Figure 18-1 The Operation of a GST of 5%
With the notable exception of the United States, most developed
economies levy a tax similar to our GST, referred to in Europe as a value-
added tax and in some countries as a consumption tax. The main advantage
of the GST (and other value-added taxes) is that it taxes expenditure
rather than income, and for this reason it generates no disincentive to
save. In contrast, since income taxes apply to all sources of income,
including interest income, they tend to discourage saving.
In practice, the GST works by taxing a firm on the gross value of its
output and then allowing a credit equal to the taxes paid on the inputs
that were produced by other firms. Thus, the GST taxes each firm’s
contribution to the value of final output—its value added. Figure 18-1
shows in a simple example how the GST is calculated at each stage from
the mining of iron ore to the final retail sale of a washing machine.
A tax on value added is the same as a tax on the value of final goods
with a credit allowed for the tax paid for purchased inputs. The
example is for the stages involved as iron ore is mined and then sold to a