Repurposing VAT for a Circular Economy

1. Discovering a Circular Economy is necessary, since a) CO2 problem is real and is plausibly linked to the long-term trend of rising global earth/ocean/troposphere temperatures; and b) current efforts to curb CO2 emissions have not even stopped the acceleration in atmospheric CO2 concentrations; and c) relying on a voluntary or forced long-term lowering of economic opportunity is both impossible and, for most of mankind, wicked.

2. A Circular Economy is, absolutely necessarily, a holistic venture which cannot be effectively developed by individual companies on their own. That's because circular economies demand not just efficient firms and goodwill, but a network of industrial linkages which are horizontal, vertical and circular.

3. Piecemeal attempts to construct regimes of subsidies and taxes to encourage more efficient cradle-to-cradle use of resources in a particular sector - plastics for example - may (or may not) improve allocation of that resource in that sector in the short and medium term. But historically, economic activity in sectors promoted and financed by subsidy tend to be: a) inefficient, attracting rent-seekers; b) distorting to neighbouring sectors; and c) transient (because the compounding effects of a) and b) make them financially and political untenable in the long-term).

4. Despite this, at a macro-level, the tax-system remains the primary and irreplaceable mechanism by which societies express their priorities and organize systemic change. There is no substitute for this mechanism.

5. In the UK, Value Added Tax is the primary source of taxation, accounting for 20% of government current revenues, and 54% of all taxes on production. In France, VAT accounts for 54% of all fiscal revenues.

6. VAT, uniquely, interposes at every stage of production, distribution and consumption. It is, therefore, a structure which in a way already closely matches and mirrors the web of vertical, horizontal and circular linkages which form the core of the Circular Economy. It therefore has the potential to express the thoroughgoing and ubiquitous set of incentive structures/pricing structures which could allow the free market to discover for itself how a Circular Economy needs to be organized.

How VAT Works Currently

Currently, VAT works through companies charging and being charged VAT at every stage of the production of a good/service, with the end-result being charged as a sales tax on the final product. Currently in the UK, VAT is levied at 20%, and every company (except very small ones) are registered for VAT, assesses their VAT liability, and pays it usually quarterly.

Because VAT is charged at every stage of production and distribution, the system generates a cascading series of tax liabilities and offsets throughout the economy. Consider a simple transaction:

Company A sources bulk raw materials and sells them to Company B at £1000 + VAT (ie £1200, of which £200 is VAT). Because we have to start this chain somewhere, we assume that Company A has in the past paid no VAT on the materials to offset against its liabilities, so this transaction incurs a full £200 VAT liability for Company A. This is, of course, a completely unrealistic assumption, but accept it now purely for demonstration purposes.

The Company B packages these materials and sells them on to Retailer C for £2400 +VAT (ie, £2880, of which £480 is VAT). Company B's VAT liability on these transactions are £480 charged minus £200 VAT already paid by Company A, ie £280

Retailer C subsequently sells the product for £5000 + VAT (ie, £6,000, of which £1000 is VAT. Retailer C's VAT liability on the sale is £1000, minus the £480 it has already paid to Company B, ie, £520.

Overall, then, the sales price of £5,000+ VAT attracted VAT of £1,000, of which £520 has been paid by Retailer C, £280 by Company B and (we have stipulated) £200 by Company A.

The end-customer, meanwhile, simply sees the full £1,000 added to the purchase price.

Repurposing VAT to Generate Systemic Circular Economy Incentives

It would be possible to repurpose this currently existing system of chained fiscal responsibility to systemically advantage goods and services conforming to Circular Economy standards, by exempting these elements and inputs from VAT entirely. So, for example, if a company sources its plastic parts from recycled plastic pellets, they would pay no VAT on that - the resource would simply be price-competitive. The greater the proportion of recycled inputs used, the less the VAT they would have to charge their subsequent customers - all the way up to the end-retail customer who would find his/her purchase of a fully-circular product to be VAT-free.

Notice that one consequence of this is not just that at each stage there is a financial incentive to source recycled inputs, and therefore encourage the expansion of recycling industries. But in addition, because those recycling industries themselves are also concerned with sourcing the materials for recycling, then the end-product producers also experience that as an incentive to design and make their own products friendly to the very recyclers they source materials from.

This is not immediately obvious, but it is an important element in the Circular Economy dynamic - and why it is sometimes described as a cradle-to-cradle system. In the end the buying-power of the recycling companies themselves will act as a long-distance incentive to design products which are friendly to recyclers.

As a popular example, consider the mobile phone industry (and, whilst you are about it, consider Fairphone). If mobile phone manufacturers have chosen to respond to the price incentives of a repurposed VAT system by maximising the proportion of recycled elements in their phones, then it also makes sense to design that phone in a modular way. Why? Because at the end of its life, the value of an old modular phone will be greater to the e-recycling sector than a phone from which it is difficult to recapture useable elements (let's call it 'a brick'). Recyclers will therefore be willing to pay more - possibly much more - for a recycled modular phone than for a 'brick'. And, of course, they won't be paying VAT on those purchases (but they will for a 'brick'). And in turn, that greater end-life value will also end up being reflected in the end-cost of ownership.

The crucial point is that the cascading incentives expressed by zero-rating circular economy goods for VAT itself directly encourages the sort of horizontal, vertical and circular linkages which are the very essence of the Circular Economy.

Unlooked for Benefits

Again, consider mobile phones. Environmentalists often deplore the commercially-driven habit of frequently 'upgrading' your phone to the latest model, as being pointless, wasteful and stupid - and more to their point, environmentally irresponsible since these phones end up in toxic electronic waste-dumps, usually in poor countries. But if your mobile phone is in fact fully embedded in a circular economy structure, then whilst upgrading every year might still be seen as pointless, wasteful and stupid, it need no longer be environmentally irresponsible. In short, if annual upgrades are your thing . . . knock yourself out. A hair shirt is not obligatory wear for consumers in the Circular Economy.

Unlooked for Costs

Whilst the chains of fiscal responsibility necessary to VAT, and the administrative mechanisms, are already familiar and in place wherever VAT is charged, the infrastructure for determining whether a particular input forms part of the circular economy is not. This is a new cost, and a new managerial/administrative responsibility which would be incurred in the repurposing of the VAT system.

If this cost/burden turns out to be very high, then it is a serious objection to the repurposing of the system. And at first glance, this would seem threateningly likely - after all, what would it take to work out what proportion of a mobile phone forms part of the circular economy? From a standing start, the task would seem dauntingly complex. But the way VAT works means that no-one is asked to perform this assessment from a standing start: rather, the responsibility is shared at each stage of the industrial process. It is not difficult to ascertain if the plastic parts are made from pellets of recycled plastic; it is no hard task to work out if an electronic or optical component is recycled or new.

Nevertheless, it would seem very likely that some sort of authorising function would be necessary to ensure that 'circular economy inputs' are genuinely circular. This function would be the exact equivalent to, and most probably an adjunct to, the existing auditing function.

It's Capitalism Jim, but Not As We Know It

This is a final but important point: the way Western capitalism has evolved over the past 30 years or so has produced wealth and growth but not prosperity. Indeed, it is increasingly seen as leaching hope from the future, whether owing to the rise in inequalities which threaten to give birth to new caste systems in developed economies, or to the perceived loss of work-dignity and security; or to the impact of capitalism on the environment.

These failures undermine confidence in the ability of people to organize themselves freely in a way which will in fact deliver prosperity. With this undermined, the very cause of freedom itself is threatened: after all, if we cannot organize ourselves freely to deliver the results we want - or even just avoid the results we fear - then quite possibly we will look for someone to do the organizing for us.

Repurposing the VAT system to generate incentive structures for the development of a Circular Economy is fortunately consistent with the preservation of economic freedom. Indeed, it recruits precisely the forces of the market to deliver the desired ends. It is, in short, repurposing for prosperity.