What is value added tax? What is the difference between VAT and sales tax?

What is Value-Added Tax (VAT)?

Value-Added Tax (VAT) is a consumption tax levied at each stage of the supply chain where value is added to goods and services. It is applied from the initial production of goods and services to the point of sale. The tax is based on the value added at each stage, which includes labor costs, profits, and other expenses. VAT is widely used in over 170 countries, including all European Union member states, but not in the United States135.

Difference Between VAT and Sales Tax

1. Collection Point

• VAT: Collected at each stage of the supply chain, including production, distribution, and retail. Businesses pay VAT on their purchases and can claim back the VAT paid on inputs when they sell their products125.
• Sales Tax: Collected only once at the final point of sale to the consumer. It is typically levied by state governments in the U.S. and varies by state24.

2. Tax Burden

• VAT: Although VAT is collected at multiple stages, the economic burden ultimately falls on the final consumer. Businesses can offset the VAT they pay on inputs against the VAT they collect on sales45.
• Sales Tax: The tax burden is directly on the final consumer, as businesses do not pay sales tax on their purchases if they provide a resale certificate4.

3. Tax Rates

• VAT: Often has a single rate across a country, though some countries may have multiple rates for different goods and services2.
• Sales Tax: Rates vary significantly by state in the U.S. and can also depend on the type of goods or services being sold2.

4. Revenue Collection

• VAT: Governments receive revenue throughout the supply chain, making it a more consistent source of income45.
• Sales Tax: Revenue is collected only at the point of final sale, which can lead to variability in government income4.

In summary, while both VAT and sales tax are consumption taxes, VAT is collected at multiple stages of production and distribution, whereas sales tax is collected only at the final sale to the consumer.