Value-Added Tax
Value-added tax (VAT) is a consumption tax levied on the value added to a good or service at each stage of production and distribution. It is collected by businesses on behalf of the government and is ultimately borne by the final consumer. VAT is a major source of revenue in many countries and is known as a goods and services tax (GST) in some jurisdictions, including Australia, Canada, and India.[1]
Definition and mechanism
VAT is charged at each stage of the production chain on the value that a business adds to its inputs. Businesses charge VAT on their sales and reclaim VAT paid on their purchases, remitting only the net difference to the tax authority. This mechanism ensures that the tax is applied to the full value of the final product without being levied repeatedly on the same value.[1]
Types of rate structure
| Structure | Description |
|---|---|
| Single rate | One standard rate applies to most goods and services. |
| Multiple rates | A standard rate plus reduced rates for essentials such as food and medicine. |
| Zero rate | A rate of zero, with input VAT still reclaimable, often applied to exports and some essentials. |
| Exempt | Some goods or services are exempt, so no VAT is charged and input VAT is not reclaimable. |
Economic effects
VAT is a broad-based consumption tax and is generally regarded as economically efficient because it does not distort the choice between saving and consumption. However, it is often criticised as regressive—that is, it takes a larger share of the income of poorer households—although reduced rates and exemptions are often used to mitigate this effect. Because it is levied on consumption, VAT is usually considered to have a smaller effect on incentives to work and invest than taxes on income.[1]