"Whenever we buy something in a store, we can see on the receipt that VAT is added to the net sale price. However, VAT is not levied only on sales to final consumers: it also applies to all preceding transactions in the supply chain between businesses, reminiscent of a turnover tax. Without adjustment, this would cause cascading of taxes (payment of tax on tax), which creates major economic distortions.
To avoid this, VAT uses a crediting mechanism, whereby businesses have the right to credit VAT paid on their business inputs (input VAT) against the VAT collected on their sales (output VAT). VAT thus sticks only with final consumers."
The article was prepared and published in Finance&Development magazine (March, 2022 issue) of the IMF. Click here to access the full version.
Source: RUUD DE MOOIJ, ARTUR SWISTAK, FINANCE & DEVELOPMENT, March 2022
Illustration: ISTOCK/RASTUDIO