What Is VAT and How Is It Calculated?
Learn what VAT is in one simple sentence, how the calculation works, what rates apply around the world, and who ultimately pays it.
VAT in One Simple Sentence
VAT, or Value Added Tax, is a consumption tax added to the price of goods and services at each stage of production and sale, ultimately paid by the end consumer. It is the European and international equivalent of what many Americans think of as sales tax, though the mechanism of collection differs.
Unlike US sales tax, which is only collected at the final point of sale to a consumer, VAT is collected at every step in the supply chain. A manufacturer pays VAT on raw materials. A wholesaler pays VAT on goods purchased from the manufacturer. A retailer pays VAT on goods purchased from the wholesaler. But businesses can reclaim the VAT they paid on their inputs, so the burden accumulates and is ultimately borne by the end consumer.
Most countries that use VAT display prices inclusive of VAT already, so consumers see the final price on the shelf. In the United States, sales tax is typically added at checkout, which is why American travelers in Europe are sometimes surprised that the price on the tag is the price they actually pay.
How the VAT Calculation Works
Adding VAT to a price is simple. Multiply the pre-tax price by one plus the VAT rate expressed as a decimal. If an item costs $100 before VAT and the VAT rate is 20%, the calculation is $100 times 1.20, which equals $120. The $20 is the VAT amount, and $120 is the VAT-inclusive price.
Removing VAT from a VAT-inclusive price requires dividing the gross price by one plus the rate. If you paid $120 for something in a country with 20% VAT and want to know the pre-VAT price, divide $120 by 1.20, which gives you $100. The VAT amount is the difference: $120 minus $100 equals $20.
Businesses that are VAT-registered collect VAT on their sales (output VAT) and pay VAT on their purchases (input VAT). They remit the difference to the government. If a business collected $5,000 in output VAT and paid $3,000 in input VAT on its purchases, it owes the government $2,000. This mechanism is why VAT does not cascade or compound the way a turnover tax would.
VAT Rates Around the World
VAT rates vary significantly by country. In the European Union, the standard rate must be at least 15% by regulation, though actual rates are higher. The United Kingdom has a standard rate of 20%. Germany and France use 19% and 20% respectively. Scandinavian countries like Sweden and Denmark apply 25%. Hungary has the highest standard rate in the EU at 27%.
Most countries that use VAT also have reduced rates for essential goods. In the UK, food for home consumption, children's clothing, and books are zero-rated — meaning VAT is technically applicable but at 0%. Medical supplies and public transport often carry reduced rates. These exemptions and reduced rates reduce the regressive nature of consumption taxes.
The United States does not have a federal VAT or national sales tax. Sales taxes in the US are levied at the state and local level, vary by jurisdiction, and are collected only at the point of sale to the final consumer. Countries like Canada use a hybrid system called GST/HST that has both VAT-like and sales-tax-like characteristics.
Who Actually Pays VAT in the End
The end consumer ultimately bears the full cost of VAT. While businesses collect and remit it at each stage of production, they recover the VAT they paid on their inputs. Only the final consumer — the person who buys the product or service without reselling it — cannot reclaim the VAT. The consumer pays the full accumulated VAT embedded in the final price.
This makes VAT regressive in the sense that lower-income households spend a larger proportion of their income on consumption and therefore pay more in VAT relative to income. Governments mitigate this by exempting or zero-rating necessities like basic food, healthcare, and children's clothing.
Tourists visiting countries with VAT often can reclaim the VAT paid on goods they take home, through programs at airports and border crossings. In the EU, non-resident visitors can typically reclaim VAT on purchases above a minimum threshold. This is why you sometimes see VAT refund services advertised in international airports and duty-free shops.