What Is a “Value-Added Tax,” Anyway?

Marla Walters — Sat, 24 Oct 2009 15:00:01 +0000

I’m sure many of you have already heard of a value-added tax, or VAT. Some of you may even be, or have been, subject to it (around 130 countries currently utilize this type of tax). It appears to be an idea that is being kicked around by some U.S. elected officials.

Why is it even being discussed? This idea came up during the Clinton administration, but failed to gain favor. However, the United States national debt is presently at about $11.4 trillion dollars. Somehow, that needs to be whittled down, and this is one of the proposals supposedly still on the table.

What is a VAT?

Briefly, it is a tax levied on goods and services at each stage of production and distribution.

The following is an example based upon the VAT in effect in the European Union, members of which levy a minimum of 15% VAT. Please pardon it for being horrifically simplistic. My intention is to simply bring the concept to your attention, in case you want to further investigate and send a “yea” or a “nay” to your elected representatives.

My husband and I need a new toaster. Ours is missing the finger pad, so to pop the toast down, we push down on a sharp piece of metal. The toast, when done, is also sometimes propelled completely out of the toaster. I’m tired of looking for my toast. So let’s say we decide to buy a new one.

Our future toaster is manufactured by Tasty Toast of Decatur, Illinois (not really, but play along). Tasty Toast purchases its raw materials for one toaster, specifically stainless steel, from SuperSteel, Inc., for $5, plus a 20% VAT, of $1. SuperSteel is responsible to remit that dollar of VAT to the Treasury. Tasty Toast also needs other parts, which it obtains from Toaster Parts, Inc., for another $5, plus a 20% VAT, of $1. Toaster Parts, Inc., is responsible to remit that dollar to the Treasury. Tasty Toast then sells that toaster to GiantMart for $20. Tasty Toast actually collects $24 from GiantMart, to include the 20% VAT on the entire wholesale value of the toaster. However, Tasty Toast is now responsible to remit only $2 to the Treasury — the $4 it charged to GiantMart, less the dollar it paid to SuperSteel, and less the dollar it paid to Toaster Parts, Inc.

My husband and I then buy the toaster from GiantMart for $30, plus a VAT of $6. As you probably guessed, GiantMart is then responsible to remit only $2 to the Treasury — the $6 it collected from us, less the $4 it paid to Tasty Toast. So, on a product with a final retail value of $30, the Treasury has collected $6 — one dollar from SuperSteel, one dollar from Toaster Parts, Inc., two dollars from Tasty Toast, and two dollars from GiantMart. As you can also see, we, the consumers, have paid the entire $6. In Hungary, the VAT rate is currently 20%. Our toaster would cost $36. It would be cheaper to go buy it in Luxembourg, where the tax is at 15%.

Not reflected in my example is an important point, omitted to keep it simple. In addition to deducting the VAT they have paid for raw materials, registered businesses also get to deduct VAT they have paid on operating costs, overhead, etc., in the process of adding value to a product or service. So, for example, if they buy a new file cabinet, the VAT they pay on that purchase is also deductible from the total they remit to the Treasury.

What are the pros of a VAT?

Well, depending on what goods and services are taxed, and the rate at which they are taxed, vast sums could be collected and applied to the debt, or to wherever elected officials deem additional funding is needed: healthcare, Social Security, etc. The possibilities are numerous.

Another likely result of the imposition of a VAT is that a short-term economic stimulus would occur. For instance, if you knew you were going to need a new refrigerator soon, or wanted to have a living trust drawn up anyway, you might rush to do so before a value-added tax were implemented. This would result in a one-time boost in the sales of goods and services.

What are the cons?

Well, it is a tax. Opponents also point out the added burden to the poor. Someone who does not earn enough to have to pay income taxes would still have to pay value-added taxes on their taxable purchases. Everyone needs some type of goods, and as a percentage of their income and wealth, consumption is greater for the poor. Opponents also argue that, in countries that have implemented a VAT, government growth is greater than it is in countries without a VAT. To those who believe in a limited government, this is considered a disadvantage.

It doesn’t appear that, if implemented, a U.S. VAT would replace our income tax system. It appears at this point that it would just be an additional tax.

It’s an important concept to understand, for those of us who strive to monitor our money, and where and how it is spent. And, remember; only two things in life are certain.

This article is from Marla Walters of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

vat

What Is a “Value-Added Tax,” Anyway?

What is a VAT?

What are the pros of a VAT?

What are the cons?