Value-Added Tax (VAT) Examples

Updated on June 4, 2022

At every stage where value has been added, a value-added tax (VAT) must be collected. When raw materials producers sell products to factories, factories sell their finished goods to wholesalers who then pass the goods on to retailers who in turn pass the goods on to end users, a tax is levied at each of these points.

The retail customer is ultimately responsible for VAT. The succeeding customer in the chain reimburses the VAT paid by the buyer at each previous stage of the product’s manufacture. European countries use VAT on a regular basis. The United States does not have a VAT. 1

There are many ways to express the value added tax (VAT). Because VAT is 15%, customers pay $115 to the merchant when they buy a product that costs $100. To the government, the merchant remits $15 of the $100 they received.

KEY TAKEAWAYS

From the time raw materials are purchased to the time the product is sold to the end user, a value-added tax (VAT) must be paid.
The prior buyer in the chain is reimbursed for each assessment. As a result, the consumer is ultimately responsible for the tax.
Customers with lesser incomes, say their critics, should not be forced to pay more in VAT than those who are better off.
By giving a physical or electronic record of taxes for each product, proponents claim it reduces tax evasion.

VAT vs. Sales Tax

A national sales tax and a VAT system are often used interchangeably. Sales tax, on the other hand, is collected at the point of purchase by the end user exclusively. As a result, the only person who ever has to pay for it is the retail client.

The VAT system is based on invoices and collects VAT at various stages of the manufacturing process. In order for the government to get its money, a tax is collected each time value is added. 2

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Example of VAT

As an illustration, the following is an example of a 10 percent VAT applied sequentially along a production chain:

A merchant sells raw materials made of various metals to a maker of electronic components. At this stage in the industrial cycle, the metals dealer is the seller. As a result, the dealer receives $1 and 10 cents from the producer, and then pays the government 10 percent of that amount in VAT.

Cell phone manufacturing companies buy electronic components from the manufacturer for $2 plus a 20-cent VAT, which the manufacturer uses to build electronic components. Rather than handing the government 10 cents, the producer keeps the other 10 cents, which it uses to pay back the metals dealer for the VAT it previously paid.

If you’re looking for a new cell phone, you can get one from a cell phone retailer for $3 + 30 cents in VAT. The government receives 10 cents of the VAT it collects. Cell phone manufacturers get reimbursed for 20 cents of the VAT they paid to the electronic components manufacturer.

Final price: $5 plus 50 cents VAT, 20 cents of which goes to the government and the rest goes to the merchant as a rebate for VAT it previously paid. The retailer sells the phone.

Ten percent of the value contributed by the seller is paid in VAT at each sale point.

The VAT in the United Kingdom

Since 2011, the standard VAT rate in the United Kingdom has been 20%. 3

Certain purchases, such as child safety seats and home energy, are subject to a 5 percent tax. Some commodities, such as food and children’s clothing, are exempt from VAT. Transactions involving money or property are not included either. 4

Arguments in Favor of VAT

Value-added tax advocates claim that a VAT system deters tax evasion. To encourage tax compliance and discourage subterranean operations, VAT is charged (and documented) at every stage of production. 2

Manufacturing and supplying companies must collect VAT on their outputs in order to be credited with their inputs’ VAT payments.

In order to get a credit for the VAT they had to pay while purchasing their items wholesale, retail enterprises have an incentive to collect the tax from their customers.

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Better Than a Hidden Tax

Compared to so-called hidden taxes, a VAT is preferable. People don’t often know about these levies, such as taxes on gasoline and alcoholic beverages. This is a tax on top of the sales tax in the United States, however it isn’t broken out separately. 56

Compared to income taxes, VATs have a lower impact on individual economic decisions because they are levied at the same percentage on many or most products and services.

A country’s economy, however, can be affected by it. Government deficits can be eliminated and GDP growth accelerated through the implementation of a value-added tax (VAT).

Arguments Against VAT

VAT critics claim that it unfairly burdens the poor.

With a VAT, consumers regardless of income pay the same percentage of tax, as opposed to the U.S. system’s progressive income tax, which charges higher-earning individuals a higher tax rate.

It’s obvious that the 20% VAT in the UK, for example, bites further into the budget of the less well-off person.

Most nations with VAT, notably Canada and the UK, give exemptions or discounts on necessities like children’s clothing and groceries in an attempt to decrease this income inequality.

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