There are many ways in which taxes are collected by world governments, and the value added tax, or VAT for short, and sales tax represent two very prominent yet opposing methods in that effort. How do these taxes work, and how do they compare to one another? Here’s the rundown on these two rivaling tax systems today.
Value added taxes are taxes that, as their name suggests, are based on the value added to a product or service as it is being created and sold. A good way to view this system is by taking a look to the manufacturing process of a car. As it’s built, the car’s value grows, and as such, VAT assessments are added at each step of value growth and per that value growth. As windows, a computer system, electronics, tires, and more are added to the car, its value climbs, and VAT assessments are there every step of the way to charge for each value-adding step.
Sales Taxes Explained
Very different from VAT systems, sales taxes are simply assessed at the end sale after the product or service has been retailed. In the U.S. for example, one may buy that very same car discussed above, and at the time of sale, that buyer is responsible for the tax duty in the form of sales taxes. In this system, there is no continual process of tax assessment while an item or service is being built or having value added to it.
At first glance, this system may have the reader thinking that the manufacturers and service providers then get off easy. This is not true. As buyers through the product or service-generating process, manufacturers too must pay sales taxes on all items they may need to buy in the name of creating a product to sell. For example, the car manufacturer must buy tires and auto glass from tire and auto glass companies. Each sale of tires or glass to that manufacturer, just like with the simple car-buying consumer, comes with a sales-associated tax. Ultimately, all sales taxes are based on a law-assigned percentage of the price of the items being sold.
VAT vs. Sales Taxes
As there can be much at stake in terms of national economics, government function, and more, these rivaling systems are often compared and contrasted as viable taxation systems across the globe. To that end, the differences between them give plenty to consider in comparison. In a VAT system, a stronger incentive to make money is generally provided across the markets but at the detriment of a much more complex system to administer that often causes the poorest of the population to be levied with the most tax burdens at the end of the day. On the other hand, with sales taxes, the system is much less complicated and fairer to the poor while coming at the unfortunate price of creating higher manufacturing costs and being an “uncertain” government revenue due to ever-fluctuating sales activity.
It can be somewhat confusing to understand varying governments’ tax systems, but these are the basics of how these two rival tax approaches operate. Each system has its associated pros and cons, and each is utilized in different places around the world. For more information on the varying global tax systems such as value added tax and sales tax systems, the Tax Foundation and the International Economic Association represent two of the top resources with which further inquiry is highly recommended.