You can probably guess from the name:
VALUE ADDED TAX(VAT) is a tax on the value added to an item.
But just in case that’s not entirely clear, lets revisit our Salt and Pepper shakers from yesterday. Actually, no lets try a new product, I’m sure we can find one that’s been done to death in one of the “Amazon Review Groups.”
Pour over coffee maker? Yikes. This is a bit saturated, but okay. Here’s how VALUE ADDED TAX works in the world of product sales.
Unlike SALES (Consumption) TAX which is applied at the last stage of a product (Right before it gets thrown in the trash), VALUE ADDED TAX (or VAT) gets added (surprise) each time value is added to the product.
Let’s assume the VAT for this country is 10%, just because that’s easier mathetmatically.
So… assuming this is made out of metal, a… it’s rare that you get to use a word for the first time in your life, but I’m pretty confident this is that time for me. Here it comes… a metallurgist (maybe?) takes a bunch of metal and using something that is probably not super safe or easy to use bangs this into shape and sells the raw pieces to the manufacturer.
METALLURGIST: I’m not putting this together, but you can CLEARLY see that if you did, it’d be a pour over coffee maker.
MANUFACTURER: Yeah I can put that together, no big deal, how much?
GOVERNMENT: AHA! YOU MADE SOMETHING OF VALUE.
METALLURGIST: Crap. Yes. I did.
GOVERNMENT: 10% GIMME.
METALLURGIST: Wait why again? Oh right. Death squads. Here. Take it.
GOVERNMENT: KTHXBAI. SEE YOU IN A MINUTE MANUFACTURER.
TOTAL SPENT: $1
TOTAL VAT COLLECTED: $0.10
Now the manufacturer has his employees assemble the pieces for this pour over coffee maker, slap a box on it, and a label, and then sells it to YOU, the RETAILER.
RETAILER: I’d like to buy ONE pour over coffee thinggy, just to see if I can sell it on Amazon.
MANUFACTURER: Sounds good that’ll be $1.50.
RETAILER: Damn that’s cheap. I can probably sell this for like $15.
MANUFACTURER: Okay, fine $1.75.
RETAILER: I desperately need an inner monologue.
MANUFACTURER: I meant $2.00.
RETAILER: Sigh. I’ll take it.
GOVERNMENT: WE MEET AGAIN. YOU ADDED MORE VALUE!
RETAILER: That makes 2 of us.
MANUFACTURER: Shh. Death squads. That’s a real thing. Show some respect.
GOVERNMENT: 10% please.
MANUFACTURER: Of $2? Fine. This costs $2.20, I’ll give you your twenty cents if that’s what it costs to NOT have death squads.
GOVERNMENT: No, not TWENTY cents. Just TEN.
MANUFACTURER/RETAILER: Wait what?
GOVERNMENT: Paying TWENTY cents would mean the TOTAL VAT for this would be 30 cents, 10 cents from before, and 20 cents now. I don’t need you to pay for the value THE METALLURGIST added. Just the value that YOU added. Which was $1. So, 10% of $1 please.
TOTAL VAT COLLECTED: $0.20
It’s probably worth restating. In a VAT system the government doesn’t tax for the price of the item. The government only taxes for the *additional* value of the item, at each step. The value added. So if you make something for $10, and sell it for $20, you’ve added $10 of value, and will be taxed on those $10.
If the person who bought it from you for $20, then sells it for $25, they’ve only added $5 of value to it, so they get taxed on that $5.
If that person then sells it for $200, after purchasing it for $25, they’ve added $175 of value, and will be taxed on *that*.
So, to re-state. Value Added Tax is applied to a product on the value that is added to it at each step of the chain.
We’re not done yet, but we’re close. There are TWO more aspects to Value Added Taxes, and once you’ve learned that, you’ll have learned as much as you realistically need to know.
Those two things are IMPORT VAT, and THRESHOLDS. But we’ll save those for later posts.