Value-added tax (VAT) is widely used in more than 160 countries around the world and it is most commonly found in the European Union. It is a consumption tax placed on a product along the manufacturing-distribution-sales process whenever value is added.

Value-added tax is levied on taxpayers’ consumption and the amount taxpayers pay is accord with the cost of the product. Unlike income tax which is progressive, value-added tax is equal to everyone despite their financial status.

How does it work?

Value-added tax is based on the gross margin at each point of the supply chain and it is collected at each stage, instead of at the end.

Now, let’s use an example to see how it works.

Supposed manufacturer A produces a machine in country B which has a 10% value-added tax.

  • Manufacturer A buys the raw materials for $200, he should pay a total price of $220, with a VAT of $20.
  • Manufacturer A sells the machine to a retailer for $300, the VAT manufacturer A gains is $10 since the gross margin is $100 at this point.
  • The retailer sells the machine to consumer for $600, the VAT the retailer gains is $30 since the gross margin is $300 at this point.

Pros and Cons

  • Pros
  • Value-added tax will provide additional income and raise government revenues to reduce the deficit without any discrimination between the poor and the wealth.
  • Value-added tax covers all sales, even online sales.
  • Value-added tax helps improve U.S. income tax system and is more efficient.
  • Cons
  • Value-added tax is very costly and will increase the economic burdens on businesses and lower-income taxpayers.
  • Value-added tax’s cost will fall mostly on the poor.

One thought on “What is value-added tax?”

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