VAT vs Sales Tax

Discussion in 'Politics, Religion, Social Issues' started by CalBoy, Nov 25, 2007.

  1. CalBoy macrumors 604


    May 21, 2007
    Ok, I'm going to need some of your more taxation-minded folks to help me out with this. Why exactly is VAT used in so many areas? It seems to be a less efficient form of tax collection as it requires more auditors and more paperwork. Why would governments do this?

    To be sure I'm understanding this right, I'm going to draw out a hypothetical product:

    Widget. Widget is a device that has 3 inputs: supplier of raw materials, producer, and retailer.

    The supplier sells a total of $1 worth of material per widget. VAT at 10% would require the supplier to pay 10 cents on this sold product. Since the supplier doesn't want to lose money, he will sell the raw materials at $1.10 and indicate that 10 cents went towards VAT when he sells it to the producer.

    The producer adds labor and expertise to the raw materials and sells the finished good to a retailer for $5. Because the total value added is $4 (5-1), the producer notes this on his tax records and charges the retailer $5.50 (10% VAT).

    The retailer determines that the widget must be sold at $10. The retailer is sure to note that it expended 50 cents towards VAT, and that it is adding an additional $5 to the value of the product. Thus, when the consumer comes along to buy the product, he will have to pay $11 for the widget including VAT.

    With a flat 10% sales tax, the consumer would pay the exact same amount in taxes, and the government would collect the exact same amount. However, with VAT, more auditors and accountants are needed. Most products require dozens of suppliers and producers; the process is undoubtedly much more time consuming than the one shown here. So, why would a government choose VAT over traditional sales tax?

    I'd really like to hear an explanation, because I'm sure I'm missing something obvious. :)
  2. Desertrat macrumors newbie

    Jul 4, 2003
    Terlingua, Texas
    Two ways to do it: Either cumulative, with the tax continually adding in to the sale price of the steps between raw material source and final buyer; or, VAT only on the actual value added at each step.

    Start with an intitial sale of a dollar's worth. Tax = ten cents. Add, say, four dollars in value to the original dollar. That would make five dollars worth of product and a tax of fifty cents. And so on down the line.

    Or, add four dollars in value and the buyer would pay a VAT only on that amount. If there is another step in the process and the next buyer buys it for $10, he'd pay a VAT on the now-added five dollars. His cost is $10, and he'd pay a VAT of $0.50.

    If it's now retailed at $20, the buyer would pay a VAT of $1.00.

    US retailers generally work pretty hard to not let customers know how much the items cost. Seems to me the VAT lets the cat out of the bag. Interesting...

  3. CalBoy thread starter macrumors 604


    May 21, 2007
    But how many people would actually bother to inspect VAT records to determine the cost of products? I think that even without such information, we can make some fairly general assertions and estimate the cost of most products fairly well.

    As far as I can tell, VAT doesn't really provide any more net income to the government. From a government point of view, a standard sales tax is more efficient. There must be some other reason why European governments favor it so much...
  4. miloblithe macrumors 68020


    Nov 14, 2003
    Washington, DC
    The article on Wikipedia is interesting about VAT. One benefit is that it theoretically is better at avoiding fraud, since it does not solely rely on the final transaction in the chain to collect taxes. It's also not as inefficient as you suggest, since in a sales tax system, non end-users must in some way certify that they are not retailers. There's still plently of paperwork in each system.
  5. CanadaRAM macrumors G5


    Oct 11, 2004
    On the Left Coast - Victoria BC Canada
    Eh, where do you get that VAT (or GST as it is called in Canada) lets the 'cat out of the bag'? The consumer pays a % tax on the final sales price -- that's all they know. It's the same % across the board, the consumer doesn't just pay the final leg increment.

    In Canada, the GST replaced a complex system of federal manufacturer-level taxes, which were hidden. These used to be charged on manufacture or import of the goods.

    From a business' point of view, there are two entries -- GST paid, and GST charged. Each month, the business remits the difference between the two to the Government. Charged - Paid = cheque. On occasion, the paid is higher than the charged, so the business actually gets a refund. This is a boon to businesses that have high startup costs.

    As mentioned, the advantage to the government is that the tax gets paid whenever there is value added to the goods, which roughly corresponds to the economic activity in that time period.
  6. Rodimus Prime macrumors G4

    Rodimus Prime

    Oct 9, 2006
    I might like to point out for a US retailer it kind of hard to include sales tax in the price and still be cost effective.
    Sales tax varies state to state on top of that it can vary from city to city in side a state along with county to county inside a single city. It hard to give out a unform price if the sales tax varies that much. It much easier to say here is the price. Sales tax is not hard to figure out.

    In Texas the state sales tax is 6.25%. Each city can add 1% and each county is allowed to added 15 (providing there is not a metro district in the county already taking the 1%) for a max sales tax of 8.25% in the state of Texas. Now I have seen in Texas 6.25% 7.25% and 8.25% all with in about 5 miles of each other. That is not very easy on a company to do.

    If you are not used to it, it will seem like they are hiding it. But if you think about it sales tax makes it very clear what the item cost and what the government is taking and they can set the same price nation wide.

    It would not be as easy for the US to set one system nation wide because each state has better ways to collect money based on its people. Some will do income tax, others go for property tax and others sales tax heavy. All comes out in the end.

    Also i might like to point out VAT and Sales tax are regressive tax because they tax the poor more than rich. The poor pay a much large share of the cost of government than the rich do.
  7. CalBoy thread starter macrumors 604


    May 21, 2007
    The fraud argument is weak at best. A small increase in the number of government auditors would be able to be more effective at fraud prevention than a more complex tax system. With the way modern products have dozens of suppliers and manufacturers, VAT seems to be needlessly complex .
    So VAT has the potential to tax goods that never make it to the consumer market correct?

    Yes, but most necessities are exempt (at least in CA). Food for example, is rarely taxed. I believe that luxury items (like boats) are taxed at a higher rate than normal consumer goods. However, I do agree that the poorest are usually asked to pay the most of their income towards taxes, and that's not how it should be.
  8. Rodimus Prime macrumors G4

    Rodimus Prime

    Oct 9, 2006
    most states have necessities are exempt, normal that just food and meds. Luxury items that will have to depend on the state. In Texas they are tax the same as everything else (some where between 6.25-8.25)
    There are a lot of items that we need that are taxed. Now they may not be required to live but they are needed to get threw life. That is the big thing I do not like about high sales tax is it is regressive. I do not mind sales and vat until they get very high. Texas's is already at the borderline for me. Heck I already look for ways to avoiding having to pay it.

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