Value-Added Tax (VAT) Examples

Updated on July 4, 2022

Any point of sale where a product’s worth has been increased is subject to a VAT, which is a type of consumption tax.

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 VAT is ultimately paid by the end user, the retail customer.

The succeeding buyer in the chain reimburses the buyer in the earlier stages of the product’s manufacture for the VAT.

In Europe, VAT (Value Added Tax) is widely used. The VAT system does not exist in the United States. 1

There are many ways to express the value added tax (VAT). Suppose a product costs $100 and there is a 15% VAT.

The customer pays $115 to the vendor. The businessman keeps $100 and sends $15 to the IRS as a tax payment.

KEY TAKEAWAYS
From the sale of raw materials until the ultimate purchase by a consumer, a product’s 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.
According to critics, lower-income consumers are unfairly taxed because they must spend more of their money on VAT than wealthy consumers.
There are many who believe the paper or electronic trail it leaves behind inhibits people from trying to evade paying taxes.

VAT vs. Sales Tax

A national sales tax and a VAT system are frequently conflated in the public’s mind. It’s only once a buyer buys anything that a sales tax is collected. So, the retail client is the only one who pays.

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At many times along the manufacturing process of a final product, VAT is collected. In order for the government to get its money, a tax is collected each time value is added. 2

Example of VAT

The following is an example of how a 10% VAT might be applied in a chain of production:

A merchant sells raw materials made of various metals to a maker of electronic components. Currently, the metals dealer is acting as both the buyer and the seller. There’s a ten-cent VAT added to the manufacturer’s $1 fee. The dealer then submits the ten percent to the government.

For $2 plus a 20 cent VAT, the firm turns the raw materials into electronic components that go into cell phones. 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.

When a phone maker makes its phones, it adds value by charging a phone merchant $3 plus a 30-cent VAT for each one. Taxpayers get a tenth of a cent of the VAT. Cell phone manufacturers get reimbursed for 20 cents of the VAT they paid to electronic components manufacturers.

Final price: $5 plus 50 cents VAT, 20 cents of which goes to the government and the rest goes to the shop as a compensation for past VAT payments.

Ten percent of the value added by the seller is reflected in the VAT paid at each of the sales points.

The VAT in the United Kingdom

The normal VAT in the U.K. has been 20 percent since 2011. 3

The rate is decreased to 5 percent on specific goods such as children’s car seats and home electricity. There is no VAT on various things such as food and children’s clothing. Financial and property transactions also are exempt. 4

Arguments in Favor of VAT

Value-added tax advocates say that a VAT system inhibits tax evasion by businesses and individuals. At each stage of production, VAT is levied (and documented) and serves as a deterrent to operating in the underground market. 2

A manufacturer or supplier can only be reimbursed for the VAT paid on their inputs if they also collect VAT on their outputs.

The only way for retail enterprises to recoup the VAT they paid while purchasing their items wholesale is 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. Surcharges on top of sales taxes are not itemized in the United States. 56

A VAT is perceived as having less of an impact on individual economic decisions than an INCOME TAX because it is paid at the same rate on the majority of goods and services.

Even so, it has the potential to have an impact on the economy. Government deficits can be eliminated and GDP growth accelerated through the implementation of a value-added tax (VAT).

Arguments Against VAT

People with lesser earnings are argued to be unfairly taxed by VAT opponents.

A VAT, unlike a progressive income tax like the one in the United States, is a flat tax: All consumers pay the same proportion regardless of their income.

VAT in the United Kingdom, for example, has a significant impact on the budget of those who earn less money.

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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