VAT vs. Sales Tax: 4 Differences Between VAT and Sales Tax

Sales tax and value-added tax are two different methods of tax collection for inside and outside the United States, respectively.

What Is VAT Tax?

A value-added tax, or VAT, is a consumption tax levied at each stage of the supply and retail chain to generate government revenue for a country. VAT adds a tax at every stage of production from the purchase of raw materials, to the assembly of those materials. The sum of the value-added at each point of sale is tacked on to the final retail sale price, making the end-user responsible for the entirety of the VAT. Each wholesaler, producer, or retailer in the supply chain adds their applicable percentage of VAT tax to a sale in order to be reimbursed from the previous step in the supply chain. Specific goods are eligible for a reduced rate or exemption, like children’s clothes and groceries.

Unlike US sales tax or use tax, the rate of VAT is determined by the national government of a country rather than the states. VAT is a flat tax across the board, unlike the progressive income tax system which charges people with higher incomes higher income tax rates. One criticism of this tax policy is that lower-income individuals end up spending higher proportions of their earnings on goods. On the other hand, VAT increases tax accountability at every level of the supply chain and prevents tax evasion.

What Is Sales Tax?

In the US, sales tax is when a percentage fee is applied to the price of goods and services at the point of sale. It is a form of consumption tax—a general sales tax applied to the purchase of goods or services—in which the product’s end-user is subject to the tax. Sales taxes are applicable wherever the business—whether a private small business or a delivery hub for a large corporation—has a sales tax nexus, which is a physical presence or volume of sales in a particular jurisdiction. State and local authorities levy taxes on a business location that falls within their tax jurisdiction, but sales tax is not applied at the federal level.

Most consumer goods bought at retail stores—like clothing and accessories—are subject to sales tax, in some states over a certain amount. In some states, certain goods like prescriptions and groceries intended for home use are exempt from sales tax. Each state can impose its own regulations on the amount of sales tax that must be collected and remitted to the appropriate taxing authority. Outside of the US, excise taxes or a value-added tax (VAT) are applied instead of conventional sales tax.

How Does a Value-Added Tax Work?

A value-added tax code works by using a flat tax rate to add an extra fee at each stage of a good’s production. If a country’s value-added tax rate is 10 percent, then the government gets to collect 10 percent of every transaction in the supply chain, from the exchange of raw materials to the final sale.

Although a tax is paid at every level, each subsequent taxpayer reimburses part of the previous taxpayer’s load, which makes the end consumer responsible for the net economic burden of the entire transaction. This system provides documentation for all transactions which makes it easier to hold everyone in the distribution chain responsible for their amount of VAT, which encourages wholesalers and producers to follow tax law.

How Does US Sales Tax Work?

In the United States, sales tax liability varies by state as well as which goods are included or exempt from sales tax. In general, the seller is responsible for levying the tax on the consumer, which is then remitted to state or local tax authorities. Here are some examples of the varying state sales tax methods.

  • Seller or vendor privilege tax states: Vendor or seller privilege states will tax the seller for the privilege of doing business within a state. The business can either pay their own sales tax—also known as absorbing the tax—or pass the tax along to the consumer. In vendor privilege tax states like Michigan, Missouri, and South Carolina, businesses are allowed to absorb the sales tax. However, in privilege tax states like Connecticut and Kentucky, the seller is legally obligated to tax the consumer at the point of sale.
  • Consumer tax states: Consumer sales tax is when a tax is applied to a consumer during a retail sale. The customer is responsible for consumer retail sales taxes with the seller collecting the tax on behalf of the state government. In most consumer tax states like Vermont, West Virginia, and Oklahoma, sellers are prohibited from absorbing the tax.
  • Transaction tax states: Transaction tax states like Colorado, Florida, Georgia, and Illinois hold both the buyer and seller responsible for paying the sales tax, though in Colorado it is illegal for the seller to absorb the tax, whereas in Georgia it is legal.
  • Gross receipts tax (GRT) states: States that do not charge income tax, like Washington and Delaware, will calculate a GRT which is a state tax on the gross sales of a business rather than charge sales tax. In the United States, sales tax liability varies by state as well as which goods are included or exempt from sales tax. In general, the seller is responsible for levying the tax on the consumer, which is then remitted to state or local tax authorities. Here are some examples of the varying state sales tax methods.

What Is the Difference Between VAT Tax and Sales Tax?

VAT and sales tax are two distinct systems for determining how and when taxes are collected, with the tax burden ultimately falling to the final consumer. Here are the ways that VAT and sales tax differ.

  1. National vs. district rates: One of the main differences between a VAT and a retail sales tax is that a VAT is a flat tax rate across the board—everyone pays the same percentage regardless of income—which is set by the national government. Sales tax rates are determined by state and local governments instead of the federal government. This means that the amount of tax varies widely between states and districts in the US, while the VAT rate stays constant.
  2. When the tax is owed: A VAT is due at each stage of the production process, while a sales tax is only applied at the final sale. Those who pay a value-added tax—with the exception of the end-user—will use VAT on their subsequent sales to reimburse themselves for previous VAT tax from an earlier transaction. A US retailer applies the state and local sales taxes to the purchase price of the product only at the point of sale, then remits that amount to the tax authorities.
  3. The amount of documentation: VAT requires strict documentation for every transaction which makes it easier to hold entities in the supply chain accountable for tax revenue. This can reduce the possibility of tax evasion. Since sales tax is only applied at the end of the supply chain, it’s harder to track throughout the process. Even if avoidance occurs during the VAT process, only the tax revenue for that production stage would be lost, rather than the entire retail sales, as is the case with sales tax.
  4. Location: With the exception of the United States, all member countries of the Organization for Economic Co-operation and Development (OECD)—including the United Kingdom, Canada, France, Germany, Denmark, Japan, and Korea—as well as over 100 additional countries, use a VAT system to collect tax revenue on the sale of goods and services. The United States relies on sales tax to generate state and local revenue from the sale of goods and services.