VAT is a modern tax; as of 2018, over 160 countries have a VAT. Some countries refer to the tax as General Sales Tax (GST) or Goods and Services Tax (GST) published by IMF (2020)
VAT is a broad-based tax on the consumption of goods and services. The tax liability arises at transactions taking place at each stage of the production process, irrespective of the use of the good or service. Hence, it includes transactions from business to business (B2B) and from business to consumers (B2C). When the purchased goods or services are subsequently used by businesses as intermediate inputs into production, the tax paid on these inputs is credited. This ensures that only the value added in each production stage is ultimately taxed. This avoids cascading—imposing tax on taxes—an effect associated with other indirect taxes such as turnover taxes and which can create significant economic distortions. VAT is thus effectively levied only on final consumption, as no credits are provided to final consumers of goods and services.
VAT is an ad-valorem tax, since the tax due is calculated by multiplying the rate by the value of the transaction. Many choices must be made in designing and implementing a VAT. This explains the important differences between VATs across countries.
The diagnostic framework that follows draws significantly on the seminal work by Liam Ebrill, Michael Keen, Jean-Paul Bodin, and Victoria Summers (2001), The Modern VAT (Washington, D.C.: International Monetary Fund).
