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In the United States, most consumers are used to paying a sales tax - a couple of percentage points per dollar of goods sold - that are used to fund government. By contrast, Europeans pay a "VAT" - a value added tax - a more complicated scheme by which each time a product changes hands in the business development cycle, a portion of the added value is taxed and used for funding.

What is the benefit of doing this?

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It's simply another solution. You have to organize tax system in some way, and there are many ways to achieve that.

The main idea behind VAT tax is that you never pay it twice. You're obliged to pay the VAT as soon as you have issued an invoice, but you can substract from that sum the VAT you've paid to you supplier etc.

There are 2 alternate solution, paying a tax based on sales - than each time the product changes the owner, the tax have to be paid in full sum. Such solution makes outsourcing less profitable, and long supplier chains completely unprofitable.

Second is to tax only when the product is sold to private person - end consumer. It promotes outsourcing, such as VAT, but the problem is as long as the good is in storage, the tax is not paid.

VAT joins the benefits on both of those systems. The tax is never paid twice, but it is paid on each production level as soon as the invoice is issued, so it provides constant cash flow to the government.

You're asking for benefits only, but there are also big disadvantages. VAT is relatively easy to collect, but expensive to pay - because of the complications, many even small companies are forced to hire an accountant. It is also vulnerable to fake invoices, there are organised crime groups which are specialized in taking money from government because of fake invoices - because VAT works so, that if you have paid to you contrahents more as you are about to pay, the government pays you back the difference.

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In the US there are thousands of jurisdictions levying sales tax.

In Europe VAT is always paid to the same taxing agency, thus the value added accounting is relatively simple. Worst case you buy in EU country X and sell in EU country Y, but most of the businesses operate within the same country. Only one taxing agency to talk to.

In the US a business can buy in Los Angeles and sell in New York City, thus the VAT accounting would be between the following entities:

  1. The County of Los Angeles (sales tax rate of 1.5%)
  2. The State of California (sales tax rate of 7.5%)
  3. The State of New York (sales tax rate of 4%)
  4. The City of New York (sales tax rate of 4.875%).

Add to that potential Federal accounting (currently there's no Federal sales tax or VAT).

The benefit of VAT in Europe on the other hand is simplifying the compliance. Businesses do not need to check exemptions and such, and always charge and remit the differential VAT, thus ensuring the VAT is properly collected. The Wikipedia article explains this point very well.

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    To whoever who downvoted - I'd like to hear your objections. If something is incorrect - do point it out please. – user1413 Jan 25 '13 at 20:22
  • I did not downvote, but @lechlukasz hits the point much better: having only the final customer actually pay the tax. – o0'. Jan 26 '13 at 17:33
  • This is a good answer (I actually +1d) and had a difficult time choosing. I liked both, but decided ultimately the other categorized the advantages (and disadvantages) slightly better. – Affable Geek Jan 27 '13 at 16:04

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