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What is a Value-Added Tax – VAT?


What is a Value-Added Tax – VAT?

Value Added

More than 160 countries around the world use value-added taxation, and it is most commonly found in the European Union. But it is not without controversy. Advocates say it raises government revenues without punishing success or wealth, as income taxes do, and it is simpler and more standardized than a traditional sales tax, with fewer compliance issues. Critics charge that a VAT is essentially a regressive tax that places an increased economic strain on lower-income taxpayers, and also adds bureaucratic burdens for businesses.Value-added taxation is based on a taxpayer's consumption rather than their income. In contrast to a progressive income tax, which levies greater taxes on higher-level earners, VAT applies equally to every purchase.

How a VAT Works
A VAT is levied on the gross margin at each point in the manufacturing-distribution-sales process of an item. The tax is assessed and collected at each stage, in contrast to a sales tax, which is only assessed and paid by the consumer at the very end of the supply chain.Say, for example, Dulce is an expensive candy manufactured and sold in the country of Alexia. Alexia has a 10% value-added tax. Dulce’s manufacturer buys the raw materials for $2.00, plus a VAT of $0.20 – payable to the government of Alexia – for a total price of $2.20.The manufacturer then sells Dulce to a retailer for $5.00 plus a VAT of 50 cents for a total of $5.50. However, the manufacturer renders only 30 cents to Alexia, which is the total VAT at this point, minus the prior VAT charged by the raw material supplier. Note that the 30 cents also equals 10% of the manufacturer’s gross margin of $3.00. Finally, the retailer sells Dulce to consumers for $10 plus a VAT of $1 for a total of $11. The retailer renders 50 cents to Alexia, which is the total VAT at this point ($1), minus the prior 50-cent VAT charged by the manufacturer. The 50 cents also represents 10% of the retailer’s gross margin on Dulce.

VAT's International Track Record
The vast majority of industrialized countries that make up the Organisation for Economic Cooperation and Development (OECD) have a VAT system. The United States remains the only notable exception.Most industrial countries with a VAT adopted their systems in the 1980s. Results have been mixed, but there is certainly no tendency among VAT countries to have small budget deficits or low government debt. According to one International Monetary Fund study, any state that switches to VAT initially feels the negative impact of reduced tax revenues despite its greater revenue potential down the road.VAT has earned a negative connotation in some parts of the world where it has been introduced, even hurting its proponents politically. In the Philippines, for example, Senator Rafael Recto, the chief proponent of VAT in the 1990s, was voted out of office by the electorate when he ran for re-election. But in the years that followed its implementation, the population eventually accepted the tax. Recto ended up finding his way back to the Senate, where he became the proponent of an expanded VAT.In 2009 and 2010, respectively, France and Germany famously implemented huge cuts in their VAT rates – France by almost 75%, from a 19.6% rate to a 5.5% rate.



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