The Value Added Tax (VAT): What is it?

The Value Added Tax (VAT) is a system of taxation which has been getting a lot more press in the US lately. VATs are currently in many countries around the world, most notably in Europe.

The VAT is a type of national sales tax which is levied on "value-added" at each stage of production. That means that each different "producer" throughout the chain of manufacture pays the tax at each different stage of production. The tax rate is single and it is a consumption based system.

Daniel J. Mitchell explains it like this:

Consider a piece of furniture: The VAT would be imposed when the raw timber is sold, when the sawmill produces lumber, when the manufacturer builds a chair, a tax at the wholesaler level and then when a retailer sells the chair to a consumer.

In order to avoid double taxation, each seller gets a credit for the taxes paid by the earlier stages of the production process. When the end consumer purchases the product at the retail store, it pays the final tax levy.

Many analysts favor the VAT because it reduces economic distortion in the market-place and is a far more simple system than our current income tax.