| Value added tax (VAT) is a type of sales tax. | | | | their expenditure). |
| In some countries, including Australia, | | | | |
| Canada, New Zealand, and Singapore, this tax | | | | Note that in each case the VAT paid is equal |
| is known as "goods and services tax" or GST; | | | | to 10% of the profit, or 'value added'. |
| and in Japan it is known as "consumption | | | | |
| tax". VAT is an indirect tax, in that the tax | | | | The advantage of the VAT system over the |
| is collected from someone other than the | | | | sales tax system is that businesses cannot |
| person who actually bears the cost of the tax | | | | hide consumption (such as wasted materials) |
| (namely the seller rather than the consumer). | | | | by certifying it is not a consumer. |
| As VAT is intended as a tax on consumption, | | | | |
| exports (which are, by definition, consumed | | | | Limitations to VAT |
| abroad) are usually not subject to VAT or VAT | | | | |
| is refunded. | | | | In the above example, we assumed that the |
| | | | same number of widgets were made and sold |
| VAT was invented by a French economist in | | | | both before and after the introduction of the |
| 1954. Maurice Lauré, joint | | | | tax. This is not true in real life. |
| director of the French tax authority, the | | | | |
| Direction | | | | The fundamentals of supply and demand suggest |
| générale | | | | that any tax raises the cost of transaction |
| des impôts, as taxe sur la | | | | for someone, whether it is the seller or |
| valeur ajoutée (TVA in | | | | purchaser. In raising the cost, either the |
| French) was first to introduce VAT with | | | | demand curve shifts leftward, or the supply |
| effect from 10 April 1954 for large | | | | curve shifts leftwards. The two are |
| businesses, and extended over time to all | | | | functionally equivalent. Consequently, the |
| business sectors. In France, it is the most | | | | quantity of a good purchased, and/or the |
| important source of state finance, accounting | | | | price for which it is sold, decrease. |
| for approximately 45% of state revenues. | | | | |
| | | | This shift in supply and demand is not |
| Personal end-consumers of products, consumers | | | | incorporated into the above example, for |
| and services cannot recover VAT on purchases, | | | | simplicity and because these effects are |
| but businesses are able to recover VAT on the | | | | different for every type of good. The above |
| materials and services that they buy to make | | | | example assumes the tax is non-distortionary. |
| further supplies or services directly or | | | | |
| indirectly sold to end-users. In this way, | | | | A VAT, like as any other tax, distorts what |
| the total tax levied at each stage in the | | | | would have happened without it. Because the |
| economic chain of supply is a constant | | | | price for someone rises, the quantity of |
| fraction of the value added by a business to | | | | goods traded decreases. Correspondingly, some |
| its products, and most of the cost of | | | | people are worse off by more than the |
| collecting the tax is borne by business, | | | | government is made better off by tax income . |
| rather than by the state. VAT was invented | | | | That is, more is lost due to supply and |
| because very high sales taxes and tariffs | | | | demand shifts than is gained in tax. This is |
| encourage cheating and smuggling. It has been | | | | known as a deadweight loss. The income lost |
| criticized on the grounds that it is a | | | | by the economy is greater than the |
| regressive tax. | | | | government's income; the tax is inefficient. |
| | | | The entire amount of the government's income |
| Example | | | | (the tax revenue) may not be a deadweight |
| | | | drag, if the tax revenue is used for |
| Consider the manufacture and sale of any | | | | productive spending or has positive |
| item, which in this case we will call a | | | | externalities - in other words, governments |
| widget. | | | | may do more than simply consume the tax |
| | | | income. While distortions occur, consumption |
| Without any sales tax | | | | taxes like VAT are often considered superior |
| | | | because they distort incentives to invest, |
| A widget manufacturer spends $1 on raw | | | | save and work less than other types of |
| materials and uses them to make a widget. | | | | taxation - in other words, a VAT discourages |
| | | | consumption rather than production. |
| The widget is sold wholesale to a widget | | | | |
| retailer for $1.20, making a profit of $0.20. | | | | VAT criticisms |
| | | | |
| | | | The "Value added tax" has been criticized as |
| The widget retailer then sells the widget to | | | | the burden of it relies on personal |
| a widget consumer for $1.50, making a profit | | | | end-consumers of products and is therefore, |
| of $0.30 | | | | as any sales tax based on the consumption of |
| | | | essentials, a regressive tax (the poor pay |
| With a U.S.-style sales tax | | | | more, in comparison, than the rich). French |
| | | | President Jacques Chirac has often pleaded |
| With a 10% sales tax: | | | | for a reduction of European VAT concerning |
| | | | catering, in order to win favour from this |
| The manufacturer pays $1.00 for the raw | | | | sector. |
| materials, certifying it is not a final | | | | |
| consumer. | | | | Revenues from a value added tax are |
| | | | frequently lower than expected because they |
| The manufacturer charges the retailer $1.20, | | | | are difficult and costly to administer and |
| checking that the retailer is not a consumer, | | | | collect. In many countries, however, where |
| leaving the same profit of $0.20. | | | | collection of personal income taxes and |
| | | | corporate profit taxes has been historically |
| The retailer charges the consumer $1.65 | | | | weak, VAT collection has been more successful |
| ($1.50 + 10%) and pays the government $0.15, | | | | than other types of taxes. VAT has become |
| leaving the same profit of $0.30. | | | | more important in many jurisdictions as |
| | | | tariff levels have fallen worldwide due to |
| So the consumer has paid 10% ($0.15) extra, | | | | trade liberalisation, as VAT has essentially |
| compared to the no taxation scheme, and the | | | | replaced lost tariff revenues. Whether the |
| government has collected this amount in | | | | costs and distortions of value added taxes |
| taxation. The retailers have not lost | | | | are lower than the economic inefficiencies |
| anything directly to the tax, but they do | | | | and enforcement issues (e.g. smuggling) from |
| have the extra paperwork to do so that they | | | | high import tariffs is debated, but theory |
| correctly pass on to the government the sales | | | | suggests value added taxes are far more |
| tax they collect. Suppliers and manufacturers | | | | efficient. |
| are not affected by the tax, though they have | | | | |
| to check their customers' status. | | | | Due to the fact that exports are generally |
| | | | zero-rated (and VAT refunded or offset |
| With a VAT | | | | against other taxes), this is often where VAT |
| | | | fraud occurs. In sectors or countries where |
| With a 10% VAT: | | | | VAT fraud is prevalent, attempts by |
| | | | authorities to control fraud may have |
| The manufacturer pays $1.10 ($1 + 10%) for | | | | unintended consequences, and raise costs for |
| the raw materials, and the seller of the raw | | | | honest companies. This problem is also true |
| materials pays the government $0.10. | | | | of other types of taxation, however. |
| | | | |
| The manufacturer charges the retailer $1.32 | | | | Certain industries (small-scale services, for |
| ($1.20 + 10%) and pays the government $0.02 | | | | example) tend to have more VAT avoidance, |
| ($0.12 minus $0.10), leaving the same profit | | | | particularly where cash transactions |
| of $0.20. | | | | predominate, and VAT may be criticised for |
| | | | encouraging this. From the perspective of |
| The retailer charges the consumer $1.65 | | | | government, however, VAT may be preferable |
| ($1.50 + 10%) and pays the government $0.03 | | | | because it captures at least some of the |
| ($0.15 minus $0.12), leaving the same profit | | | | value-added. For example, a carpenter may |
| of $0.30. | | | | offer to provide services for cash (i.e. |
| | | | without a receipt, and without VAT) to a |
| So the consumer has paid 10% ($0.15) extra, | | | | homeowner, who usually cannot claim input VAT |
| compared to the no taxation scheme, and the | | | | back. The homeowner will hence bear lower |
| government has collected this amount in | | | | costs and the carpenter may be able to avoid |
| taxation. The businesses have not lost | | | | other taxes (profit or payroll taxes). The |
| anything directly to the tax, but they do | | | | government, however, may still receive VAT |
| have the extra paperwork to do so that they | | | | for various other inputs - lumber, paint, |
| correctly pass on to the government the | | | | gasoline, tools, etc. While the total tax |
| difference between what they collect in VAT | | | | receipts may be lower compared to full |
| (output VAT, an 11th of their income) and | | | | compliance, it may not be lower than under |
| what they spend in VAT (input VAT, an 11th of | | | | other feasible taxation systems. |