contrition — I should not have interfered with the VAT rates. It was a mistake and the wrong thing to do. We have lost €700m in revenue going to the North.”

While the wording of this statement appears to connect the raising of VAT rates with a figure of €700 million in lost revenue, a quick look at the relevant figures suggests that this is simply not credible.

VAT revenue for 2009 was projected to be €13.4 billion in the October budget. If an increase in the standard rate of VAT from 21% to 21.5% results in a decline in revenue of €700m (a decline of over 5% in the projected revenue) then this would suggest that Irish VAT is well beyond the diminishing returns point of the Laffer curve and that we could increase revenue by making substantial cuts in VAT rates. However, as far as I know, nobody who has examined this issue has ever made such a claim. The budget had estimated that the half-point rise would raise an additional €227 million. Without doubt, the October budget figure for VAT will not be met, but this is not due to the sudden emergence of a massive cross-border-shopping Laffer curve.

The Minister’s €700 million figure almost certainly reflects his estimate of the total amount of VAT revenue lost from all cross-border shopping, with the quoted statement being an unfortunate running-together of two different points. The article states that “Yesterday, a Department of Finance spokesman confirmed the Minister’s comments” but the spokesperson was likely confirming the total-revenue-lost interpretation rather than the impact-of-rate-hike interpretation.

Applying the 21.5% rate to the lost revenue figure of €700 million (though lower rates apply to some goods), we get a rough estimate of the total extent of cross-border shopping of €3.3 billion. The ESRI’s last Quarterly Commentary projected total consumption expenditures in the Republic of €88.3 billion in 2009. This indicates the scale of the cross-border shopping phenomenon—it amounts to about 3.5% of total Irish consumption, which is pretty small given the enormous attention it receives.

Also, as the Minister’s new advisor Alan Ahearne pointed out on this blog a while back, differences in VAT rates likely account for a relatively small fraction of the current North-South price differentials, with recent sterling-euro movements being more important. (An argument that the Minister himself has also made.) Indeed, given the extent to which the budgetary figures from last October have gone off track, it is a little bizarre for the Minister to be focusing on this particular red herring as his sole act of contrition. Maybe the fact that it would go down well on the Joe Duffy show was a contributory factor here.

Perhaps the government should learn from this that, despite its recent preference for this particular form of communication, off-the-cuff comments at Chamber of Commerce dinners are not, in fact, the best way to communicate important economic issues to the public.