Sharon Kartika

Sales tax

Price: \(y\)

Sales tax rate: \(t\)

The good is then sold for \(y+ty\)

Price: \(y +ty\)

tax rate: \(t\)

Sold for: \((y+ty)+t\cdot (y+ty)\)

And so on for the subsequent sales.

This creates a tax cascading effect. Not desirable. Increases artifically the price of inputs used in production. Thus sales tax was abandoned and moved to a system of value added tax (VAT)

Value added tax

\(y-x\)

Output, input

Then,

\[ \text{VAT} = t(y-x) \\=ty-tx \]

Example. Say you purchase input for \(100\), with a tax \(10\%\). Thus Rs \(100+10\) is paid for the input. When you sell this good, the tax rate is again \(10\%\), applied on Rs \(110\). The buyer pays \(110+110\cdot10\%\) which is Rs \(121\). The tax you will pay to the goverment is \(11-10\). The \(10\) Rs deducted is called ITC (input tax credit). This ensures that there is no tax cascading. The producer does not pay tax on inputs.

\[ A\xrightarrow[10%]{100}B\xrightarrow[10%]{110+20}C:\;{143} \]

B adds 20 rupees value.

\[ A\xrightarrow[10\%]{100(v)}B\xrightarrow[10\%]{100(v)+10(t)}C:120 \]

Thus,

However, disadvantages,

Sharon Kartika. Last modified: January 04, 2024.