Value added tax or VAT is an indirect tax, which is imposed on goods and services at each stage of production, starting from raw materials to final product. VAT is levied on the value additions at different stages of production. VAT is widely applied in the European countries. However, now a number of countries across the globe have adopted this tax system.
VAT was first introduced in France as taxe sur la valeur ajoutee or TVA. In 1954, the French economist, Maurice Laure, the joint director of the French tax authority, the Direction generale des impost, initiated the concept of VAT, which came into effect on April 10, 1954. Initially introduced for large businesses of France, with the passage of time, VAT was employed for all business sectors of the country. In France, value added tax is considered to be one of the major sources state finance.
Value added tax, also known as goods and services tax or GST proves to be beneficial for the government. Through implementation of this tax system, government can raise revenues invisibly, where the tax is not shown on the bill paid by the buyer. VAT is different from sales tax in various aspects. While sales tax is to be paid on the total value of the goods and services, VAT is levied on every exchange of the product, so that consumers do not have to carry the total cost of tax. However, VAT is generally not applied on export goods to avoid double taxation on the final product. However, if VAT is charged on export goods, the tax amount is usually refunded to the tax payer.
Value added tax can also be recovered. The individual consumers cannot recover VAT on purchases made by them. However, businesses can recover VAT on the services and materials, which are bought by them in order to continue the supply of the products and services.
VAT was introduced to arrest the increasing smuggling and cheating, which were resultants of high sales tax and tariffs. Initiated in France, VAT is used as an instrument of taxation in all the member states of the European Union. Different VAT rates are employed in different member states of EU. The minimum VAT rate for the EU members is 15%. However, the reduced rate of VAT can be as low as 0%. The rate is determined by the VAT authorities of different countries.
There are also some countries, where VAT has been introduced to replace sales tax. India is one such country, where the system of VAT has been adopted for replacing the sales taxation system.
The value added tax serves as the solution for different problems related to the sales tax system. Unlike sales tax, in VAT, there is provision for input tax credit or ITC. Due to the simplicity of the VAT system, the entire taxation system on consumer products and services has become easier.
Mario I. Blejer is a former governor of the Central Bank of Argentina and former Director of the Center for Central Banking Studies at the Bank of England. Eduardo Levy Yeyati is Professor of Economics at Universidad Torcuato Di Tella and Senior Fellow at The Brookings Institution.