A direct tax on individuals that is measured by their level of consumption rather than their income is commonly referred to as a cash-flow or consumption-based income tax. Most taxes on consumption are indirect taxes. These taxes are collected by sellers of taxable goods and services and are expected to be borne by final consumers of those goods and services. The indirect tax on consumption may take the form of a single-stage tax such as the retail sales tax or a multistage tax such as a value added tax.
A value added tax is a generic name associated with a multistage tax that is levied on the value added by each business firm at every stage of production and distribution of goods and services. In part, the description of a VAT depends on the method used in calculating tax liability. In this chapter, there is a discussion of the addition, sales-subtraction, and credit-subtraction methods of calculating VAT liability.
The legislature may alter a VAT base by removing some sellers or some goods and services. This alteration of tax base is accomplished by providing an exemption for designated businesses (such as small businesses) or entities, such as units of government or nonproi t organizations. The legislature also can alter the tax base by granting exemption or altering the rate for particular goods and services, regardless of the nature of the seller. This chapter also discusses these various methods of providing special treatment under a value added tax.