The Benefits and Drawbacks of a Value Added Tax (VAT)

••• stocknshares/Getty Images

A VAT tax, or Value Added Tax, is a taxing method that has been used throughout the world since the 1950s. The principle behind the VAT tax is that a tax is imposed on the buyer all the way up the supply chain of a product from the initial purchase of raw materials through to the retail consumer of the product. It also applies to the sale of services. 

As the Wall Street Journal puts it, the VAT tax is "baked into the retail price."

All European Union countries and many other countries around the world have a VAT or GST. The EU describes a VAT as:

  • A general tax that applies, in principle, to all commercial activities involving the production and distribution of goods and the provision of services.
  • A consumption tax because it is borne ultimately by the final consumer. It is not a charge on businesses.

VAT Tax and Out-of-Country Tourists

The exception to the consumers paying the VAT tax is that if the consumers are not a resident of the country, they can apply for a refund of the VAT tax they paid. Of course, many tourists forget to claim this refund, with the result that the money goes to the nation's revenue department. 

Here's an example of how a VAT tax works for out-of-country consumers: In Ireland, the VAT tax rate is 23%. But visitors from non-European Union countries can claim a refund from this tax if the refund is filed (with detailed receipts) within 3 months.

VAT Tax vs. Sales Tax

A sales tax is imposed only on the consumer at the end of the line. The consumer cannot apply for a refund. The VAT and sales tax are similar in the respect that the businesses can have a  sales tax exemption from paying sales tax on products they ultimately end up selling to a consumer.

Should the U.S. Have a VAT Tax?

A possible way to fund the largest deficit in U.S. history is a value added (VAT), also called a national sales tax. Here is a summary of the arguments for and against a VAT tax in the U.S.

Benefits of a VAT for the U.S.

  • A VAT would eliminate (so advocates assert) the labyrinthine U.S. income tax system, since the VAT is so much more efficient and would bring in more revenue.
  • A VAT would also solve the problem of lost online sales taxes since the imposition of a VAT would mean that all sales, even online sales, would be taxed.
  • A VAT would provide additional income to reduce the deficit and fund critical programs like health care for every American.

VAT Drawbacks/Problems

  • VAT's are hugely regressive, with the cost falling mostly on the poor.
  • It will be difficult, if not impossible, to eliminate the IRS and the income tax system in the U.S., so the VAT will be just another tax imposed on the American people.
  • If the VAT replaces state sales taxes, the states will raise a fuss. The state sales tax system is extremely complex, with some states not charging state sales tax and others taxing at different rates, including local option taxes charged by cities and counties. Eliminating this mess could take many years.
  • VAT calculations would be terribly costly to businesses, which would have to calculate VAT on every product, at every step of the process. These costs, of course, would be passed on to consumers, along with the VAT rates.
  • Financial advisers working on a project

    3 Examples of How Indirect Taxes Affect Consumers

  • Internet Sales Tax - Who Pays and Why

    Who Must Pay Internet Sales Tax? What Is the Law?

  • Sales Tax on Products and Services

    What Products and Services are Subject to Sales Tax?

  • How to Register to Collect Sales Taxes

    How to Get a Seller's Permit to Collect Sales Tax in Your State

  • a handing holding up a folder marked

    States That Impose a Gross Receipts Taxes and How They Do It

  • Business Licenses

    How to Get a Home Business License

  • Use Tax Explained

    Clearing Up the Confusion About Use Taxes

  • Couple at an arbitration meeting across table from an arbitrator

    What Are the Benefits and Drawbacks of Arbitration?

  • Man sitting on chair throwing money in the air

    Can Your Small Business Get a Tax Refund?

  • Retail Sales Tax Process for Businesses

    How to Pay State Sales Taxes in 8 Steps

  • Tax Nexus for Income and Sales Taxes

    How is Tax Nexus Determined for Sales Tax and Income Tax

  • Woman trying on shoes in store

    What You Need to Know About Charging HST in Ontario

  • Man Calculating the S-Corporation Income Taxes

    How an S-Corporation Pays Taxes and Avoids Double Taxation Problems

  • What's the difference between tax avoidance and tax evasion?

  • Many Currency

    How to Report Foreign Business Income on Your Canadian Tax Return

  • How Much Tax Does a Small Business Pay?

    All the Taxes Your Business Must Pay