What is the VAT?

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9. starts original manufacture

A value-added tax (VAT) is a fee that is assessed against businesses by a government at various points in the production of goods or services—usually any time a product is resold or value is added to it. For tax purposes, value is added whenever the value of a product increases as a result of the application of a company's factors of production, such as labor and equipment. VAT must be paid by every company that handles a product during its transition from raw materials to finished goods. For example, tax is charged when a manufacturer sells to a wholesaler and again when a wholesaler sells to a retailer.

With VAT, the taxable amount is based on the value added at each stage of the process of producing goods and bringing them to market. As an example, say that a company that makes socks buys cotton yarn for $1,000; adds $500 to its value in terms of labor, depreciation of knitting machines, and profits; then sells the completed socks for $1,500. VAT would be calculated as a percentage of the $500 value added by turning cotton yarn into socks. Of course, the sock company would also get credit for the amount of VAT it paid on the purchase of inputs, like cotton yarn.

In general, the total VAT accrued during the production of goods is reflected in the price of items sold to final consumers, because each reseller along the way usually passes along its VAT costs. In this way, VAT is somewhat similar to a national sales tax, and the two forms of taxation are often compared by governments. Experts claim that VAT entails higher administrative costs but is easier to enforce than a national sales tax.

The concept of VAT was first adopted by France in 1954. By 2000, it was used by Canada and 40 other industrialized countries. In most cases, the percentage of tax charged varies based on the necessity of the particular product, so the tax on food would generally be less than the tax on luxury items like boats. In recent years, VAT has been proposed for use in the United States as a way to simplify business and personal income tax laws. Proponents claim that VAT would replace other forms of taxation and reduce the costs of tax compliance. In fact, some people say that adopting VAT would eliminate tax returns for individuals and make the Internal Revenue Service obsolete. On the other hand, opponents argue that VAT would be more complicated to implement than other tax-reform options, such as a national sales tax. They also worry that it would increase the cost of food, medicine, and other necessities, which would hurt the poor.

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