INDIRECT TAXES - SALES AND VAT

In recent years there has been a tendency in many countries to move from direct taxes on income to indirect ones on spending. These may be simple sales taxes, by which a percentage is added to the final price in the shops, with the revenue raised used by local or central government. Alternatively, they may be Value Added Taxes (VAT), which are now compulsory in all EU countries. VAT is normally administered by Customs and Excise authorities.

VAT, being levied at every stage of manufacture and service, is a rather different concept from sales tax. In other words, a tax is imposed as the value of the product increases at each stage of manufacture. The aim is to tax the additional value which every stage of manufacture puts on a particular product. Self-employed individuals (above a certain level of income) and companies must pay VAT. Another difference between sales taxes and VAT is that the former tend to be levied on virtually all goods, while some items may be exempt from VAT or zero-rated. There is a difference, too, in concept between what is zero-rated and what is exempt. In theory, anything zero-rated could be charged at any time, and anyone selling a zero-rated article can claim a refund for any VAT paid to other people. Where goods are exempt, no reclaims can be paid. The type of product or service is quite different. For example, in the UK food, books, children's clothing are all zero-rated; postal services, insurance, burial and cremation charges are exempt from VAT.

In the UK, the current rate of VAT is normally 17.5% (8% for fuel bills), but sales taxes are not usually levied at such high levels. A sales tax may be fixed by central government or by local or state authorities.

Both sales tax and VAT may be at a uniform rate regardless of products they are charged on. They can, however, be at different rates (say, higher on what are seen as luxuries and lower, or not applicable at all, on essential items). There is no uniform rate of VAT throughout the EU: governments are free to set their own rates. From relatively low rates when first introduced, VAT rates have increased progressively as more and more countries have come to regard VAT as a ready source of income to compensate for lower taxes on income. Needless to say, any benefit from lower income taxes enjoyed by the payers is often lost through higher rates of VAT. But few voters are aware of paying VAT and everyone is conscious of the income tax they pay.

Some countries (tax havens) have no direct taxes on income and few indirect taxes. They may, however, impose visitors' taxes to be paid at airports on departure or on hotel accommodation. More common, however, are no indirect taxes, except for excise duties, imposed for social and revenue-raising purposes.

(from "Guide to International Finance" by Alen M.)