Consumption Taxes Are Better
Risk & Progress| A hub for essays that explore risk, human progress, and your potential. My mission is to educate, inspire, and invest in concepts that promote a better future for all. Subscriptions and new essays are free and always will be. Paid subscribers gain access to the full archives.
The VAT, or Value Added Tax, is a powerful and often misunderstood, revenue-generating tool. In America, politicians on both the left and right have derided the VAT for narrow political reasons. The rest of the world, on the other hand, has embraced its potential. I illustrate how the VAT works, why it is not truly regressive, and how it can be used as an alternative to income taxation.
Consumption Taxes are exactly what they sound like, taxes levied on the things one buys or consumes. Consumption taxes come in three primary flavors, Excise, Sales, and VAT. Excise taxes are levied on specific kinds of goods, often to counteract negative externalities. Think taxes on cigarettes or taxes on sugar-sweetened beverages, as I discussed here.
Sales and VAT, on the other hand, are more broad-based levies on a wide variety of goods and services. However, unlike a Sales Tax, where tax is collected only at the final sale, the VAT is collected at each stage in the lifecycle of the product, from production to consumption.
How the VAT works
Imagine a chair manufactured and sold in a jurisdiction with a 10 percent VAT. The lumber company sells the raw material to a manufacturer for $100, which becomes a purchase price of $110 after including the VAT. The $10 tax is remitted to the government.
The manufacturer then fashions the lumber into a chair, selling it to a retailer for $300, which becomes $330 with the VAT. But instead of remitting the full $30 tax to the government, the manufacturer can deduct the $10 tax they already paid, remitting $20 to the government. The retailer then sells the product to the end consumer for $500, or $550 with VAT. The retailer remits $20 to the government, the total tax collected less the $30 tax they already paid when they purchased the chair from the manufacturer.