Economics

What Is A Value-Added Tax (VAT)?

VATs are imposed in increments at each stage of the development, production, and/or use of a good or service where monetary value is added.

Value added tax (VAT) is also known as goods and services tax in some countries. It ha been defined as a tax on the amount by which the value of a product has bee increased in each stage of production. On average, VATs raise around 20% of the total revenue in an economy.

History of VAT Taxes

The history of value added taxation (VAT) can be traced back to England in 1973. Before that, the British government used to have a consumption tax known as the purchase tax which they levied at different rates. Luxury products attracted the highest rates while the essential products attracted very low taxes. In 1973, when the United Kingdom joined the European Economic Community, the government replaced the purchase tax with VAT to fit into the European trading bloc. The VAT rate ha increased from 8% in 1974 to the current 22.5%. Under the current European Union (EU) laws, the standard VAT rate cannot be lower than 15%, but a state can have up to two goods with reduced rates of up to 5%.

Relevant Application

A value added tax is an incremental tax charged only on the value added from one transaction to the next, and not the entire cost. It is an indirect tax because the final consumer is the one who bears its burden, but it is charged at different production stages. There are two methods used in charging VAT. Namely, these are the invoice-based method and the accounts-based method. In the invoice-based method, the customer is informed of the VAT on the transaction. Using the accounts-based method, the business will calculate the taxable sales and subtracts all the taxable purchases and VAT is then applied to the difference. All countries in the world use the invoice based method apart from Japan which uses the accounts based method.

Evolution Over Time

Value added taxes have changed with time from being just a tool of earning government revenue into having more complex applications. One of these is trying to bridge the gap between the haves and the have not’s. This is done by having a higher tax rate for luxury goods that are non-essential and are mainly used by the by wealthy and lower tax rates on basic products. In other areas, the tax is used to discourage the use of certain products. For example, in most African countries including Kenya and Nigeria, the government has put in place very high VAT on alcoholic drinks.

Praises and Criticisms

Proponents of value added taxes have argued that trade liberalization has led to many economies losing income that was initially derived in the form of tariffs. As such, VAT has come in handy to replace the lost tariffs. However, the tax system has been criticized for passing the tax burden to the final consumer. Customers who earn low incomes use a higher proportion of their salaries to purchase goods and services, and hence this burden hits them hardest. The revenues from VAT are also lower than expected due to collection cost and avoidance. In an attempt to avoid VAT, small businesses opt to conduct their business using cash, and this has encouraged the use of cash in trade.

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