Difference between VAT and Sales Tax

VAT or final Sales Tax are the favorite options for indirect taxation. But, do we know the difference? Here we will show an example:

1. Pretcher spends 2000USD in meat and spices to prepare raw hamburgers. He is certified as a non-final consumer.

2. Pretcher sells his raw burgers to McBurgers for 3000USD.

3. McBurgers sells the now cooked burgers for 5000USD to hungry customers.

If the government charges a VAT=7%, the calculations are the following:

i. Pretcher spends 2140USD (2000+(2000×7%)) for the ingredients, and the seller of the meat pays the government 140USD.

ii. Pretcher charges McBurgers 3210USD (3000+(3000×7%)) and pays the government 70USD (210 minus 140), getting the same margin of 1000USD (321 –70–2140).

iii. McBurgers charges the final consumer a total of 5350USD (5000+(5000×7%)) and pays the government 140 (350 minus 210), leaving the same gross margin of 2000USD (5350–140–3210).

If there was no tax, Pretcher would make a profit of 1000/2000=50% and McBurgers (5000-3000)/3000=66.6%. With taxes their respective profits are 1000/2140=46.7% and 2000/3210=62.3%, lower in percentage.

The government receives 140+70+140=350USD.

If instead of VAT, we use Sales Tax, the calculations are much simpler, because only the final customer, the burger eater will have to pay, 350USD, that will go entirely to the government.

The use os VAT is more complicated and remove resources to comply with the tax filling. Besides, it might create an illegal net of false invoices. The only advantage is that under sales tax, nobody has any incentive to pay or collect the tax. Under VAT, an intermediate purchaser has an incentive to deduct input VAT.

Of course, we prefer a Sales Tax system for its clarity and efficiency.