Accounting terms

Dictionary of all accounting terms

What is a Value-Added Tax (VAT)?

A value-added tax (VAT) is a type of tax in which the tax is applied to a product whenever any value is added, including in the product's production and final stage.

VAT is used in 160 countries around the world and is preferred over the sales tax. The US is notably the only Organization for Economic Co-operation and Development (OECD) member that does not use the VAT system.

VAT allows the end user to only pay the cost of the product minus any of the materials costs that have already been taxed by the time it gets to the consumer.

For example, if a company creates a pair of shoes in a VAT region, the manufacturer is charged VAT for all the supplies and materials used to produce the shoes. By the time the pair of shoes reaches the consumer, he or she must pay the applicable VAT.

VAT is used worldwide as a way to tax the consumption of goods and not the taxpayer's income. It helps increase government revenues by collecting tax on all goods, online and offline, and stops businesses from evading their taxes.

The debate in the US for switching to a VAT system states, on the positive side, that it would increase government revenues, reduce the federal deficit and help fund social service programs.

Opponents, on the other hand, state that because the VAT is applied equally to everyone, high-income families would benefit the most. Low-income families, however, who tend to live paycheck-to-paycheck, would spend much more on taxes with a VAT system.

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