What is a Value Added Tax (VAT) paid for?

A Value Added Tax (VAT) is a consumption tax that is assessed at each stage of the production and distribution process, meaning it applies to the value added at each stage. This includes various stages such as manufacturing, distribution, and retail, where companies producing or distributing goods pay VAT based on the value they add to the final product.

For example, if a manufacturer creates a product and sells it to a distributor, the manufacturer pays VAT on the sale price minus the costs of materials used. The distributor, in turn, pays VAT on the price at which it sells that product to a retailer, again based on the value added. This ensures that VAT is collected incrementally and is ultimately passed on to the final consumer.

It is important to differentiate this from a tax that is only applied at retail level or solely on imports or personal income, as the VAT system is designed to be pervasive throughout the entire production and sales process. This broad application makes it an effective revenue-generating mechanism for governments.