VALUE-ADDED TAX (VAT)



A value-added tax (VAT) is a tax levied on the value added to goods or services produced by businesses. Such a tax is collected in stages from each business that contributes to the final market value of goods and services. While VAT is paid by businesses, the actual tax burden is typically passed along to consumers. While sales tax is easily perceived by consumers, VAT is generally considered invisible to consumers because retailers add little value to the goods they sell, so there is little or no VAT charged to retailers. By the time goods reach the retail level, the VAT that has been charged along the way to companies in the manufacturing and distribution sectors has been incorporated into the selling price.

The concept of "value added" in manufacturing is used to measure the productive activity of a business. The tax base on which VAT is calculated is the difference between the selling price of a firm's output and the purchase price for intermediate products. That difference is known as the value added by the firm. Value added consists of productive activity, such as labor done by workers and manufacturing operations performed by machines.

In countries that have a VAT, such as Canada and member states of the European Union, the tax generally affects goods bought and sold within the country as well as imports into the country, while exports from the country receive a credit on the VATs that have been paid or assessed. Goods that are exempt from the VAT are said to be zero-rated. In addition to exports, goods that may be zero-rated typically include food and other necessities. Countries may also charge a "luxury" rate on certain goods that is higher than their standard VAT.

In the EU, each country has a different VAT rate. Thus far, there has been little or no progress made on standardizing the different rates among the member countries, especially in terms of trade between member countries. As of 1992-93, the standard VAT rates varied from a low of 15 percent charged in Germany, Luxembourg, and Spain, to high rates of 21 percent in Ireland and 25 percent in Denmark. The United Kingdom was charging businesses a 17.5 percent VAT. In 1997-98 the European Commission took the lead in proposing a common system of VAT within the EU.

Canada adopted a national VAT in 1991, called the federal goods and services tax (GST). It replaced the federal manufacturers' sales tax, which was based on the total resale value of a manufacturer's goods, not just the value added. The Canadian GST is imposed on every recipient of a taxable good or service made in Canada, with the vendor being responsible for collecting the tax and paying the government. A GST taxable good or service is considered made in Canada only if it is delivered or made available to the recipient in Canada; if delivered outside of Canada, then no GST is applied. In at least one Canadian court case, mail-order goods shipped from New York into Canada were ruled subject to the GST.

The United States considered adding a VAT in the early 1980s as part of a general tax reform, and proposals to introduce a VAT resurfaced in the late 1990s. It was argued that a VAT would result in balance-of-payments stability in international trade and that it would provide the government with enough revenue to reduce income taxes. The United States did not adopt a VAT, however, in part because it is considered a regressive tax that places a proportionally larger tax burden on lower-income consumers.

[ David P. Bianco ]

FURTHER READING:

David, Irene, and Alison Pavlin. "Professional Taxing." CA Magazine, June/July 1998, 34-35.

Gale, William G. "What Can America Learn from the British Tax System?" National Tax Journal, December 1997, 753-77.

Seaton, Peter. "Westminster, VAT Are You Playing At?" Accountancy, March 1998, 65.

Zink, Bill. "The Long Arm of the Canadian Goods and Services Tax." Tax Adviser, February 1998, 82.



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