What are the Benefits and Drawbacks of a Value Added Tax (VAT)?

VAT Tax Benefits and Drawbacks
VAT Tax Benefits and Drawbacks. stocknshares/Getty Images

What is a VAT Tax? 

A VAT tax, or Value Added Tax, is a taxing method that has been used throughout the world since the 1950s. The principle behind the VAT tax is that a tax is imposed on the buyer all the way up the supply chain of a product from the initial purchase of raw materials through to the retail consumer of the product. It also applies to the sale of services. 

As the Wall Street Journal puts it, the VAT tax is "baked into the retail price."

All European Union countries and many other countries around the world have a VAT or GST. The EU describes a VAT as:

  • a general tax that applies, in principle, to all commercial activities involving the production and distribution of goods and the provision of services.
  • a consumption tax because it is borne ultimately by the final consumer. It is not a charge on businesses.

VAT Tax and Out-of-Country Tourists

The exception to the consumers paying the VAT tax is that if the consumers are not a resident of the country, they can apply for a refund of the VAT tax they paid. Of course, many tourists forget to claim this refund, with the result that the money goes to the nation's revenue department. 

Here's an example of how a VAT tax works for out-of-country consumers: In Ireland, the VAT tax rate is 23%. But visitors from non-European Union countries can claim a refund from this tax, if the refund is filed (with detailed receipts) within 3 months.

 

VAT Tax vs. Sales Tax

A sales tax is imposed only on the consumer at the end of the line. The consumer cannot apply for a refund. The VAT and sales tax are similar in the respect that the businesses can have a sales tax exemption from paying sales tax on products they ultimately end up selling to a consumer.

 

Should the U.S. Have a VAT Tax?

A possible way to fund the largest deficit in U.S. history is a value added tax (VAT), also called a national sales tax. Here is a summary of the arguments for and against a VAT tax in the U.S. 

 Benefits of a VAT for the U.S.

  • A VAT would eliminate (so advocates assert) the labyrinthine U.S. income tax system, since the VAT is so much more efficient and would bring in more revenue.
  • A VAT would also solve the problem of lost online sales taxes, since the imposition of a VAT would mean that all sales, even online sales, would be taxed.
  • A VAT would provide additional income to reduce the deficit and fund critical programs like health care for every American.

VAT Drawbacks/Problems:

  • VAT's are hugely regressive, with the cost falling mostly on the poor.
  • It will be difficult, if not impossible, to eliminate the IRS and the income tax system in the U.S., so the VAT will be just another tax imposed on the American people.
  • If the VAT replaces state sales taxes, the states will raise a fuss. The state sales tax system is extremely complex, with some states not charging state sales tax and others taxing at different rates, including local option taxes charged by cities and counties. Eliminating this mess could take many years.
  • VAT calculations would be terribly costly to businesses, which would have to calculate VAT on every product, at every step of the process. These costs, of course, would be passed on to consumers, along with the VAT rates.