A VAT is a consumer tax levied on products at every point of sale where value has been added, starting from raw materials and going all the way to the final retail purchase. Ultimately, the consumer pays the VAT; buyers receive reimbursements for the previous VAT they paid at earlier stages of production.
Usually, VAT is expressed as a percentage of total cost. For example, the consumer pays $115 to the merchant if a product costs $100 and there is a 15 percent VAT. The merchant is holding $100 and providing the government with $15.
There is often confusion between a VAT system and a national sales tax. The tax is only collected once with a sales tax–at the final point of a consumer’s purchase. So it is always paid by the retail customer. The VAT system is based on invoice and collected throughout the production of an item at several points. Each time value is added and a sale is made. Each seller in the production chain charges the buyer a VAT tax, which is then passed on to the government. The amount of tax levied on each sale along the chain is based on the latest seller’s added value.
Example of Value-Added Taxation
To calculate the amount of VAT that a consumer or business has to pay, take the cost of the goods or services and remove any previously taxed material costs. An example of a 10% VAT sequence through a production chain can be as follows:
A manufacturer of electronic components purchases from a dealer raw materials made from different metals. The metals dealer–the seller in the production chain at this point–charges $1 plus a 10-cent VAT to the manufacturer and then pays the government 10 percent VAT.
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The manufacturer adds value by creating the electronic components through its manufacturing process. Which it then sells for $2 plus a 20-cent VAT to a cellphone manufacturing company. The producer remits to the government 10 cents of the 20-cent VAT that it collected. While the other 10 cents reimburse it for the VAT that it previously paid to the metal dealer.
The manufacturer of cell phones adds value by making their mobile phones, which they then sell for $3 plus a 30-cent VAT to a cell phone retailer. It pays 10 cents of this VAT to the government; the other 20 cents reimburse the manufacturer of cell phones for the previous VAT paid to the company of electronic components.
Finally, the retailer sells a phone for $5 plus a 50-cent VAT to a consumer, 20 cents payable to the government.
The value added by the seller represents 10 percent of the value added at each point of sale along the way.
Value Added Tax Arguments
In favor of VAT
Those who favor value-added taxation argue that a system of VAT promotes tax payment and discourages attempts to avoid it. The fact that VAT is charged at each stage of production rewards tax compliance. And, it acts as a disincentive from operating on the black market. It is their responsibility to collect VAT on their outgoing–the goods they create or sell –for manufacturers and suppliers to be credited for paying VAT on their inputs. Retail companies have incentives to collect tax from consumers. As this is the only way they can get credit for the VAT they paid when buying wholesale goods. As a better alternative to so-called hidden taxes, a VAT is also supported.
Because it is typically levied on various products and services at the same percentage. A VAT tends to have less impact on economic decisions than a tax on income. It can still register on the economy of a country. A VAT is considered as an effective way to improve the growth of a nation’s gross domestic product (GDP), raise tax revenues, and eliminate government budget deficits, along with improving tax collection efficiency.
Against VAT
VAT opponents claim it unfairly burdens people with lower incomes. Unlike a progressive tax (like the U.S. income tax system where higher-income individuals pay a higher percentage of tax), a VAT is like a flat tax where all consumers of all income levels pay the same percentage irrespective of earnings:
Whether your annual income is $50,000 or $500,000, you are levied the same 15 percent VAT on goods and services. Obviously, that 15 percent cut the $10,000 individual’s budget deeper than the $500,000 individual. If the former paid $1,000 in VAT taxes, that’s 2% of his annual income. If the latter pays the same $1,000 in VAT, that’s just 0.02 percent of its revenue.
Most countries with VAT (including Canada and the United Kingdom) offer numerous exemptions to combat this income inequality argument, usually on necessities such as clothing for children, child care, and grocery stores.
You can simply calculate VAT on VAT calculator instead of all these manual calculations.
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