Value Added Tax or VAT is a method of taxing that is in existence for many years. The idea behind the tax is that a tax is imposed on the consumer from the stage of the purchase of raw materials to the sale of the final product. The tax also includes the sale of services. Several countries have adopted the Value Added System. The tax applies to all commercial operations that involve the manufacture and distribution of goods and providing services. This tax is ultimately borne by the consumer and is not charged on the business.
How VAT works
VAT is similar to sales tax except that every individual in the chain pays tax. Let us take an example for a better understanding. Suppose there is a 10% VAT tax in effect. When a plastic manufacture sells $200 worth of plastic to a factory, the factory owner will pay $200 * 1.10 and the $20 will be sent to the tax agency. The buyer will use the plastic to make $500 worth of bottles and sell to a restaurant. The factory owner will send $50 to the tax agency. The restaurant will sell the bottles for a total of $700 and the $70 VAT that ultimately the consumers pay for will be sent to the tax agency. It is important to consider that every intermediate player will subtract the value-added tax they paid for. It can get slightly complicated.
Exception to VAT
There is one exception to the consumers paying VAT tax when they are not a resident of the country. In this case, they will get a refund for the amount paid by them. A lot of tourists are not aware of this and they do not claim the refund. The money eventually goes into the revenue department of the nation.
VAT vs. Sales tax
There is a significant difference between sales tax and VAT. A sales tax will be applicable at the time of the final sale of the product. This means the consumer will pay sales tax only at the time of purchase of the product. One cannot apply for a refund on the tax paid. The similarity between VAT and sales tax is that the businesses are eligible for a sales tax exemption from paying the tax on goods they sell to the ultimate consumer.
Benefits of Value Added Tax system
- Implementation of VAT can eliminate the labyrinthine income tax system in the country. VAT is very efficient and it can generate higher revenue.
- The tax can put an end to the problem of online sales tax because it will bring both, online and offline sales under the tax purview.
- VAT can provide extra income and help bring down the deficit. This money can help fund critical healthcare programs for citizens.
Problems of Value Added Tax System
The biggest limitation of VAT is that it is very controversial. Even if the government tried to implement VAT, the opposition would be intense.
- Value Added Tax is highly regressive and the cost mostly falls on the poor.
- Implementation of VAT can be difficult in the U.S. because it is hard to eliminate the IRS and the current tax system. VAT will become just another tax on the people.
- The current state sales tax system is highly complex and if VAT replaces the same, the states may create a fuss. Some states might not charge sales tax and several others might charge it at a different rate. This could lead to a lot of complexity and confusion.
- The calculation of VAT can be very costly for a business. The businesses will be required to calculate VAT on each and every product and this can take a lot of time and effort.
- The paperwork for VAT is a lot more complicated as compared to other taxes.
- Critics also say that VAT would be bad as it makes it easy to raise revenue. Instead of doing that, the government should reduce its spending.
VAT or no VAT?
Supporters of VAT believe that some problems can be handled. If the income tax rates are adjusted, it can make up for the nature of the VAT tax. However, the introduction of any new tax requires a lot of research and consideration. It is not easy to simply implement VAT and expect consumers to accept it. The calculation will be complex and it will but a huge burden on the poor. The pros and cons should be carefully considered before implementing VAT in the country. There are VAT supporters and critics. While the supporters believe that VAT will make accounting and reporting easier, the critics think that the disadvantages win over the advantages.