What Is a Value-Added Tax (VAT)?
Written by True Tamplin, BSc, CEPF®
Updated on July 10, 2021
A value-add tax is a tax charged on the gross profit of every step in the supply chain.
It’s best understood using an example:
The country of Decivat has a 10% value added tax.
A flour manufacturer will buy $1,000 worth of grain from a farmer for $1,100, $100 of which will go to the government as VAT, to create flour.
If the manufacturer sells the flour to a baker for $1,500, he will charge $1,550 since a 10% VAT is imposed on the gross profit of $500.
A value-added tax is the most common form of consumption tax for industrialized countries with over 160 countries levying a VAT, excluding the United States.
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Advocates of the tax claim the following:
- It helps raise government revenues without punishing wealth or success (like income tax)
- Replacing other taxes with a VAT would close tax loopholes
- It is based on consumption and therefore encourages saving
Those against a VAT argue the following:
- A VAT would be felt less by the wealthy as lower-income earners would pay a higher percentage of their earnings in taxes with a VAT system
- A VAT creates higher costs for businesses
- Local governments are unable to set localized tax rates