The value added tax (VAT) was created in France in the 1930s, with the aim of avoiding an effect called a cascade, which is the accumulated collection of taxes at different stages of product production. This system was successful and soon spread to Europe and America.
What is Value Added Tax (VAT)?
The Value Added Tax, known as VAT, is a proposal to simplify the taxation on consumption in just one tax, that is, to concentrate in one tax all the charges that would exist in the consumption cycle. Several taxes affect consumption, which causes: i) confusion for companies, which need to pay different rates (percentage that affects the value of the product) of different taxes and on different dates; ii) generates a double taxation, which is a taxation that occurs twice (or more).
As a result of this repeated taxation, the value of the product becomes more expensive, burdening the population, especially the lower economic classes. The idea of adding taxes to just one is to avoid this repetition of charges and simplify the process. Check out further VAT Threshold guide for more details.
The cascade effect
The ripple effect is the collection of taxes on other taxes. This happens when a tax is levied on the value of a product that has already been taxed in previous steps. For example: a product costs $5 and $2 of taxes are charged on its production, totaling its value at $7, to be levied on $5 – which would be the real amount – it is levied on $7, causing double taxation, that is, taxation occurs twice.
This effect ends up burdening the consumption of lower class families, as different from Income Tax – whose rate varies according to income – consumption taxes are levied in the same way for the entire population.
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