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— CH. 1 · ORIGINS AND INVENTION —

Value-added tax

~4 min read · Ch. 1 of 7
7 sections

  • German industrialist Georg Wilhelm von Siemens proposed the concept of a value-added tax in 1918 to replace the German turnover tax. The proposal sat dormant for decades until Maurice Lauré, joint director of the French tax authority, implemented VAT on the 10th of April 1954 in France's Ivory Coast colony. Assessing the experiment as successful, France introduced it domestically in 1958. Initially directed at large businesses, it was extended over time to include all business sectors. In France it is the largest source of state finance, accounting for nearly 50% of state revenues.

  • Following creation of the European Economic Community in 1957, the Fiscal and Financial Committee set up by the European Commission in 1960 under the chairmanship of Professor Fritz Neumark made its priority objective the elimination of distortions to competition caused by disparities in national indirect tax systems. The Neumark Report published in 1962 concluded that France's VAT model would be the simplest and most effective indirect tax system. This led to the EEC issuing two VAT directives, adopted in April 1967, providing a blueprint for introducing VAT across the EEC. Other member states including Belgium, Italy, Luxembourg, the Netherlands and West Germany introduced VAT following these directives. As of January 2025, 175 of the 193 countries with UN membership employ a VAT, including all OECD members except the United States.

  • VAT can be accounts-based or invoice-based. All VAT-collecting countries except Japan use the invoice method. Using invoices, each seller pays VAT on their sales and passes the buyer an invoice that indicates the amount of tax paid excluding deductions. Buyers who themselves add value and resell the product pay VAT on their own sales. The difference between output tax and input tax is the amount paid to the government. Using accounts, the tax is calculated as a percentage of the difference between sales and purchases from taxed accounts. A manufacturer spends $1.00 on raw materials and uses them to make a widget. The manufacturer sells the widget to a retailer for $1.20. The retailer sells the widget to an end consumer for $1.50. Under a 10% Value-Added Tax scheme, the taxes paid by both the manufacturer and the retailer to the government are 10% of the values added by their respective business practices.

  • VAT raises about a fifth of total tax revenues worldwide and among the members of the Organisation for Economic Co-operation and Development (OECD). In Bangladesh, VAT became the largest source of government revenue, totaling about 56%. Chile's VAT makes up 41.2% of the total revenue of the country. China's VAT produces the largest share of its tax revenue. In Sweden, reducing VAT on restaurant meals from 25% to 12% created 11,000 additional jobs. The system generates substantial revenue while maintaining economic neutrality regarding production decisions.

  • VAT has been criticized by opponents as a regressive tax, meaning that the poor pay more, as a percentage of their income, relative to the wealthier individuals. An OECD study found that VAT could even be slightly progressive. Defenders reply that relating taxation levels to income is an arbitrary standard. VAT's effective regressivity can be reduced by applying a lower rate to products that are more likely to be consumed by the poor. Some countries compensate by implementing transfer payments targeted to the poor. For instance, Japan applies a rate of 8% to food, beverages, and newspaper subscriptions with certain criteria, while the standard rate remains at 10%.

  • The main disadvantage of VAT is the extra accounting required by those in the supply chain. In the UK, compliance costs for VAT have been estimated to be about 4% of the yield, with greater impacts on smaller businesses. Under a sales tax system, only businesses selling to the end-user are required to collect tax and bear the accounting cost. Under VAT, manufacturers and wholesale companies also incur accounting expenses to handle the additional paperwork required for collecting VAT. This increases overhead costs and prices. Businesses must document purchases to make them eligible for a VAT credit through registration.

  • VAT offers distinctive opportunities for evasion and fraud, especially through abuse of the credit and refund mechanism. VAT overclaim fraud reached as high as 34% in Romania. Exports are generally zero-rated, creating opportunity for fraud. In Europe, the main source of problems is carousel fraud. This fraud originated in the 1970s in the Benelux countries. VAT fraud then became a major problem in the UK. To avoid this, countries such as Sweden hold the major owner of a limited company personally responsible. The government creates a trail of information for every transaction to help motivate compliance and facilitate any potential audit.

Common questions

Who proposed the concept of value-added tax in 1918?

German industrialist Georg Wilhelm von Siemens proposed the concept of a value-added tax in 1918 to replace the German turnover tax.

When did Maurice Lauré implement VAT in France's Ivory Coast colony?

Maurice Lauré implemented VAT on the 10th of April 1954 in France's Ivory Coast colony after assessing the experiment as successful.

What percentage of state revenues does VAT account for in France?

In France, value-added tax is the largest source of state finance and accounts for nearly 50% of state revenues.

Which countries introduced VAT following the EEC directives adopted in April 1967?

Other member states including Belgium, Italy, Luxembourg, the Netherlands and West Germany introduced VAT following these directives.

How much VAT revenue does Bangladesh generate compared to other countries?

In Bangladesh, VAT became the largest source of government revenue totaling about 56% of total tax revenues worldwide.

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