Taxation
VAT / GST — Value Added Tax / Goods and Services Tax
An indirect tax collected at every stage of production, where each business is credited for tax it already paid — so the same total tax gets collected in pieces instead of all at once, and evasion at one stage doesn't erase what was already collected earlier.
Definition
VAT (Value Added Tax) — called GST (Goods and Services Tax) in some countries — is an indirect, consumption-based tax collected at each stage of a product's production and distribution chain. Each business charges tax on what it sells, but gets credit for the tax it already paid on what it bought — so tax ultimately applies only to the value each business actually added, not to the full price over and over again.
Why this exists
Taxing income isn't the only way to raise government revenue — taxing consumption, what people actually spend, is a genuinely different base that reaches spending regardless of where the money came from (a paycheck, savings, a gift). VAT/GST is built on that consumption base, but it makes one specific design choice worth understanding: instead of taxing only the final retail sale once, it collects a little tax at every stage along the way.
That design has a real advantage over collecting everything at one final point (see Sales Tax): each business in the chain has its own incentive to document its purchases accurately, since doing so is how it claims credit for tax it already paid. That creates a self-reinforcing paper trail across the whole supply chain — evasion at any single stage doesn't erase the tax that was already correctly collected at earlier stages, unlike a system where all the tax rides on one single, final transaction.
Formula & mechanics
Each business remits the tax it charged on sales (output tax), minus the tax it already paid on its own purchases (input tax), keeping the credit system self-correcting stage by stage:
Tax remitted by a business = Output tax (on sales) − Input tax (already paid on purchases)
Worked example
A wooden table moves through three stages, with a 10% VAT rate at each one:
Stage 1 — Supplier sells wood to a manufacturer for $100 (+ $10 VAT = $110 total) Supplier remits: $10 output tax − $0 input tax = $10 Stage 2 — Manufacturer sells the finished table to a retailer for $300 (+ $30 VAT = $330 total) Manufacturer remits: $30 output tax − $10 input tax (paid to supplier) = $20 Stage 3 — Retailer sells the table to a customer for $500 (+ $50 VAT = $550 total) Retailer remits: $50 output tax − $30 input tax (paid to manufacturer) = $20 Total government revenue: $10 + $20 + $20 = $50
$50 is exactly 10% of the final $500 sale price — the same total a single tax on the final sale would raise, just collected in three pieces along the way, each proportional to the value that stage actually added ($100 of value at stage 1, then $200 more at each of the next two stages).
Try it yourself
Total (tax-inclusive)
$120.00
Pre-tax amount
$100.00
Tax amount
$20.00
How the math works
$100.00 plus 20% tax adds $20.00, for a total of $120.00.
Common misconceptions
“VAT means the government collects more total tax than a single sales tax at the same rate, since it's charged at every stage.”
As the worked example shows, once every business's input tax credit is netted out, the total collected across the whole chain equals the same rate applied once to the final price — VAT isn't extra tax stacked on top at each stage.
“Businesses pay VAT out of their own profit at every stage.”
Each business generally passes its VAT along in the price it charges and gets credited for VAT it already paid — in principle, a business's own profit isn't directly reduced by VAT. It's ultimately the end consumer, who has no one further to pass the cost to, who bears it.
“VAT and sales tax are basically the same thing with a different name.”
They're mechanically distinct. VAT collects and credits tax at every stage of the supply chain; sales tax collects once, only at the final retail sale — see Sales Tax for a side-by-side comparison using the same example.
Also in the Glossary: Input Tax, Output Tax, VAT / GST