Value-Added Tax (VAT) Examples

Updated on May 16, 2022

At every point where value has been added to a product, VAT is levied. Thus, the tax is levied at each stage of the supply chain: when raw materials producers sell raw materials to a manufacturer, when that manufacturer sells its finished product to a wholesaler, and lastly to a retail outlet where the customer can purchase it.

The VAT is ultimately borne by the retail customer. The succeeding customer in the chain reimburses the VAT paid by the buyer at each previous stage of the product’s manufacture. The value-added tax (VAT) is widely utilised throughout Europe. The United States does not have a VAT. 1

There are many ways to express the value added tax (VAT). Consumers must pay the merchant $115 if a product costs $100 and a 15% VAT applies. To the government, the merchant remits $15 of the $100 they received.

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KEY TAKEAWAYS

From the sale of raw materials through the ultimate purchase by a consumer, a product’s value-added tax (VAT) is paid at every stage of manufacturing.
In order to pay back the prior customer, a separate evaluation is made for each item on the chain. 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.
Those in favour claim that by making a record of all taxes paid on each item, it deters tax evasion of all kinds.

VAT vs. Sales Tax

A national sales tax and a VAT system are frequently conflated in the public’s mind. However, a consumer’s final site of purchase is where a sales tax is collected only once. Only the retail buyer is responsible for paying this fee.

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At many times along the manufacturing process of a final product, VAT is collected. A sale is made and a tax is collected and sent to the government each time value is added. 2

Example of VAT

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

A merchant sells raw materials made of various metals to a maker of electronic components. When it comes to metals, the dealer is the seller. For every dollar that the manufacturer pays to the dealer, the dealer adds a tenth of a penny in VAT.

When the raw materials are sold to a cell phone manufacturer, the manufacturer utilises them to make electrical components, which it then sells for $2 plus a 20-cent VAT. 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.

For $3 plus a 30-cent VAT, the cell phone producer makes its mobile phones and sells them to a cell phone shop. Taxpayers get a tenth of a cent of the VAT. In addition, the cell phone manufacturer receives 20 cents back in VAT reimbursement from the electronic component manufacturer.

Customers pay $5 + VAT, of which retailers keep 20 cents as compensation for the VAT they previously paid. The other 50 cents are then given to consumers as a discount on their next purchase.

The seller’s worth is represented by the VAT paid at each sale point along the way, which is 10% of the total value.

The VAT in the United Kingdom

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

Certain items, such as children’s car seats and home energy, are eligible for a 5% discount. 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 say that a VAT system inhibits tax evasion by businesses and individuals. Having to pay VAT at each level of manufacturing encourages tax compliance while discouraging black market activity. 2

The outgoings of manufacturers and suppliers must be taxed in order for them to receive credit for paying VAT on their input costs.

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.

Better Than a Hidden Tax

A VAT is also preferable than so-called hidden taxes, in some respects. 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. 56

An income tax is seen to have a greater impact on individual economic decisions than a VAT because it is charged at the same rate on so many different goods and services.

Still, it might have an impact on the economic of a country. 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.

For example, in the United Kingdom, where VAT is now set at 20%, those with lower incomes are disproportionately affected.

Most nations that have VAT, notably Canada and the United Kingdom, offer exemptions or discounts on necessities like children’s clothing and groceries in an effort to lessen this income gap.