Examples of a value added tax.

Those who favor value-added taxation make the argument that a VAT system encourages payment of taxes and discourages attempts to avoid proper tax payments. Businesses that have previously paid VAT are encouraged to collect the tax from consumers, since that is the only way for them to obtain credit for the VAT they have paid at an earlier stage in production. A VAT is also supported as a better alternative to so-called hidden taxes. Opponents of VAT do not like the fact that it is a consumption tax, claiming that it unfairly burdens people with lower incomes. To minimize the impact on lower-income earners, most governments offer numerous exemptions to the VAT, typically on items such as groceries or children’s clothing.

A VAT system is often confused with a national sales tax. However, it differs from a sales tax in that a VAT system is invoice-based and collected at several points in a chain of production, each time value is added and a sale is made. Every seller in the production chain charges a VAT tax to the buyer, which it then remits to the government. The amount of tax levied at each sale along the chain of production is based on the value added by the seller. With a sales tax, the tax is only collected once – at the final point of purchase at the retail level by a consumer.