Value-Added Tax (VAT): What It Is, How It Works

Value-added tax (VAT) is a tax on goods and services, not unlike a sales tax but with some major differences. While the U.S. doesn’t levy a VAT, this type of tax exists in many other countries.

Both sales and value-added taxes are a tax on the consumption of goods and services, as opposed to an income tax. But how these taxes are collected is different: VAT is applied at multiple stages of production and distribution, while sales tax is collected at the final point of sale.

As a consumer, paying VAT vs. sales tax will feel quite similar. The key difference is how VAT impacts businesses and governments behind the scenes. While VAT is often seen as more complex, proponents say it can reduce tax evasion and create more revenue stability.

What is value-added tax (VAT)?

Rather than solely taxing the final transaction — as is the case with sales tax — VAT is collected at multiple stages as a good or service moves through production and into the market.

VAT is assessed, collected and remitted to the government whenever value is added, including during manufacturing and distribution. When the product is ready to sell, the business conducting the sale will collect VAT from the consumer but will deduct VAT already paid on product inputs during previous stages, remitting what’s still owed to the government.

Consumers still ultimately bear the cost of VAT in the final transaction, just as they do with sales tax. However, this structured collection process distributes the tax reporting duties among the businesses involved at every stage, ensuring more consistent government revenue and reducing tax evasion.

Currently, 175 countries use a value-added tax (or a goods and services tax known as GST, which is similar to VAT) as their form of consumption tax, according to a report by VATCalc, a research company based in Belgium and the U.K.

The United States is in a small minority of countries, currently totaling 19, that use sales tax instead of VAT.

VAT rates around the world

VAT rates are typically managed and enforced at the national level, rather than regionally or locally. In Europe, many countries’ VAT rates range from about 20 to 25 percent, but outside of Europe, VAT rates tend to be lower, generally between 10 and 20 percent, according to 2025 data from Global VAT Compliance, a Netherlands-based consulting firm.

However, a country’s VAT rate is not always standard across all products, and many countries offer reduced VAT rates on some essential goods.

For example, the United Kingdom applies a standard VAT rate of 20 percent to most consumer goods and services, while certain items, such as children’s car seats and home energy, qualify for a reduced rate of 5 percent. Other goods, including children’s clothes and most food items, have no VAT at all. See this U.K. government page for more.

Example: How does a value-added tax work?

To get a better idea of how a VAT works, consider the following example. Let’s say you’re traveling in France and stop at a souvenir store in Paris to purchase a T-shirt. The standard VAT rate in France is currently 20 percent. The following stages of taxation occur:

1. The T-shirt manufacturer purchases the fabric for 1 euro to make the shirt and needs to pay a VAT of 0.20 euro for the raw material purchased. So far, they have spent 1.20 euros.
2. The manufacturer sells the T-shirt to a French souvenir shop for 5 euros plus the VAT of 1 euro — which is the 20 percent VAT tax, due to the French government — for a total of 6 euros. The manufacturer only pays the French government 0.80 euro of the 1 euro since it paid 0.20 euro in VAT for the raw materials already.
3. When you purchase the T-shirt from the souvenir shop, you pay 12 euros for it, which is the 10 euro cost plus 20 percent VAT. The souvenir store will be responsible for paying a VAT tax of 1 euro since it collected 2 euros in VAT from the customer but had already paid 1 euro in VAT when purchasing the T-shirt wholesale.

As you can see, VAT is more complex than a traditional sales tax, requiring businesses to collect and pay taxes at multiple stages.

Value-added tax vs. sales tax

Many Americans are not familiar with value-added tax because it doesn’t exist in the U.S.

Instead, the U.S. relies on a sales tax system at the point of purchase — a system that operates primarily at the state and local level.

Sales tax is fairly simple to understand. In nearly all cases, the price you see for an item or service will be subject to an additional cost for sales tax, calculated as a percentage of the item’s price. Therefore, the $10 shirt you buy will cost you $11 at the register when you add a 10 percent sales tax. In contrast, many foreign countries build the VAT tax into the price tag.

Sales tax can vary by city or state. Value-added tax is typically the same throughout a country. For example, the VAT in Spain is generally 21 percent, while in France it’s 20 percent.

Sales tax is paid for by the end consumer when the finished good or product is sold. In the case of value tax, it is levied and collected at each stage of the supply chain, starting with the purchase of the raw materials, through distribution and sale. That means both businesses and individuals are paying VAT, instead of putting the full burden on the consumer.

Each system has its pros and cons:

• Government revenue: A VAT system generally ensures steady government revenue since it’s collected at multiple points in the supply chain. In contrast, sales tax is applied only at the final transaction, which tends to make revenue less frequent and more susceptible to fluctuations based on consumer spending.
• Tax evasion: A VAT system creates a detailed audit trail, which may minimize tax evasion by requiring businesses to report taxes at each stage of production and distribution. Sales tax, on the other hand, can allow business-to-business transactions to go untaxed via resale certificates or exemptions. With only a single collection point at the final transaction, sales tax systems may be more prone to tax evasion.
• Administrative costs: A VAT requires businesses to keep detailed records and report tax at multiple stages, which can be costly and burdensome. Sales tax, which is collected only at the final point of sale, is generally easier and cheaper to manage.
• Tax implementation: VAT rates are usually set at the national level. The U.S. sales tax system varies by state, with additional sales tax potentially applied at the city or county level. However, some states, including Oregon and New Hampshire, don’t impose a sales tax at all.