What Is a Value-Added Tax (VAT)?

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on January 11, 2021

VAT Definition

A value-add tax is a tax charged on the gross profit of every step in the supply chain.  

It’s best understood using an example:

The country of Decivat has a 10% value added tax. 

A flour manufacturer will buy $1,000 worth of grain from a farmer for $1,100, $100 of which will go to the government as VAT, to create flour.

If the manufacturer sells the flour to a baker for $1,500, he will charge $1,550 since a 10% VAT is imposed on the gross profit of $500. 

A value-added tax is the most common form of consumption tax for industrialized countries with over 160 countries levying a VAT, excluding the United States. 

VAT Advantages

Advocates of the tax claim the following:

  • It helps raise government revenues without punishing wealth or success (like income tax)
  • Replacing other taxes with a VAT would close tax loopholes
  • It is based on consumption and therefore encourages saving

VAT Drawbacks

Those against a VAT argue the following:

  • A VAT would be felt less by the wealthy as lower-income earners would pay a higher percentage of their earnings in taxes with a VAT system
  • A VAT creates higher costs for businesses
  • Local governments are unable to set localized tax rates

What Is a Value-Added Tax (VAT) FAQs

VAT stands for Value-Added Tax.
A value-add tax is a tax charged on the gross profit of every step in the supply chain.
Advocates of the VAT claim that it helps raise government revenues without punishing wealth or success, replacing other taxes with a VAT would close tax loopholes, and it is based on consumption and therefore encourages saving.
Those against a VAT argue that a VAT would be felt less by the wealthy as lower-income earners would pay a higher percentage of their earnings in taxes with a VAT system, a VAT creates higher costs for businesses, and local governments are unable to set localized tax rates.