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Can it be true?  Did I read that right?  Can you imagine purchasing an item and paying a 21% tax on the purchase price? Not only is it not an ordinary sales tax; but a value added tax.  The citizens of Spain found out today that their value added tax was going from 18% to 21%–a 3% increase.  What’s the difference between a sales tax and value added tax?

A sales tax is a tax based on the purchase price that an end consumer pays when they purchase an item.  A value added tax is a taxed that is added onto a product’s cost during the manufacturing of the item which increases the value of the item.  Value added tax and the sales tax are both consumption taxes.  Let’s take a closer look at the difference between the two taxes.

Example

An item is produced in 2 stages.  During the first phase of production, the cost to produce the item is \$100.  The second phase the final cost to products the item is another \$100.  The consumer’s or retail price of the item is \$250 due to competition.

Under the value added tax, the tax is added each time the product is created which brings the production cost of the item to \$242.

1st Cost                                      \$100

Value added tax  (first cost)     \$21

2nd Production Cost               \$100

Value added tax (Second cost)  \$21

Total Production Cost            \$242

Company Profit                           \$8

Cost to Consumer                  \$250

Total Cost to Consumer with the tax \$302.50

Total Value Tax Collected by the Government – \$94

Under the Sales Tax, it is much simple to calculate the tax:

Cost   – \$200

Sales Price – \$300

Company Profit – \$100

Consumer Price – \$250

Sales Tax  (21%)   \$52.50

Total Sales price with Tax:   \$302.50

Total Sales Tax Collected by the Government \$52.50

\$94.50 vs 52.50.  The government will bring in \$42.00 more in tax revenue under the value added tax than the sales tax.  There are some people who would like to replace the U.S. income tax with a National Sales Tax or a Value Added Tax.  Where I live in Tennessee, the sales tax is 9.25% which some people consider to be high.  At the same time; however, Tennessee does not have a true income tax on wages.  The State does have a tax on investment income (Dividends, capital gains, interest, etc.) of 6% with a \$2,500 married exemption or \$1,250 single exemption.  For me, a 9.25% sales tax is a better deal than 21% value added tax and/or income tax.  Which do you prefer a value added tax, sales tax, or income tax?  I am sure the citizens of Spain are not too thrilled about \$1 out of \$5 going for taxes.  Do you think increasing the value added tax will decrease Spain’s economy further?

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