Value added tax (VAT) is an indirect tax on consumption, it is a type of tax which replaces the consumption tax (tax on the sale price paid by consumers). VAT applies to economic activities and is exercised independently. Thus, the employees are not subject to value added tax as they are subordinate to their employers
Consumers of products and services are not in a position to recoup value added tax (VAT), however business entities can recover VAT so as to produce more goods. As such, the entire tax charged at every point in the supply chain constitutes a portion of the value added by a business to its products.
Value added tax (VAT) was initiated due to the fact that high sales taxes induce smuggling and cheating. However, its opponents contend that it disproportionately hikes taxes in respect of middle and low income earners.
In essence, this kind of tax has two major drawbacks; VAT is difficult to control because it is based only on the statements of the trading firms, which they may simply defraud by undervaluing total sales.
And the tax is paid as many times as there are intermediaries, which has many harmful effects which include stimulating inflation and dissatisfied consumers, who pay the final price thus integrating multiple taxation.
The idea of VAT is to allow intermediaries to obtain a refund of VAT paid to their suppliers, the so-called recovery of VAT. Compared to the old taxes, this system has advantages in terms of fairness and simplicity, while providing the state with a good performance.
VAT is an indirect tax on consumption, which gives it more features that can be seen as defects from a certain point of view. By definition, it weighs more on an economic agents consuming a larger fraction of their income. The charge is associated with weighing heavily on the poor, who consume a large portion of their earnings than the rich who can afford to save more.
And it does not entail a tax redistribution: the rate paid is the same for all, regardless of income. VAT is criticized by some political forces that prefer progressive taxes. For businesses, even if they do not pay value-added tax directly, it increases the final price of the item, thus reducing their market potential.
For the state, the tax generates revenues which depend on consumption, hence the importance of economic flows (not the stock of wealth available). This puts the public finances in line with economic activity (they mechanically increase with growth, diminishing resources and vice versa in case of recession) which can be seen as a disadvantage.