A sales tax is a government fee imposed on the sale of a product or service. There are several different types of sales taxes used by governments around the world:

• Retail sales tax: A percentage of the sale price that is only paid by an end-user (as opposed to a reseller) of a product.
• Value-Added Tax (VAT): A percentage of the difference between the price a business buys a product for and the price it is sold at. VAT is paid by each business in the supply chain.
• Excise Tax: Excise taxes generally only apply to specific products or services (such as gasoline or cigarettes), and they are generally based on the units sold rather than the price of a sale.
• Tariff: A tariff is a tax on importers of certain types of products from certain countries covered by the tariff.

What is a retail sales tax?

A retail sales tax is the most common type of sales tax in the U.S. It is usually a percentage of the sale price of a product and is only charged when a product is purchased by someone who intends to use it. If someone purchases a product with the intention of reselling it, they don’t have to pay sales tax on the purchase.

For example, suppose the sales tax rate is 7%.

If Bob purchases a TV for personal use and pays $100 for it, he will have to pay an extra $7 in sales tax. That $7 is collected from Bob by whoever sold the TV to Bob. The person who sold the TV then sends that $7 to the government.

If Bob purchases that TV in order to resell it at his own store, he does not have to pay sales tax. However, if Bob later succeeds in reselling the TV for $200 to the Southbend Paper Company for use in the company office, then the Southbend Paper Company will have to pay a sales tax of $200*7% = $14. That $14 sales tax will be collected by Bob who will then send it to the government.

What is a VAT?

A value-added tax (VAT) is a tax on a sale where the amount is based on the difference between the price an item is purchased for and the price it is resold for.

For example, suppose the VAT tax rate is 7%.

A mining company sells raw materials for $25 to a TV manufacturing company. The TV manufacturing company pays $25*7% = $1.75 of VAT. That VAT is collected by the mining company and sent to the government.

The TV manufacturing company then turns those raw materials into a TV and sells the TV to Bob’s Electronics Store for $100. Bob’s Electronics Store pays a VAT of 7% * ($100 – $25) = 7% * $75 = $5.25.

Bob’s Electronics Store then sells the TV to Alice for $200. Alice pays 7% * ($200 – $100) = $7 of VAT.

Altogether, the total VAT paid along the TV supply chain is $1.75 + $5.25 + $7 = $14. That’s the same as would have been paid under a retail sales tax system with the same tax rate. However, rather than the tax being collected and paid only at the final retail sale, it has been collected in pieces all along the supply chain.

Most large countries around the world rely on value-added taxes rather than retail sales taxes. The reason for this is a historical anomaly. In the past, most transactions were in cash. Such transactions were difficult for governments to track which meant it was relatively easy for businesses to evade sales taxes. Under a retail sales tax system, if a retail store didn’t report some of its cash transactions, the entire tax revenue from those sales would be lost. However, under a VAT system, some of the tax would have been collected farther back in the supply chain.

Additionally, under a VAT system, each business in a supply chain is incentivized to report what it purchases from other businesses so that it has to pay less VAT. That makes it harder for businesses further back in the supply chain to evade reporting their sales to the tax authorities.

However, with the vast majority of transactions now occurring electronically, it’s difficult for any business to evade their tax responsibility. That means a VAT system has lost its primary advantage over a retail sales tax system. However, the retail sales tax system still has a large advantage over a VAT system: A retail sales tax system imposes much less administrative complexity (and therefore less cost) on an economy.

What is an excise tax?

An excise tax is similar to a retail sales tax but it has a couple major differences:

1. Excise taxes usually only apply to a specific type of product (e.g. gasoline or cigarettes) rather than applying broadly to most types of products.
2. Excise taxes are usually based on the units sold rather than the price of a sale. For example, the U.S. federal excise tax on gasoline is specified as a number of cents per gallon sold.
3. Excise taxes are not charged to a customer as a separate line item as is the case with a retail sales tax. Instead the company selling the product pays the excise tax, and the cost of paying the tax is incorporated into the purchase price of the product so that the end consumer never sees it.

Examples of excise taxes imposed by the U.S. federal government:

• Gasoline excise tax (18.4 cents per gallon)
• Cigarette excise tax ($1.01 per pack)
• Firearms excise tax (10% of the sale price for pistols and revolvers, and 11% for other firearms — Yes I know I said excise taxes are usually based on units sold rather than purchase price, but I did only say “usually”.)

What is a tariff?

A tariff is a tax on importers. Tariffs typically only apply to specific categories of products coming from specific countries. Whenever a person or business imports such a product from such a country, that person or business must pay the tariff.

For example, the U.S. federal government imposes a 25% tariff on many types of steel imported from any country other than Canada or Mexico. That means if a U.S. manufacturing company purchases $100 million of steel from China and imports that steel into the U.S., that manufacturing company will have to pay a $25 million tariff on that steel.

Tariffs generally have two effects on an economy:

1. Tariffs often reduce the amount of material subject to tariffs being imported from countries targeted by the tariff.
2. Tariffs typically increase the price of products which are imported (or made using imported raw materials) that are subject to the tariffs.

Both of the effects just mentioned are generally inflationary.