What Is a Value-Added Tax (VAT)?

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on June 08, 2023

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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

Value-Added Tax (VAT) FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.

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