Value-added tax (VAT)
Value-added tax (VAT) is a consumption tax levied on the value added to goods and services at each stage of production and distribution. Used by over 100 countries, VAT is a significant source of revenue for governments, contributing to public spending. Proponents argue that VAT is equitable, as it is linked to consumption, meaning those with higher disposable incomes pay more due to their purchasing habits. However, critics highlight that lower-income individuals may bear a disproportionate tax burden, as they tend to spend a larger share of their income on consumption compared to wealthier households.
In the United States, the tax system primarily relies on sales tax rather than VAT, with sales tax applied only at the final sale. Countries like the UK have established specific VAT rates, with a standard rate and reduced rates for certain essential items, contributing significantly to government revenue. Recent legislation in the European Union has also altered how VAT applies to digital products, requiring compliance from businesses selling to EU customers. Overall, while VAT is seen as a means to stabilize government revenues, concerns about implementation costs and potential inflation persist in discussions regarding its adoption in different jurisdictions.
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Value-added tax (VAT)
The term VAT refers to a tax based on the value of goods and services. More than 170 countries have a form of value-added taxation (VAT), which makes it one of the most important taxes in use. Value-added taxes, which are collected by businesses on behalf of the taxing authorities, are a source of public spending and generate a significant amount of money for governments. Proponents say VAT is a fair system because it is tied to the sale of goods and services. The theory is those with disposable income buy more and, therefore, pay more VAT. Critics of VAT say those with lower incomes would remain disadvantaged and actually pay more taxes because higher-income households spend less of their total wealth on consumption. In the United States, most goods sold are subject to sales tax instead of VAT. Unlike VAT, which is a form of indirect tax that is imposed at different stages of production on goods and services, US sales taxes are levied as a percent of the final sale price of goods purchased, and rates are determined at the state level.
Background
In the United Kingdom, VAT rates are set by the Chancellor of the Exchequer. For many years the UK VAT remained at 17.5 percent; however, in 2009, it was temporarily dropped to 15 percent. The drop was an attempt to stimulate the economy by reducing the cost of purchases. In 2009, VAT accounted for £78,439 million, nearly 18 percent of the government’s annual receipts. The only taxes bringing in more money for the UK government were the National Insurance Contributions (at 22 percent and £96,882 million) and the income tax (at 34 percent and £147,856 million). After returning to 17.5 percent in 2010, UK VAT increased to 20 percent in 2011.
There are three VAT rates in the UK: The standard rate of 20 percent applies to most goods and services. Certain items, such as electricity for the home and children’s car seats, receive a reduced rate of 5 percent. There is zero VAT on specific items, including books, magazines, and newspapers; public transportation fees; food items and groceries; children's clothing and shoes; women’s sanitary protection, such as tampons and pads; and certain medical items.
Each European Union (EU) country has its own VAT rate ranging from 27 to 15 percent. Legislation was enacted on January 1, 2015, requiring that the EU VAT be charged in the country where digital products (digital downloads, online courses, and e-books) are purchased. The previous law stated that VAT must be charged only where a product is sold. In practical terms, this means that if someone who owns a small business sells a digital item to someone in the EU, they will have to pay VAT in that country. They will also have to register for VAT in that country to comply. In addition, in the UK, the business must submit a single calendar quarterly return, or VAT payment. The new law resulted in protests by many small businesses, who say they may stop doing business in Europe.
In the late 2010s and into the 2020s, the rate of VAT fraud in the EU rose drastically, with member states losing an estimated €61 billion to fraud in 2021. To limit VAT fraud in the modern era, the European Commission tendered the VAT in the Digital Age (“ViDA”) proposal in 2022. This proposal involved changes to digital invoicing, a merger toward a single EU VAT registration, and changes to the platform economy. These changes were set to be implemented over time, with single VAT registration plans taking effect in January 2025.
Overview
Proponents of VAT say the biggest benefit is that the system encourages a healthy economy through personal savings and investment by taxing only consumption. In comparison, US federal taxes are paid twice: once when income and other taxes are withdrawn from one’s paycheck and a second time when taxes are paid on earned interest from capital gains (investments). In addition, the US tax system encourages the use of debt financing because some interest accrued is tax deductible.
Another perceived benefit of VAT is the continuous flow of revenue. Those who support VAT believe it creates more financial stability than the US system of taxation, where economic changes impact government revenues. In addition, VAT is a consumption tax, and proponents believe it would motivate US consumers to save their income while reducing tax advantages enjoyed only by the wealthiest citizens. However, critics fear implementing VAT in the United States would cause inflation. They also point out the enormous cost required to implement a US VAT. There are concerns that state funding would be reduced and that there could be a net loss in revenue for some cities and states.
Bibliography
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