Value Added Tax for Beginners

[Kanastrous]

...is the explanation I'm looking for. I understand that passions can run high both pro- and con-, and I have read basic descriptions of the scheme but they don't help me very much with apprehending whether this is a good or bad policy for us to adopt in the USA (or at the state level).

Pros/cons, from people familiar with how the arrangement works? What sort of changes in revenues and distribution of tax payments should we expect if a VAT were to be imposed here in the United States?

[Vendetta]

This is a good introduction

Essentially, it's sales tax, though some specifics may differ, and the UK rate is very high (15% at the moment, down from it's normal 17.5%).

[Phantasee]

After going over that page, it seems to me that it is very similar to the GST we have in Canada. We don't have the reduced rate category, but we have the others and they are very similar.

The neat thing about a GST or VAT is that it's only paid once, effectively.

If you have a product that you purchase at the store for $10, at 5% GST, you pay $10.50.

This is how that tax ends up there. Company A buys the raw materials for the product, and pays GST on them. When they put together part of the product, say, an engine in a lawn mower, and sell that part to another company, Company B, they charge the GST on it. What they then do is take the GST they paid for their production inputs, and balance it against the GST they collected when they sold their product. Generally, this doesn't net out to zero because the value of the product is a little more than the value of the raw materials. So now Company A has passed on the tax to Company B. Company B puts the rest of the product together, and sells it to some distributor or store. They charge GST on it as well, and use the GST they collect to offset the GST they paid when they purchased the product, giving them close to net zero GST payment. Now the store sells it to you, and charges you the GST on it. You pay the GST, which the store uses to offset the GST they paid when they bought the product wholesale. So the only GST they forward to the government is the GST on their markup. What happens is that the government gets the GST every time the price of the product goes up, but only on the difference in the price. This ends up giving them 5% of the price, but only the consumer is really paying for it, and it doesn't ding every company at every step the 5% tax.

Now, if you have your own company, you can save your receipts, claim them as an expense, and use that GST you paid on all your products to offset the GST you pay from your own business, but the same rules for expenses apply here as for corporate income taxes.

[Uraniun235]

The only thing I want to know is why the fucking sales tax cannot be part of the fucking price on the price tag.

[Kanastrous]

So the retailer can advertise the price as a lower and therefore more attractive-seeming figure.

Although I don't see what that specifically has to do, with VAT.

[Master of Ossus]

The only thing I want to know is why the fucking sales tax cannot be part of the fucking price on the price tag.

That would, actually, be fairly difficult from an inventory-management perspective. Companies often sell the same product in many different states or counties that each have different sales taxes. They would have to print up different UPC's (or, alternatively, have different adjusters) for each store or area, which would also be a major headache for companies that were trying to advertise deals across those lines (come to our store for the $5.00 deal... or is it $5.18 in your area? $5.36?....).

I imagine companies with very good inventory management systems and that rarely advertise (e.g., Walmart) could do something like that, but there's no way that normal businesses would be able to get it done.

[Kanastrous]

I don't really find it too difficult to add 8.25% in my head while looking at the tag. And I'm pretty math-challenged by SDNet standards. Should be even easier for everyone else...

[Darth Tanner]

and the UK rate is very high (15% at the moment, down from it's normal 17.5%).

The 15% is mandated by the EU. All members must have a minimum of 15% and a maximum of 25%. (Although it varies or doesn't exist for some products) As I understand it the EU itself gets a cut from the VAT, although only a few percent. Sweden, and most other Nordic countries have the 25% rate if I remember correctly. (Hey someones got to pay for the free healthcare)

The only thing I want to know is why the fucking sales tax cannot be part of the fucking price on the price tag.

We do in the UK. I assume the reason you don't in the USA is that practically every state has a different VAT rate and companies can't be arsed to work it out on a regional basis. As I understand it its even worse in Alaska which gives the local boroughs the right to collect a VAT at whatever rate they want, although how that doesn't work out as a death sentence for every retailer inside the VAT districts is beyond me.

which would also be a major headache for companies that were trying to advertise deals across those line

No reason they couldn't have the VAT inclusive price beneath the main price. Its a practice that some electronics and computer retailers do in the UK at least, mostly to get you interested in their goods that appear several hunded pounds cheaper at first glance.

[Count Chocula]

One thing the VAT seems to do, if I'm reading The Bandit's explanation correctly, is charge manufacturers a GST on raw materials. That would increase their inventory costs by 5% automatically, and hence the corporate taxes paid on any inventory at year end (hence the "almost no net effect to manufacturers," again if I interpret this correctly). Such a system would seem, through my American eyes, to put extra pressure on manufacturers to reduce their inventory and force them to resort to JIT (Just In Time) inventory deliveries, based on forecasts. One indirect effect I can see is that not every company forecasts accurately, and can easily get caught short on raw materials if a sizeable order comes through the door. A 5% margin may not sound like much, but many industries, such as electrical wire/distribution and grocery stores, work on 5%-8% GROSS margins. A lost order due to not having the raw material to deliver would affect them more than the consumer who ends up paying the VAT.

Canadians, please let me know if I'm off base since I'm just connecting the dots.

[Master of Ossus]

We do in the UK. I assume the reason you don't in the USA is that practically every state has a different VAT rate and companies can't be arsed to work it out on a regional basis. As I understand it its even worse in Alaska which gives the local boroughs the right to collect a VAT at whatever rate they want, although how that doesn't work out as a death sentence for every retailer inside the VAT districts is beyond me.

No US jurisdiction that I am aware of has a VAT--sales taxes are not VAT's because they are applied only at the register.

Also, several US states give local counties substantial control over sales tax rates. For instance, Virginia.

One thing the VAT seems to do, if I'm reading The Bandit's explanation correctly, is charge manufacturers a GST on raw materials. That would increase their inventory costs by 5% automatically, and hence the corporate taxes paid on any inventory at year end (hence the "almost no net effect to manufacturers," again if I interpret this correctly).

No. The reason is that they deduct the cost of their purchases of raw materials (as they do with all of their other inputs) from their profits at the end of the year, and hence pay no taxes on the "additional" cost of the VAT.

Such a system would seem, through my American eyes, to put extra pressure on manufacturers to reduce their inventory and force them to resort to JIT (Just In Time) inventory deliveries, based on forecasts. One indirect effect I can see is that not every company forecasts accurately, and can easily get caught short on raw materials if a sizeable order comes through the door. A 5% margin may not sound like much, but many industries, such as electrical wire/distribution and grocery stores, work on 5%-8% GROSS margins. A lost order due to not having the raw material to deliver would affect them more than the consumer who ends up paying the VAT.

Canadians, please let me know if I'm off base since I'm just connecting the dots.

Most US Tax scholars agree that a uniform VAT has a number of properties that make it preferable to the current system. Personally I think that they underestimate the amount of "gamesmanship" that would occur under a VAT, but even I admit that it has a sort of theoretical elegance to it that would eliminate chicanery about accounting profits, deferred earnings, etc. and would probably be better, overall.

Democrats killed the last serious effort to implement a VAT in the US (I believe it was referred to as the "Armey-Shelby" tax plan after its primary congressional proponents) partly because of confusion over the idea that it was packaged as a "flat tax" when in fact it was a two-stage VAT but largely because it was an explicit effort to reduce taxes in the US.

[Phantasee]

Sales taxes are collected quarterly or annually, depending on the type of business, IIRC. I know we pay quarterly. So you add up the GST on your receipts (expenses), add up the GST you collected from customers, and find the difference. If you spent more than you made, you get a GST refund, or credit that is carried on for the next quarter(s), and if you made more than you spent (which you should be doing, usually ), you send a cheque to the Minister of Finance.

[Netko]

The only thing I want to know is why the fucking sales tax cannot be part of the fucking price on the price tag.

That would, actually, be fairly difficult from an inventory-management perspective. Companies often sell the same product in many different states or counties that each have different sales taxes. They would have to print up different UPC's (or, alternatively, have different adjusters) for each store or area, which would also be a major headache for companies that were trying to advertise deals across those lines (come to our store for the $5.00 deal... or is it $5.18 in your area? $5.36?....).

I imagine companies with very good inventory management systems and that rarely advertise (e.g., Walmart) could do something like that, but there's no way that normal businesses would be able to get it done.

Companies, even international ones don't seem to have problems with it here (Croatia - 4.5 million people so not that different then some of the less populous US states) where its mandated by law that companies selling to the public display prices with VAT included (and we have an absolutely murderous 22% rate). The only companies exempt are wholesalers who sell exclusively to other companies (usually enforced by some sort of club membership), for obvious reasons related to the functioning of VAT.

[Psychic_Sandwich]

That would, actually, be fairly difficult from an inventory-management perspective. Companies often sell the same product in many different states or counties that each have different sales taxes. They would have to print up different UPC's (or, alternatively, have different adjusters) for each store or area, which would also be a major headache for companies that were trying to advertise deals across those lines (come to our store for the $5.00 deal... or is it $5.18 in your area? $5.36?....).

I imagine companies with very good inventory management systems and that rarely advertise (e.g., Walmart) could do something like that, but there's no way that normal businesses would be able to get it done.

So they advertise as '$5.00 deal plus tax'. Or even just put the price plus tax on in smaller numbers, in the same way the price per kilo of price per 100 ml is sometimes added. So, it'd be '$5.00 deal! $5.25 incl tax'. I assume that a lot of places don't so that, since the complaint exists in the first place.

[Enigma]

Companies, even international ones don't seem to have problems with it here (Croatia - 4.5 million people so not that different then some of the less populous US states) where its mandated by law that companies selling to the public display prices with VAT included (and we have an absolutely murderous 22% rate). The only companies exempt are wholesalers who sell exclusively to other companies (usually enforced by some sort of club membership), for obvious reasons related to the functioning of VAT.

Not only that but it is also done in gas stations. Here the GST, plus the Federal and Provincial gas tax are added to the gas price. So the price you see at the pump is what you pay.

[Jalinth]

VAT is conceptually pretty simple.

Each layer of production until the final consumer charges a tax based on the value they add to the product/service. Because of the way refunds and payments are calculated, the final consumer (either an individual or a business not subject to VAT like banks) is the only one who should actually pays VAT in the long run.

VAT can either be baked into the price or not. I personally prefer it to be excluded simply because it highlights how much you are paying to the government. But I also feel that it should only be taxes (meaning payments to a government) that can be added to the final price tag. Anything else must be included (airlines piss me off on this point). It shouldn't be a big issue for an IT system in general. A particular SKU would have a price in the system and each store would be set-up with a particular tax rate. The practical problem is that in the US you can have state, county, district, city, and sometimes other jurisdictions imposing a tax and they aren't consistent. But a national US VAT with a second state layer which is limited strictly to a percentage (what is in and out is done nationally) would greatly simply people's lives if it replaced all other sales taxes.

As far as what changes it would make, it really depends on how the government introduces it. The most logical way would be for the US federal government to impose it nationally and collect a fairly small tax for itself (in the 1% range) which could be used to help reduce the massive structural deficit. But each state could then repeal their sales tax and piggy back on the national VAT with the US government doing the auditing and collecting and simply forward the funds to the right states. If the overall rate was lower than current state taxes, you'd find that very high income earners would pay more tax since services are caught - so getting divorced just became more expensive. Lower income earners would either need a rebate or groceries would be exempted.

[Rogue 9]

Companies, even international ones don't seem to have problems with it here (Croatia - 4.5 million people so not that different then some of the less populous US states) where its mandated by law that companies selling to the public display prices with VAT included (and we have an absolutely murderous 22% rate). The only companies exempt are wholesalers who sell exclusively to other companies (usually enforced by some sort of club membership), for obvious reasons related to the functioning of VAT.

Not only that but it is also done in gas stations. Here the GST, plus the Federal and Provincial gas tax are added to the gas price. So the price you see at the pump is what you pay.

It is that way for gasoline in the United States; just not for most consumer products. It's more practical for gasoline since the price changes so much anyway; adding the taxes (which are much more than normal sales tax) isn't a huge logistical burden over and above the difficulties of changing the price every other day anyway.

[Surlethe]

It seems like a value-added tax is simply one on the difference between the price at which you bought a good and the price for which you sell a good. A simple sales tax at every level of production is going to 'overtax' the good. For example, consider a three-step production process: extraction, processing, retail. If the extractor sells the good at $100 to the processor, the processor sells the good at $150 to the retailer, and the retailer sells the good at $200 to you, the extractor has added $100 of value to the good, the processor has added $50 of value to the good, and the retailer has added another $50. A flat value-added tax (say, 10%) would thus pull $10 at the first transaction, $5 at the second, and $5 at the third -- $20, or 10% of the final value of the good. A flat sales tax (10%), on the other hand, would pull $10 at the first transaction, $15 at the second, and $20 at the third. That amounts to $45, which is closer to 23% of the actual value of the good.

[Beowulf]

It seems like a value-added tax is simply one on the difference between the price at which you bought a good and the price for which you sell a good. A simple sales tax at every level of production is going to 'overtax' the good. For example, consider a three-step production process: extraction, processing, retail. If the extractor sells the good at $100 to the processor, the processor sells the good at $150 to the retailer, and the retailer sells the good at $200 to you, the extractor has added $100 of value to the good, the processor has added $50 of value to the good, and the retailer has added another $50. A flat value-added tax (say, 10%) would thus pull $10 at the first transaction, $5 at the second, and $5 at the third -- $20, or 10% of the final value of the good. A flat sales tax (10%), on the other hand, would pull $10 at the first transaction, $15 at the second, and $20 at the third. That amounts to $45, which is closer to 23% of the actual value of the good.

Right, but sales taxes are usually retail taxes. So it's only the last one who pays sales taxes up to the government, and that amounts to 10%, or $20. This also makes it easier to enforce payment of sales taxes, since you have less companies that you need to monitor for compliance.

[Master of Ossus]

Right, but sales taxes are usually retail taxes. So it's only the last one who pays sales taxes up to the government, and that amounts to 10%, or $20. This also makes it easier to enforce payment of sales taxes, since you have less companies that you need to monitor for compliance.

Actually, almost all tax specialists believe that the VAT would be easier to enforce than sales taxes because it doesn't draw a distinction between retail sales and non-retail sales. Basically every business already has accountants (or, at least, maintains accounts), and so it's pretty easy for them to tally up their sales and purchases quarterly or annually and then submit those for taxation. That eliminates some of the gamesmanship, particularly with small businesses, as to what's a business expense vs. personal expenses and wages.

Edit: If you think about it, the real problem is that a sales tax unfairly penalizes businesses for selling to consumers instead of other businesses. The VAT eliminates this distortive effect on the economy, and European countries that have switched to it have generally reported either slightly higher levels of tax compliance or stable tax compliance.

[Phantasee]

The GST in Canada is like the VAT in that way too. We don't deal with consumers, usually. We subcontract from the bigger contractors, on projects ranging from highways to bridges to subdivision prep, and sometimes little jobs like a farmer wanting to level a field or something. Everybody we bill gets charged the GST, which we collect, but we deduct our expenses from that (well, the GST from our expenses).

And those companies use the GST they paid us to reduce the GST they would pay the government themselves.

I wonder how it works when you're contracting from the government, though. For City contracts we would probably charge the GST, since it's a federal tax, and I suppose provincial jobs would be the same deal, but would we collect GST when we're being paid by the feds? Not that I've ever heard of a federal job, I believe even the Trans-Canada highway was funded by the feds but built by each province individually (who probably split the contract up for every section).

[Master of Ossus]

The GST in Canada is like the VAT in that way too. We don't deal with consumers, usually. We subcontract from the bigger contractors, on projects ranging from highways to bridges to subdivision prep, and sometimes little jobs like a farmer wanting to level a field or something. Everybody we bill gets charged the GST, which we collect, but we deduct our expenses from that (well, the GST from our expenses). [snip]

Isn't the General Sales Tax in Canada really just a VAT, though?

[Phantasee]

The GST in Canada is like the VAT in that way too. We don't deal with consumers, usually. We subcontract from the bigger contractors, on projects ranging from highways to bridges to subdivision prep, and sometimes little jobs like a farmer wanting to level a field or something. Everybody we bill gets charged the GST, which we collect, but we deduct our expenses from that (well, the GST from our expenses). [snip]

Isn't the General Sales Tax in Canada really just a VAT, though?

It's the Goods & Services Tax, and I believe it is. The PST is the Provincial Sales Tax, but being an Albertan, I don't have much familiarity with it.

I always heard negative things about it, from the conservatives around here, old-timers and the like, but my father explained it to me like this: without the GST, our industries would be uncompetitive with foreign industries. If someone made sneakers here, and was taxed by the government (I think it was called a Manufacturer's Tax or something like that), they were paying it, increasing the price of the good, but if some company was making a similar product in, say, Korea, they wouldn't have to pay that tax. What the GST did was make every good subject to the tax, while eliminating the tax burden on manufacturers (not entirely, of course), making them more competitive.

Of course, like all good decisions, it cost the PC Party the election, and they lost pretty hard. From 200+ seats in a 300 seat Parliament to 2, in 1993. Of course, there were more reasons than that, but that's the main one I heard from around here.

[Jalinth]

Right, but sales taxes are usually retail taxes. So it's only the last one who pays sales taxes up to the government, and that amounts to 10%, or $20. This also makes it easier to enforce payment of sales taxes, since you have less companies that you need to monitor for compliance.

Actually, almost all tax specialists believe that the VAT would be easier to enforce than sales taxes because it doesn't draw a distinction between retail sales and non-retail sales. Basically every business already has accountants (or, at least, maintains accounts), and so it's pretty easy for them to tally up their sales and purchases quarterly or annually and then submit those for taxation. That eliminates some of the gamesmanship, particularly with small businesses, as to what's a business expense vs. personal expenses and wages.

Master is right on this point. VAT makes it more difficult to hide outright fraud due to the way the tax cascades. Your supplier has to report the GST they charged you, so the government can theoretically determine what your cost of inputs are. Also, the government is less impacted by fraud since the government only loses the value added at the very end of the chain but not the tax charged along the way. With retail sales fraud, a fraud at the end gives a 100% revenue lose for the government.

These days, zappers and other programs can allow for a pretty sophisticated skimming operation to go on and VAT does have weaknesses where people will try to structure things to get 100% refund without charging the VAT at the end (export fraud - your sale states it is being shipped to the US but it somehow ends up going to Birmingham instead). But a retail sales tax is easier to defraud than a VAT. More importantly, VATs tend to be levied by the same body that charges an income tax, so audits tend to include both GST and income tax. So flags on either part could be the giveaway (either your input/outputs don't add up for VAT or your income and your lifestyle doesn't add up for income tax)

[Master of Ossus]

I always heard negative things about it, from the conservatives around here, old-timers and the like, but my father explained it to me like this: without the GST, our industries would be uncompetitive with foreign industries. If someone made sneakers here, and was taxed by the government (I think it was called a Manufacturer's Tax or something like that), they were paying it, increasing the price of the good, but if some company was making a similar product in, say, Korea, they wouldn't have to pay that tax. What the GST did was make every good subject to the tax, while eliminating the tax burden on manufacturers (not entirely, of course), making them more competitive.

Wouldn't it do the exact opposite and make domestic manufacturers less competitive as compared to foreign ones? If a Canadian retailer purchases a $1000 computer from some foreign manufacturer that built it entirely with foreign parts, and then sold it for $1100, they only pay the GST on the $100 because that's the entire value they added to it (they deduct the $1000 original purchase as expensed).

But if that same retailer purchased from a Canadian OEM, then the OEM would have to pay taxes on the difference between the sales price to the retailer (we'll say it's still $1000) and the parts and raw materials. So, whereas the foreign manufacturer gets to keep the full difference between the $1000 sales price and the parts, the domestic manufacturer gets to keep ($1000-parts-GST). Since GST>0, the foreign manufacturer is maintaining a higher profit even if it uses the same parts and sells at the same price (alternatively, since it has a price advantage, it could enjoy the same profits but charge a lower price and pick up market share against the domestic manufacturer).

Apart from my dislike for protectionism, I think the VAT would actually be counter-productive for those purposes.

[andrewgpaul]

At least for things I've bought off Ebay from the US, I'm supposed to pay the VAT on the item based on the price I payed, if I'm importing it. As an example, assuming $1.50/£1, and VAT at 15%, say I buy an import XBox 360 for $600 off Ebay. When it gets to customs, I should therefore cough up £60 to Alistair Darling (15% of (600/1.5)).

Also, when you sell stuff outside the EU, for which there is no VAT. In theory, you should reduce the price by 15%, but plenty of companies don't, and pocket that 15% for themselves.