Saturday, May 8, 2010

Value-Added Tax

by Richard Crews
A Value-Added Tax (VAT) consists essentially of putting a tax on each stage of a production and distribution chain. For example, if a company digs something out of the ground and delivers it to a factory, the company is charged a tax (commonly a few percent) on its profit. Then the factory makes the raw material into some product and sells that to a distributor, and the factory pays a tax on its profit. Similarly, the distributor pays a tax on its profit. And finally, the retail outlets. So at each stage along the chain, the company that handles and processes and manufactures and distributes and finally sells something, pays a tax based on how much value the company added, that is, how much the overall price increased in its hands. Providers of services (such as accounting, legal, and medical) are also taxed according to their "value," that is, their fees minus their costs.

Although the VAT is not familiar to many Americans, it is widely used as a major source of government revenue throughout the industrialized world. Of the world's largest economies, the U.S. alone does not have a VAT. Within the European Union (E.U.) the largest economies have VATs (Germany, France, U.K., Italy, Spain, etc.). Outside the EU the countries with large national economies have VATs (Japan, China, Brazil, India, Russia, etc.). Our neighbors on the North American Continent, Canada and Mexico, both have VATs.

The U.S. government gets most of its revenue from Income Taxes and Social Insurance Taxes (Social Security and Medicare). In addition, some federal income is based on the value of real estate, personal property, and inheritance, plus some tariffs, fees, etc.

The VAT can be an enormous contributor to a country's income. For example, France (the historic home of the VAT) gets 50% of its national revenue from a VAT.

A VAT has some important advantages.

(1) Most of the costs of collecting the tax are borne by businesses rather than by the government.

(2) High sales taxes and tariffs encourage cheating and smuggling; a VAT does not.

(3) Most significantly, a VAT is more "hidden" from view than an income or sales tax, or payroll deductions. A VAT is therefore less likely to become a hot political issue.

The principle argument that has been leveled against a VAT is that it tends to fall most heavily on lower and middle income groups since they do most of the end-use consuming. A comparison with other common forms of taxation (income, payroll, sales, etc.) renders this argument moot.