What Is A Value Added Tax?

In a previous post, I pledged to elucidate what a Value Added Tax (VAT) is and clarify why it should not be construed as a trade barrier. Recognizing the complexity of this topic, I opted to create a comprehensive article for Regulation. The resulting piece spans nearly 6,000 words and is rich with detailed numerical examples. This article has recently been published in the Fall 2025 issue of the magazine: “A VAT Is Not a Disguised Trade Barrier.” It is accessible free of charge and can also be downloaded in PDF format.

A VAT is categorized as a consumption tax, akin to a sales tax, that is levied on final domestic consumers within a defined jurisdiction. Unlike a standard sales tax, the VAT is collected from businesses at each step of the production process where value is added. Despite its structure, it remains a consumption tax and imposes no net burden on businesses aside from related regulatory costs. A passage from my article summarizes the mechanics of a VAT:

How does the tax authority receive its share from this consumption tax if businesses pay no net VAT, and the final seller (the retailer) retains all collected VAT? The explanation, as delineated in prior discussions and illustrated in Table 1, reveals that every business submits a VAT payment to the tax authority, calculated at a rate (20 percent in our example) based on its individual value added. However, businesses recoup this tax by incorporating it into the VAT-inclusive price of their invoices. The VAT amounts remitted by businesses at different production stages are thus effectively integrated into the cost structure of the last firm in the supply chain as input VAT.

The crux of the article’s conclusion is essential for understanding the relationship between VAT and trade:

A VAT essentially functions as a domestic retail consumption tax that is neither designed to target nor can be directed at foreign entities. While a tariff acts as a consumption tax, discriminating against imported goods, a VAT treats imported and domestically-produced goods equally, without impacting production inputs. The standard “border adjustments” in VAT-implementing countries are specifically crafted to maintain this non-discrimination, applying the same tax collection framework to imports as is utilized for domestic products. …

Why, then, do protectionists assert otherwise? Why does the current U.S. presidential administration, perhaps more than its predecessors, propagate falsehoods on this matter? A more charitable interpretation could suggest that these politicians lack a fundamental understanding of VAT operations. Yet, why hasn’t the White House sought the counsel of knowledgeable economists to clarify these points? A less generous view might posit that framing the VAT as a trade barrier serves to inflame nationalistic sentiments among voters, allowing politicians to rationalize their stance that trade should not be left solely to the discretion of individual importers and exporters.

It’s worth noting that the United States stands as the only nation among OECD members without a VAT. However, my article does not advocate for the imposition of such a tax on American consumers.