A value-added tax, or VAT, and a sales tax are similar in that both increase the price that consumers pay for goods and services. The difference is in how and when the money is collected.
A sales tax is levied on the final sale price of a product. It is paid by the buyer at the time of purchase, and the seller passes the money on to the government.
Sales Tax Example
If there is a 5 percent sales tax on clothing, a shirt with a price tag of $50 will actually cost you $52.50.
A VAT is levied on the amount of value added in each step of the production process. The money is paid directly to the government, and the cost is passed on to the consumer as part of the final price.
During production of a shirt, VAT would be paid by the textile mill that turns cotton into fabric, by the plant that dyes and finishes the fabric, by the factory that assembles the shirt and by the fashion company that puts its brand on the garment. The shirt is not sold "plus tax," but the cost of the taxes is reflected in a higher price tag.
The VAT is in use around the world, but the idea has never gained traction in the United States, according to a 2010 Fortune magazine article by Shawn Tully titled "VAT Trap: The inevitable fix for the deficit."
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.