A value-added tax (VAT), known in some countries as a goods and services tax (GST), is a type of tax that is assessed incrementally. It is levied on the price of a product or service at each stage of production, distribution, or sale to the end consumer. If the ultimate consumer is a business that collects and pays to the government VAT on its products or services, it can reclaim the tax paid. It is similar to, and is often compared with, a sales tax. VAT is an indirect tax because the person who ultimately bears the burden of the tax is not necessarily the same person as the one who pays the tax to the tax authorities.
Not all localities require VAT to be charged, and exports are often exempt. VAT is usually implemented as a destination-based tax, where the tax rate is based on the location of the consumer and applied to the sales price. The terms VAT, GST, and the more general consumption tax are sometimes used interchangeably. VAT raises about a fifth of total tax revenues both worldwide and among the members of the Organisation for Economic Co-operation and Development (OECD). As of June 2023, 175 of the 193 countries with full UN membership employ a VAT, including all OECD members except the United States, where many states use a sales tax system instead.
There are two main methods of calculating VAT: the credit-invoice or invoice-based method and the subtraction or accounts-based method. In the credit-invoice method, sales transactions are taxed, the customer is informed of the VAT on the transaction, and businesses may receive a credit for the VAT paid on input materials and services. The credit-invoice method is by far the more common and is used by all national VATs except for Japan. In the subtraction method, a business at the end of a reporting period calculates the value of all taxable sales, subtracts the sum of all taxable purchases, and applies the VAT rate to the difference. The subtraction method VAT is currently used only by Japan although it, often by using the name "flat tax," has been part of many recent tax reform proposals by US politicians. With both methods, there are exceptions in the calculation method for certain goods and transactions that are created to help collection or to counter tax fraud and evasion.
History
Germany and France were the first countries to implement a VAT, doing so in the form of a general consumption tax during World War I. The modern variation of VAT was first implemented by France in 1954 in Ivory Coast (Côte d'Ivoire) colony. Recognizing the experiment as successful, the French introduced it in 1958. Maurice Lauré, Joint Director of the France Tax Authority, the Direction Générale des Impôts implemented VAT on 10 April 1954, although German industrialist Wilhelm von Siemens proposed the concept in 1918. Initially directed at large businesses, it was extended over time to include all business sectors. In France it is the most important source of state finance, accounting for nearly 50% of state revenues.
A 2017 study found that the adoption of VAT is strongly linked to countries with corporatist institutions.
Overview
The amount of VAT is decided by the state as a percentage of the price of the goods or services provided. As its name suggests, value-added tax is designed to tax only the value added by a business on top of the services and goods it can purchase from the market.
To understand what this means, consider a production process (e.g., take-away coffee starting from coffee beans) where products get successively more valuable at each stage of the process. Each VAT-registered company in the chain will charge VAT as a percentage of the selling price, and will reclaim the VAT paid to purchase relevant products and services; the effect is that net VAT is paid on the value added. When an end-consumer makes a purchase subject to VAT—which is not in this case refundable—they are paying VAT for the entire production process (e.g., the purchase of the coffee beans, their transportation, processing, cultivation, etc.), since VAT is always included in the prices.
The VAT collected by the state from each company is the difference between the VAT on sales and the VAT on purchase of goods and services upon which the product depends, i.e., the net value added by the company.
Implementation
The standard way to implement a value-added tax involves assuming a business owes some fraction on the price of the product minus all taxes previously paid on the good.