A value-added tax (VAT) or goods and services tax (GST) is a popular way of implementing a consumption tax in Europe, Japan, and many other countries. It differs from the sales tax in that taxes are applied to the difference between the seller-purchased price and the resale price. This is accomplished by taking full tax on all sales, but refunding the tax difference to the sellers
The VAT is an alternative to a sales tax meant to deal with a specific problem.
With a sales tax, a business selling goods is responsible to make a subjective decision about the intent of the buyer, one which it may not be fully competent to make. If buyers intend to consume the goods themselves, then the seller must collect a tax on the purchase price. If instead buyers intend the goods as capital goods, to be resold at a profit after adding value to them, then the seller must not collect the tax. Sellers thus have an incentive to claim that a sale is non-taxable, in order to please customers, creating an incentive to under-collect taxes.
The refund portion of a VAT removes that incentive, and incentivizes accurate collection. If the buyer is a businessperson, then the VAT is a temporary payment to the state, based on the purchase price, eventually to be reimbursed by the state for the initial payment when the goods are resold, usually after adding value to them. Hence collecting the tax is a way to get money back. Consumers, with no possible refund, have no reason to inaccurately report their intended use.
The term "value added" refers to the sale price a business charges the customer for a product, minus the cost of materials and other taxable inputs. A VAT is like a sales tax in that ultimately only the end consumer is taxed. It differs from the sales tax in that with the sales tax, the tax is collected and remitted to the government only once, at the point of purchase by the end consumer. With the VAT, on the other hand, collections, remittances to the government, and credits for taxes that are already paid occur each time a business in the supply chain purchases products.
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