Value-added Taxes: What Are They and What Power Do They Really Hold?
Value-added taxes (VATs) are a form of corrective taxation applied to virtually every good and service that is either sold or bought in the European Union. Assessed incrementally on the value added to goods and services, a VAT is a general, broadly based consumption tax. “Value-added” refers to the increase in value that a firm adds during production to materials and services purchased from other firms. Therefore, a tax on the “value-added” of all market participants applies to all commercial activities and involves each stage of production, distribution, and sale. That being said, the burden of the tax is ultimately only borne by the final individual(s) in the transaction as the heightened price gets passed down each step along the consumption chain. VATs are extremely important to the functioning of the European Union because they make it possible to pay back the exact amount of tax at the point of export which, in turn, enables a degree of tax neutrality. Without this neutral and transparent tax system, there would be no way to maintain an efficient, single market in the EU.
A study conducted by the Economics Department at Tulane University in 2012 sought to determine whether VATs proved effective in altering rates of consumption. Their experiment used a sample of fifteen countries within the EU, looking at annual data from years 1961-2005 that included real household consumption expenditures, real household consumption expenditures per capita, real GDP, real GDP per capita, inflation, total population, elderly population, and the consumer price index. Their empirical results indicated that a one percentage point increase in the VAT rate corresponds to a roughly one percent reduction in the level of aggregate consumption in the short run and an even larger reduction in the long run. Their findings also concluded that higher VATs encouraged savings and generated higher economic growth in the nations that imposed them. Knowing that the price of a VAT is negatively correlated to the level of per capita private consumption of a specific good or service, it becomes clear how the act of raising VATs can, and sometimes is, used to direct consumption in a certain direction.
These findings lend themselves to a question that is frequently debated among economists and policymakers alike: knowing the potential of value-added taxes, or of any corrective tax, in altering consumer habits, how can we use them to accomplish our goals as a society. As we find ourselves in a world that is being increasingly focused on climate change ventures, could corrective taxes help us make our markets more sustainable? Is taxation the most efficient way for us to influence market behavior? Is it the most equitable? While individuals may find themselves on one side of the debate or the other, only time will tell what happens when we attempt to hone the power implicit in taxation.
By: Natalie Martin
