Critics argue that a VAT is essentially a regressive tax that places an undue economic burden on lower-income consumers while increasing the bureaucratic burden on businesses.
Both critics and proponents of a VAT generally argue it as an alternative to an income tax. That is not necessarily the case. Great Britain, for example, has both an income tax and a VAT. A VAT is levied on the gross margin at each point in the process of manufacturing, distributing, and selling an item.
The tax is assessed and collected at each stage. That is different from a sales tax system, in which the tax is assessed and paid only by the consumer at the very end of the supply chain.
Say, for example, a candy called Dulce is manufactured and sold in the imaginary country of Alexia. Here is how the VAT would work:. The United States remains the only notable exception. Most industrial countries with a VAT adopted their systems in the s. Results have been mixed, but VAT countries in general do not enjoy small budget deficits or low government debt.
According to one International Monetary Fund IMF study, any nation that switches to VAT initially feels the negative impact of reduced tax revenues despite greater revenue potential down the road. VAT has earned a negative connotation in some parts of the world, even hurting its proponents politically. In the Philippines, for example, Sen.
Ralph Recto, a chief proponent of VAT in the early s, was voted out of office by the electorate when he ran for reelection. However, in the years that followed its implementation, the population eventually accepted the tax. Recto ended up finding his way back to the Senate, where he became the proponent of an expanded VAT. Industrial nations that have adopted a VAT system have had mixed results, with one study noting that any country making the switch feels an initial negative impact from reduced tax revenues.
VATs and sales taxes can raise roughly the same amount of revenue. The differences lie in the point at which the money is paid and by whom. The VAT differs in that it is paid at different stops along the supply chain; the farmer pays 3 cents, the baker pays 4 cents, and the supermarket pays 3 cents.
However, a VAT offers advantages over a national sales tax. It is much easier to track. The exact tax levied at each step of production is known.
With a sales tax, the entire amount is rendered after the sale, making it difficult to allocate to specific production stages. Additionally, because the VAT only taxes each value addition—not the sale of a product itself—assurance is provided that the same product is not double taxed. There has been much debate in the United States about replacing the current income tax system with a federal VAT. Advocates claim it would increase government revenue, help fund essential social services, and reduce the federal deficit.
A VAT would change the structure of production in the United States, as not all firms will be equally able to absorb the increased input costs. It is unknown if the additional revenue would be used as an excuse to borrow more money—historically proven to be the case in Europe—or reduce taxes in other areas potentially making the VAT budget neutral.
In addition to the fiscal arguments, proponents of a VAT in the United States suggest that replacing the current income tax system with a federal VAT would have other positive effects. Proponents argue that a VAT would not only greatly simplify the complex federal tax code and increase the efficiency of the Internal Revenue Service IRS but also make it much more difficult to avoid paying taxes.
If a VAT supplants U. This change not only confers a stronger incentive to earn; it also encourages saving and discourages frivolous spending at least theoretically.
Opponents note potential drawbacks of a VAT, including increased costs for business owners throughout the chain of production. Because VAT is calculated at every step of the sales process, bookkeeping alone results in a bigger burden for a company, which then passes on the additional cost to the consumer.
It becomes more complex when transactions are not only local but also international. Different countries may have different interpretations on how to calculate the tax. This not only adds another layer to the bureaucracy but also can result in unnecessary transaction delays.
While a VAT system may be simpler to maintain, it is costlier to implement. Tax evasion can continue, and even be widespread, if the general public does not give it wholehearted support. Smaller businesses in particular can evade paying VAT by asking their customers if they require a receipt, adding that the price of the product or service being purchased is lower if no official receipt is issued.
In the United States, a federal VAT could also create conflicts with state and local governments across the country, which currently set their own sales taxes. Critics note that consumers typically wind up paying higher prices with a VAT.
While the VAT theoretically spreads the tax burden on the added value of a good as it moves through the supply chain from raw material to final product, in practice, the increased costs are typically passed along to the consumer.
European Council approval is required for a national government to reduce VAT temporarily in the public interest , as former chancellor Alistair Darling did in Historically, European VAT rates have moved in one direction.
The VAT rate in France is now a head-scratching Anti-tax lobbyists accuse VAT of being a double tax because consumers pay for goods and services from already taxed income. VAT proponents claim it is a progressive tax: individuals who pay the most VAT spend the most on purchases. This line of reasoning is truer of a tax system such as the UK's, where a relatively broad set of exemptions means that poorer people pay a lower proportion of their income in VAT.
Zero-rated VAT applies in the UK on most food with the paradoxical exception of snacks , medicines, books and some forms of transport. Because providers can claim back VAT on what it costs to produce such items, the government effectively offers subsidies to these industries. Former UK exemptions that have been sacrificed on the altar of government need for revenue include takeaway food and home improvements.
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