GST or Value Added Tax (VAT) is tax on exchanges. It is levied on the value added that results from each exchange. It differs from a sales tax because a sales tax is levied on the total value of the exchange. For this reason, GST is neutral with respect to the number of passages that there are between the producer and the final consumer. GST is an indirect tax, in that the tax is collected from someone other than the person who actually bears the cost of the tax (namely the seller rather than the consumer). To avoid double taxation on final consumption, exports (which by definition, are consumed abroad) are usually not subject to GST and GST charged under such circumstances is usually refundable.
The VAT was invented by a French economist in 1954. Maurice Lauré, joint director of the French tax authority, the Direction générale des impôts, as taxe sur la valeur ajoutée (TVA in French) was first to introduce VAT with effect from 10 April 1954 for large businesses, and extended over time to all business sectors. In France, it is the most important source of state finance, accounting for approximately 45% of state revenues.
End-consumers of products and services cannot recover GST on purchases, but businesses are able to recover GST on the materials and services that they buy to make further supplies or services directly or indirectly sold to end-users. In this way, the total tax levied at each stage in the economic chain of supply is a constant fraction of the value added by a business to its products, and most of the cost of collecting the tax is borne by business, rather than by the state. GST was invented because very high sales taxes and tariffs encourage cheating and smuggling.
The fundamentals of supply and demand suggest that any tax raises the cost of transaction for someone, whether it is the seller or purchaser. In raising the cost, either the demand curve shifts leftward, or the supply curve shifts upward. The two are functionally equivalent. Consequently, the quantity of a good purchased, and/or the price for which it is sold, decrease.
GST, like most taxes, distorts what would have happened without it. Because the price for someone rises, the quantity of goods traded decreases. Correspondingly, some people are worse off by more than the government is made better off by tax income . That is, more is lost due to supply and demand shifts than is gained in tax. This is known as a deadweight loss. The income lost by the economy is greater than the government's income; the tax is inefficient. The entire amount of the government's income (the tax revenue) may not be a deadweight drag, if the tax revenue is used for productive spending or has positive externalities - in other words, governments may do more than simply consume the tax income. While distortions occur, consumption taxes like GST are often considered superior because they distort incentives to invest, save and work less than most other types of taxation - in other words, a GST discourages consumption rather than production. However they are still considered inferior to taxes like land value tax which neither cause deadweight losses nor distort incentives.
A Supply-Demand Analysis of a Taxed Market
In the above diagram,
Deadweight loss: the area of the triangle formed by the tax income box, the original supply curve, and the demand curve
Government's tax income: the grey area
Total consumer surplus after the shift: the green area
Total producer surplus after the shift: the yellow area
GST has been criticized as the burden of it relies on end-consumers of products and is therefore a regressive tax (the poor pay more, in comparison, than the rich).
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