value-added tax

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Value-added tax

Tax added onto a product during each step of production, from raw material to finished good.

Value-Added Tax

A tax levied at each stage in the production of a good or service that results in value being added to the product. For example, a timber company pays a percentage on the timber it sells to a miller. The miller then pays the same percentage (less what the timber company paid) on the timber it has refined into planks of wood, which it then sells to a carpenter. The carpenter likewise pays the same percentage (less what the timber company and miller paid) on the planks of wood he/she makes into a table, which he/she then sells to a customer. Proponents of a VAT state that each person or company along the supply chain has an incentive to ensure that every other person or company pays the VAT, reducing the likelihood of tax evasion. They also argue that it is more straightforward than other taxes because there are no exemptions or loopholes. Opponents of a VAT counter that the tax is regressive and unduly harms poor people, who, as a rule, spend more of their discretionary income on necessary items.

value-added tax (VAT)

A tax levied on increases in a product's value at each stage of production and distribution. The value-added tax, essentially an invisible sales tax included in the final price, is ultimately paid by consumers. For example, a candy maker paying $10,000 for ingredients used in the manufacture of chocolate bars that are resold for $15,000 would be required to pay a tax on the $5,000 of value added to the product. Proponents of the value-added tax argue that it should be substituted for the current federal income tax to stimulate consumer saving. Compare consumption tax.

value-added tax (VAT)

an INDIRECT TAX imposed by the government on the VALUE ADDED to a good or service. Governments use value-added taxes both as a means of raising revenue (see BUDGET) and as an instrument of FISCAL POLICY.

A value-added tax is based on the difference between the value of the OUTPUT over the value of the INPUTS used to produce that output. The final amount of tax is added on to the selling PRICE of the product and is paid by the buyer.

The ‘mechanics’ of a value-added tax may be illustrated as follows: producer Y sells his output for £10 per unit having spent £8 on inputs. Thus, value added is £2 per unit. If VAT is set at 10%, the selling price of the product is £11 with £1 being the amount of tax paid by the final buyer. Producer Y would then set off against the £1 VAT-output tax collected from the final buyer the 80p VAT-input tax which he has already paid on his £8 of inputs bought, and remit the difference of 20p to the CUSTOMS AND EXCISE. In the same way. supplier X (who has supplied producer Y with his input for £8 per unit) will have collected 80p VAT-output tax from producer Y, against which he will offset any VAT-input tax which he paid on his inputs, and remit the difference to the Customs and Excise. The total of all these sums remitted by firms X, Y etc. to the Customs and Excise will equal the £1 charged on the final sale to the customer.

VAT rates may be applied uniformly at a single rate across the board, or, as in the UK, applied on a discretionary basis. In the UK (as at 2005) there are two VAT rates (a) zero (for example, many food and drink products, books and newspapers, children's shoes); (b) a standard rate of 17.5% on all non zero-rated products and services.

VAT is a cumbersome tax system to operate, involving as it does thousands of ‘tax points’ and related paperwork. It does, however, require all the firms contributing to a taxed product to be involved in the tax collection operation, not just final sellers.

value-added tax (VAT)

an INDIRECT TAX levied by the government on the VALUE ADDED to a good or service. The tax is based on the difference between the value of the output over the value of the inputs used to produce it. The final amount of tax is added on to the selling price of the good and is paid by the buyer. For example, trader B sells output for £100 per unit, the value of his inputs being £80 per unit. Thus, value added is £20 per unit. If VAT is set at 10%, the selling price of the good is £110, with £10 being the amount of tax paid by the final buyer. Trader B would then set off against the £10 VAT output tax that he collected from the final customer the £8 VAT input tax that he paid on his £80 of inputs bought and remit the difference of £2 to the government. In the same way, trader A (who supplied trader B with his input for £80 per unit) would have collected £8 VAT-output tax from trader B, against which he will offset any VAT-input tax that he paid on his inputs and remit the difference to the government. The total of all these sums remitted by traders A, B, etc., to the government will equal the £10 charged on the final sale to the customer.

In the UK, some products are exempted from value-added tax or are zero-rated, while for others VAT is levied at different rates for different groups of product. For example (currently), children's clothing is exempt from VAT while cars bear a 17.5% VAT charge.