VALUE ADDED TAX SYSTEM

Value Added Tax System



Value Added Tax System (VAT)

Mechanics of a VAT

A VAT is similar to a retail sales tax in a way that it applies to services and goods. It's basically tax consumption. That it applies to goods and services sold to consumers and, therefore, are a tax on consumption. The two taxes, however, have an important difference. A retail sales tax is collected once on the final sales to consumers, while a VAT is collected at every stage in the distribution and production chain. Also, a VAT may have somewhat less evasion than a retail sales tax because all collection is not concentrated at the retail level (Spilimbergo et al., 2008).

Net VAT revenue collected by the government is generally the distinction between gross tax on sales and gross credits for tax previously paid and may be only a small fraction of the gross cash flows involved (Blundell, 2009).

Types of VATs that could be considered in the United States

There are two types of VATs that are applicable in the United States; the credit method VAT and the subtraction method VAT.

Two types of VATs have been discussed in the United States: the subtraction-method VAT and the credit-method VAT, also known as the credit invoice-method VAT. The Subtraction has attracted much attention, because it's much similar to current income tax. The Credit method has been used in all 150 countries, whereas only Japan uses the subtraction method (Attanasio & Wakefield, 2008).

In Subtraction method VAt (also referred as business activity tax), the tax base for all firms is the receipts of sales of services and goods minus the purchases of services and goods from other business. All businesses sum up their sales receipts, subtract the allowed deductions and file a periodic return (Barrell & Weale, 2009).

In credit method VAT, tax on production or inputs are deducted in a different manner. In Credit method, each firm is taxed on its sales, but it also receives a credit for the tax that is paid by the suppliers on the purchase, as shown in the invoices of suppliers. Business forward taxes on sales and claims refund for the tax that is previously paid. Both the VATs methods collect the same amount of tax overall at all stages of production (Kissire & Kesterson, 2003).

Comparison of a VAT base to the corporate income tax base

There are several important differences between the tax base of a VAT and the corporate income tax that help illustrate from where a VAT derives its potential economic benefits. These points are clearest with a subtraction-method VAT but also apply to a credit-method VAT (Spilimbergo et al., 2008).

First, under a VAT, businesses would not deduct wages or other worker compensation. Unlike under the corporate income tax, employee compensation is included as part of the VAT base and is therefore taxed. Economy-wide, roughly two-thirds of value added is actually workers' wages and other compensation. This is one reason why a VAT is generally thought to be regressive, ...