Before discussing how the VAT actually works, I want to say that this discussion is not to support the VAT IN ADDITION to other taxes. That is a separate threat and a separate question.

The VAT isn’t compounded or added into the price of the product at each level as you portray. It is true it is collected at every level (see below for why), but if any product is resold, the seller subtracts the VAT the seller paid from the VAT the seller collects, thus effectively REFUNDING the VAT to the current seller. To use your numbers,
If you have to pay a 10% VAT tax on the raw materials, the cash cost of production goes from $1,000 to $1,090. My cost breakdown is thus, approximately:

Labor: 9.2% = $100
R.M. 1: 45.4% = $450 + $45 VAT
R.M. 2: 45.4% = $450 + $45 VAT

So far it looks the same. The error is in the next step. You DON’T need to sell the product at $1,560 to keep your margin. INSTEAD, you sell it at the same $1,430, and collect a VAT of $143. THEN you subtract AND KEEP the $90 of VAT you paid, sending only $53 to the tax collector. So now you are only out of pocket the original $1,000, and you have maintained your 30% margin.

Undoubtedly you will protest that your financing costs have gone up for the period the government had your $90, so you need a slightly higher profit margin. However that is far less than the compounding 10% you claimed in your post.

So, why would you even want to have any added cost? If it is in addition to an income tax, you wouldn’t. BUT, if it is INSTEAD of the income tax you might. (Personally I would prefer a 25% VAT on expenditures over a 35% income tax on income.) Consider the following “good” points about a VAT INSTEAD of an income tax.

1. Even a (mechanical) clock that won’t run is right twice a day, so just because the Europeans use it doesn’t necessarily mean it is bad. The Europeans use VAT because it is regarded as the most difficult tax to cheat on (and they know a lot about cheats). All illegal aliens in Europe still pay VAT. Criminals pay VAT. All illegal aliens (or legal aliens or citizens) do not pay the income tax they owe. By making cheats (legal and otherwise) pay the tax, a lower rate will raise the same funding. (The current tax cheating is estimated in the 10s of Billions per year.) Even it this doesn’t result in lower rates, at least it should give a lower deficit.

2. The VAT taxes consumption rather than production and does not require self reporting or detailed auditing of citizens. (On this it is the same as a sales tax.) In short, it protects liberty.

3. Under present law, a U.S. manufacturer exporting an article (say a car) to Europe pays income tax on its earnings and the Europeans pay VAT on the car. Thus the U.S. value of the car is taxed twice. However, a European car manufacturer receives a refund of all VAT taxes paid in production, and is not subject to any income tax. Thus, the European value of a car imported to the U.S. goes untaxed. This is one reason for moving manufacturing jobs overseas. It lets the costs of manufacturing for the U.S. market go untaxed. A VAT would thus help retain American employment AND protect American manufactures from foreign competition.

4. A VAT taxes everyone, not just the most productive. Right now about half of Americans pay no net income tax after considering all of the refundable and non-refundable social policy credits. Under a VAT, everyone pays their share. (Progressives call a fair share tax “regressive” because lower incomes spend a higher part of their incomes than upper income people. However, the tax itself is exactly proportionate and fair if taxes are to be measured by what you take out of society.)

5. A VAT is transparent in its impact. By law (using the current implementations of VAT in other countries) the VAT MUST be separately stated a receipt given on every transaction. Thus the buyer clearly sees how much of his or her money is going to taxes, and it is clear that only consumers actually pay any tax. With an income tax, the tax is mostly hidden since you can’t see how much of the cost of goods is going to pay corporate income tax, and most taxpayers don’t notice how much tax is being withheld from paychecks.

6. As a direct result of 5, it is harder to raise a VAT rate than an income tax rate.

7. A VAT can be used to advantage “good” products and disadvantage “bad” products (think vegetables vs candy), but can not be used to reward Democrats over Republicans or any other favored vs unfavored groups, and therefore is less suitable to political vote buying.

8. Some implementations of VAT do not require small vendors to register and pay. This gives a slight advantage to start up and family companies. (The advantage isn’t as big as it may seem because they still pay VAT on what they buy, so the savings is only on the value that is added by the small company.)

Having listed these favorable characteristics, let me again say that the VAT must be INSTEAD of the income tax for these benefits to be more valuable than the overall increase in taxes which an additional tax would produce. And if I haven’t persuaded you, thank you for at least reading this far. At least you have something to think about.

Apparently most of the commentators didn’t read the following statement in the article the original post was referring to.

“As a substitute for the income tax, the VAT would be a splendid idea. Taxing consumption makes infinitely more sense than taxing work. But to feed the liberal social-democratic project, the VAT must be added on top of the income tax.”

A sales tax is applied only on the “last sale” in the chain of commerce. A sales tax is more simple, but it is easier to cheat under the sales tax, which is why all of Europe uses a VAT.

For example, if the final seller alone is dishonest, (i.e., he or she sells the product but does not report it, or simply withdraws it from inventory for personal or friend use) the full tax is lost under a sales tax. Under a VAT, only the last lay of tax is lost. Furthermore, it is harder for intermediate suppliers to cheat because they have to give receipts which will be used to reduce taxes later. If any suppler doesn’t report VAT on intermediate sales, the receipts can bring him to the attention of the authorities.

A full explanation would require too much space, but this should give you enough idea to trust the European decision on this matter.

Reduced cheating spreads the tax over everyone, which means you pay less to give the same amount of revenue to the government.

Unfortunately, neither tax by itself keeps the government from wanting to spend everything the economy can produce plus a little more. But that is true of every kind of tax.

Since any given sale (even food at a grocery store) could be a cost of goods sold for something else, the VAT can only work if it is SEPARATELY STATED so the buyer can establish the amount to deduct on the subsequent sale.

You don’t seem to have understood the the intermediate levels of VAT are REFUNDED. The government doesn’t get to keep more than the final VAT. So the is NO COMPOUNDING. The is NO HIDDEN tax. I can’t say it any more clearly.

But maybe you will be more accepting of the opinion in the original article on which the original post is based. Charles wrote:

“As a substitute for the income tax, the VAT would be a splendid idea.” (Its a cut-and-paste from page 2.)