Comparing the FAIR TAX against Value Added Tax (VAT)

I am reading about a taxation that is surfacing known as the Value Added Tax ( VAT), I wanted to bring it forward and we need to compare it to our Fair Tax. Remember our Fair Tax has been the most studied taxation system in recent years. Fair Tax had been proven, it is the best solution for our economic growth. Fair Tax is a progressive tax not a regressive tax. Fair Tax is a transparent taxation, meaning no taxes are hidden or distorted. Take time and see why we offer the best taxation through Fair Tax.

VALUE ADDED TAXATION ( VAT)
Value added tax (VAT), or goods and services tax (GST), is a consumption tax levied on value added. In contrast to sales tax, VAT is neutral with respect to the number of passages that there are between the producer and the final consumer; where sales tax is levied on total value at each stage, the result is a cascade (downstream taxes levied on upstream taxes).
By definition, exports are consumed abroad and are usually not subject to VAT; VAT charged under such circumstances is usually refundable. This avoids downward pressure on exports and ultimately export derived revenue.
A VAT is an indirect tax, in that the tax is collected from someone who does not bear the entire cost of the tax.
Maurice Lauré, joint director of the French tax authority, the Direction générale des impôts, was first to introduce VAT with effect from 10 April 1954 for large businesses, and it was extended over time to all business sectors. In France, it is the most important source of state finance, accounting for approximately 45% of state revenues.
Personal end-consumers of products and services cannot recover VAT on purchases, but businesses are able to recover VAT on the materials and services that they buy to make further supplies or services directly or indirectly sold to end-users. In this way, the total tax levied at each stage in the economic chain of supply is a constant fraction of the value added by a business to its products, and most of the cost of collecting the tax is borne by business, rather than by the state. VAT was invented because very high sales taxes and tariffs encourage cheating and smuggling. It has been criticized on the grounds that (like other consumption taxes) it is a regressive tax.

Comparison with a sales tax
Value added taxation avoids the cascade effect of sales tax by only taxing the value added at each stage of production. Value added taxation has been gaining favor over traditional sales taxes worldwide. In principle, value added taxes apply to all commercial activities involving the production and distribution of goods and the provision of services. VAT is assessed and collected on the value added to goods in each business transaction. Under this concept the government is paid tax on the gross margin of each transaction.
In many developing countries such as India, sales tax/VAT are a key revenue source as high unemployment and low per capital income render other income sources inadequate. However there is strong opposition to this by many sub-national governments as it leads to an overall reduction in the revenue they collect as well as a loss of some autonomy.
Sales taxes are normally only charged on final sales to consumers: because of reimbursement, VAT has the same overall economic effect on final prices. The main difference is the extra accounting required by those in the middle of the supply chain; this disadvantage of VAT is balanced by application of the same tax to each member of the production chain regardless of its position in it and the position of its customers, reducing the effort required to check and certify their status. When the VAT system has few, if any exemptions such as with GST in New Zealand, payment of VAT is even simpler.
A general economic idea is that if sales taxes exceed 10%, people start engaging in widespread tax evading activity (like buying over the Internet, pretending to be a business, buying at wholesale, buying products through an employer etc.) On the other hand, total VAT rates can rise above 10% without widespread evasion because of the novel collection mechanism. However because of its particular mechanism of collection, VAT becomes quite easily the target of specific frauds like carousel fraud which can be very expensive in terms of loss of tax incomes for states.

Collection mechanism
The standard way to implement a VAT is to say a business owes some percentage on the price of the product minus all taxes previously paid on the good. If VAT rates were 10%, an orange juice maker would pay 10% of the $5 per gallon price ($0.50) minus taxes previously paid by the orange farmer (maybe $0.20). In this example, the orange juice maker would have a $0.30 tax liability. Each business has a strong incentive for its suppliers to pay their taxes, allowing VAT rates to be higher with less tax evasion than a retail sales tax.

With a North American (Canadian provincial and U.S. state) sales tax
With a 10% sales tax:
* The manufacturer pays $1.00 for the raw materials, certifying it is not a final consumer.
* The manufacturer charges the retailer $1.20, checking that the retailer is not a consumer, leaving the same profit of $0.20.
* The retailer charges the consumer $1.65 ($1.50 + $1.50×10%) and pays the government $0.15, leaving the same profit of $0.30.
So the consumer has paid 10% ($0.15) extra, compared to the no taxation scheme, and the government has collected this amount in taxation. The retailers have not lost anything directly to the tax, and retailers have the extra paperwork to do so that they correctly pass on to the government the sales tax they collect. Suppliers and manufacturers have the administrative burden of supplying correct certifications, and checking that their customers (retailers) aren’t consumers.
With a value added tax
With a 10% VAT:
* The manufacturer pays $1.10 ($1 + $1×10%) for the raw materials, and the seller of the raw materials pays the government $0.10.
* The manufacturer charges the retailer $1.32 ($1.20 + $1.20×10%) and pays the Government $0.02 ($0.12 minus $0.10), leaving the same profit of $0.20.
* The retailer charges the consumer $1.65 ($1.50 + $1.50×10%) and pays the government $0.03 ($0.15 minus $0.12), leaving the profit of $0.30 (1.65-1.32-.03).
So the consumer has paid 10% ($0.15) extra, compared to the no taxation scheme, and the government has collected this amount in taxation. The businesses have not lost anything directly to the tax. They do not need to request certifications from purchasers who are not end users, but they do have the extra accounting to do so that they correctly pass on to the government the difference between what they collect in VAT (output VAT, an 11th of their income) and what they spend in VAT (input VAT, an 11th of their expenditure).
Note that in each case the VAT paid is equal to 10% of the profit, or ‘value added’.
The advantage of the VAT system over the sales tax system is that businesses cannot hide consumption (such as wasted materials) by certifying it is not a consumer.

Limitations to example and VAT
In the above example, we assumed that the same number of widgets were made and sold both before and after the introduction of the tax. This is not true in real life.
The fundamentals of supply and demand suggest that any tax raises the cost of transaction for someone, whether it is the seller or purchaser. In raising the cost, either the demand curve shifts leftward, or the supply curve shifts upward. The two are functionally equivalent. Consequently, the quantity of a good purchased, and/or the price for which it is sold, decrease.
This shift in supply and demand is not incorporated into the above example, for simplicity and because these effects are different for every type of good. The above example assumes the tax is non-distortion.
A VAT, like most taxes, distorts what would have happened without it. Because the price for someone rises, the quantity of goods traded decreases. Correspondingly, some people are worse off by more than the government is made better off by tax income . That is, more is lost due to supply and demand shifts than is gained in tax. This is known as a dead-weight loss. The income lost by the economy is greater than the government’s income; the tax is inefficient. The entire amount of the government’s income (the tax revenue) may not be a dead-weight drag, if the tax revenue is used for productive spending or has positive externalities – in other words, governments may do more than simply consume the tax income. While distortions occur, consumption taxes like VAT are often considered superior because they distort incentives to invest, save and work less than most other types of taxation – in other words, a VAT discourages consumption rather than production.

Criticisms
The “value added tax” has been criticized as the burden of it relies on personal end-consumers of products and is therefore a regressive tax (the poor pay more, in comparison, than the rich). However, this calculation is derived when the tax paid is divided not by the tax base (the amount spent) but by income, which is argued to create an arbitrary relationship. The tax rate itself is proportional with higher income people paying more tax but at the same rate as they consume more. If a value added tax is to be related to income, then the unspent income can be treated as deferred (spending savings at a later point in time), at which time it is taxed creating a proportional tax using an income base. Such taxes can have a progressive effect on the effective tax rate of consumption by using exemptions, rebates, or credits.
Revenues from a value added tax are frequently lower than expected because they are difficult and costly to administer and collect. In many countries, however, where collection of personal income taxes and corporate profit taxes has been historically weak, VAT collection has been more successful than other types of taxes. VAT has become more important in many jurisdictions as tariff levels have fallen worldwide due to trade liberalization, as VAT has essentially replaced lost tariff revenues. Whether the costs and distortions of value added taxes are lower than the economic inefficiencies and enforcement issues (smuggling) from high import tariffs is debated, but theory suggests value added taxes are far more efficient.
Certain industries (small-scale services, for example) tend to have more VAT avoidance, particularly where cash transactions predominate, and VAT may be criticized for encouraging this. From the perspective of government, however, VAT may be preferable because it captures at least some of the value-added. For example, a carpenter may offer to provide services for cash (without a receipt, and without VAT) to a homeowner, who usually cannot claim input VAT back. The homeowner will hence bear lower costs and the carpenter may be able to avoid other taxes (profit or payroll taxes). The government, however, may still receive VAT for various other inputs (lumber, paint, gasoline, tools, etc) sold to the carpenter, who would be unable to reclaim the VAT on these inputs. While the total tax receipts may be lower compared to full compliance, it may not be lower than under other feasible taxation systems.
Because exports are generally zero-rated (and VAT refunded or offset against other taxes), this is often where VAT fraud occurs. In Europe, the main source of problems is called carousel fraud. Large quantities of valuable goods (often microchips or mobile phones) are transported from one member state to the other. During these transactions, some companies owe VAT, others acquire a right to reclaim VAT. The first companies, called ‘missing traders’ go bankrupt without paying. The second group of companies can ‘pump’ money straight out of the national treasuries. This kind of fraud originated in the 1970s in the Benelux-countries. Today, the British treasury is a large victim. There are also similar fraud possibilities inside a country. To avoid this, in some countries like Sweden, the major owner of a limited company is personally responsible for taxes. This is circumvented by having an unemployed person without assets as the formal owner.

The Nordic countries
MOMS-Danish, Norwegian, Swedish, Icelandic, Finnish are the Nordic terms for VAT. Like other countries’ sales and VAT taxes, it is a regressive indirect tax.
In Denmark, VAT is only applied at one level, and is not split into two levels as in other countries ( Germany), where VAT is split into VAT for foodstuffs and VAT for nonfood. The current percentage in Denmark is 25%. That makes Denmark one of the countries with the highest value added tax, alongside Norway and Sweden. A number of services are not taxable, for instance public transportation of private persons, health care services, publishing newspapers, rent of premises (the lessor can, though, voluntarily register as VAT payer, except for residential premises), travel agency operations.
In Finland , the standard rate of VAT is 22%. In addition, two reduced rates are in use: 17%, which is applied on food and animal feed, and 8%, which is applied on passenger transportation services, cinema performances, physical exercise services, books, pharmaceuticals, entrance fees to commercial cultural and entertainment events and facilities. Supplies of some goods and services are exempt under the conditions defined in the Finnish VAT Act: hospital and medical care; social welfare services; educational, financial and insurance services; lotteries and money games; transactions concerning bank notes and coins used as legal tender; real property including building land; certain transactions carried out by blind persons and interpretation services for deaf persons. The seller of these tax-exempt services or goods is not subject to VAT and does not pay tax on sales. He therefore may not deduct VAT included in the purchase prices of his inputs.
In Iceland, VAT is split into two levels: 24.5% for most goods and services but 7% for certain goods and services. The 7% level is applied for hotel and guesthouse stays, license fees for radio stations, newspapers and magazines, books, hot water, electricity and oil for heating houses, food for human consumption (but not alcoholic beverages), access to toll roads and music.
In Norway, VAT is split into three levels: 25% is the general VAT, 14% (formerly 13%, up on January 1, 2007) for foods and restaurant take-out (food eaten in a restaurant has 25%), 8% for person transport, movie tickets, and hotel stays. Books and newspapers are free of VAT, while magazines and periodicals with a less than 80% subscription rate are taxed. Svalbard has no VAT because of a clause in the Svalbard Treaty. Cultural events are excluded from VAT.
In Sweden, VAT is split into three levels: 25% for most goods and services including restaurants bills, 12% for foods (incl. bring home from restaurants) and hotel stays (but breakfast at 25%) and 6% for printed matter, cultural services, and transport of private persons. Some services are not taxable for example education of children and adults if public utility, and health and dental care, but education is taxable at 25% in case of courses for adults at a private school. Dance events (for the guests) have 25%, concerts and stage shows have 6%, and some types of cultural events have 0%.
MOMS replaced OMS (Danish , Swedish) in 1967, which was a tax applied exclusively for retailers.
Year Tax level OMS/MOMS
1962 9% OMS
1967 10% MOMS
1968 12.5% MOMS
1970 15% MOMS
1977 18% MOMS
1978 20.25% MOMS
1980 22% MOMS
1992 25% MOMS

United States
In the United States, the state of Michigan used a form of VAT known as the “Single Business Tax” (SBT) as its form of general business taxation. It is the only state in the U.S. to have used a VAT. When it was adopted in 1975, it replaced seven business taxes, including a corporate income tax. On August 9, 2006, the Michigan legislature approved voter-initiated legislation to repeal the Single Business Tax. The repeal became effective January 1, 2008.
Most states have sales taxes charged to the end buyer only. State sales taxes range from 0%-13% and municipalities often add an extra local sales tax. In many stores, the price tags and/or advertised prices do not include the taxes; these will be added at the cash register before the customer pays. In many states, no sales tax is charged for services. This is a key difference between most sales taxes levied throughout the United States and the value added taxes in other countries.
Ex-Presidential candidate Mike Huckabee has proposed a national sales tax at a rate of 30% (which would replace all federal income tax). This has generated considerable confusion as a 30% addition translates to 23% of the total purchasing price being paid as taxes. Huckabee’s FairTax proposal is pitched, in part, as a means of increasing the competitiveness of domestic goods against those of European producers whose VAT is refunded on exports.
As we know even Michigan’s economy is in worst of time much like the rest of the country. In conclusion there is only one taxation which would work and it would be the pride of United States once again. This is why we need to get the Fair Tax passed!

Charlie Prochaska
Volunteer Community Coordinator
FairTaxSOWEGA

Source -  VAT – Wikipedia