Value-Added Tax (VAT) Examples

Updated on June 21, 2022

Each time value is added to a product, the consumer is subject to a consumption tax known as value-added tax (VAT).

At each level of supply chain, a tax is levied: when raw materials producers sell their products to manufacturers, when those products are sold to wholesalers, and finally, when the products are sold to retailers.

The retail customer is ultimately responsible for paying VAT.

Throughout the manufacturing process, each subsequent buyer reimburses the previous buyer for the VAT that was paid by the previous buyer.

VAT is a common practice in several European countries. VAT is not in place in the United States. 1

V.A.T. can be expressed in many different ways (VAT). If a product costs $100 and VAT is 15%, customers must pay the seller $115.

The entrepreneur keeps $90 and pays $15 in taxes to the Internal Revenue Service.

KEY TAKEAWAYS

At each step of the production process, VAT is collected and documented.
For each evaluation, a previous purchaser in the buyer’s chain receives a payment in kind.

Taxes levied on purchases are the responsibility of the final consumer.

Because lower-income consumers pay a bigger percentage of their incomes in VAT, the gap between the rich and the poor widens.
Supporters say it helps fight tax avoidance because it gives an audit trail for each transaction.

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VAT vs. Sales Tax

As a result, many people mistakenly believe that VATs are national sales taxes. Sales tax, on the other hand, is collected at the point of purchase by the end user exclusively. So, the retail client is the only one who pays.

At many times along the manufacturing process of a final product, VAT is collected. Adding value generates sales, which in turn generate tax revenue, which is transferred to the government. 2

Example of VAT

As an illustration of how a 10% VAT could be imposed, consider the following scenario:

The metals needed for electronic components can be bought from an electronic components merchant.

At this point in the industrial cycle, the metals dealer is the seller. The dealer charges a 10% VAT (Value Added Tax) on every dollar billed to the manufacturer (Value Added Tax).

Manufacturers of cell phones buy electronic components from the manufacturer for $2 plus a 20-cent VAT, which the manufacturer uses to build electronic components for the phones. By returning one tenth of a cent for every dollar collected in VAT, the company is reimbursing the metal trader for the tax he has already paid.

For each phone produced by a phone manufacturer, the phone merchant is charged $3 plus a 30-cent VAT. 10% of VAT is paid by the tax payers. Cell phone manufacturers receive a refund of twenty cents of the VAT paid by electronic component producers.

To get a phone, you have to pay $5 plus a 50-cent VAT, of which the government gets 20 cents and you get your money back for the VAT you already paid.

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Value added by the seller is reflected in the amount of VAT paid at each sale.

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. Financial and real-estate transactions are not included under this definition. 4

Arguments in Favor of VAT

Value-added tax advocates claim that a VAT system deters tax evasion. Having to pay VAT at each level of manufacturing encourages tax compliance while discouraging black market activity. 2

Manufacturers and suppliers must collect VAT on their outputs, the things they generate or sell, in order to be credited for VAT they paid on their inputs.

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

Additionally, a VAT is better than so-called “hidden taxes,” according to others. People don’t often know about these levies, such as taxes on gasoline and alcoholic beverages. These are additional costs on top of sales taxes in the United States, although they are not disclosed to customers. 56

A VAT has 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. It is widely accepted that a VAT is a good approach to boost GDP growth, enhance tax collections, and eliminate government budget deficits in countries.

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Arguments Against VAT

Some feel that VAT is disproportionately taxed on low-income families.

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.

For example, in the United Kingdom, where VAT is now set at 20%, those with lower incomes are clearly hit harder by this tax.

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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