What is Value-Added Tax (VAT)?

Value Added Tax (VAT) is a tax levied on goods and services at each stage of the supply chain.

Value Added Tax (VAT) is a consumption tax levied on goods and services at each stage of the supply chain where value is added, from initial production to the point of sale. The amount of tax paid by the user is based on the cost of the product minus any materials costs that have already been taxed at a previous stage.

In contrast to a progressive income tax, which raises taxes on the wealthy, value added tax is levied uniformly on all purchases. It’s most common in the European Union (EU). However, it is not without controversy.

It’s supporters argue that it increases government revenue without charging wealthy taxpayers more, as income taxes do. It is also thought to be simpler and more standardized than traditional sales taxes, with fewer compliance issues.

VAT, according to critics, is essentially a regressive tax that imposes an undue economic burden on lower-income consumers while increasing the bureaucratic burden on businesses. Both opponents and supporters of the same, argue that it is an alternative to income tax.

Why was VAT introduced?

The primary goal of instituting VAT was to eliminate double taxation and the cascading effect of the then-existing sales tax structure. A cascading effect occurs when a product is taxed at each stage of its sale. Because the tax is levied on a value that includes tax paid by the previous buyer, the consumer ends up paying tax on tax that has already been paid.

The VAT system does not allow for exemptions. Taxing at every stage of the manufacturing process ensures better compliance and fewer loopholes to exploit.