How VAT actually works

Value-added tax is the most successful tax most people never think about — used in about 170 countries, baked invisibly into shelf prices across Europe and beyond, and quietly responsible for a fifth of the world's tax revenue. It's also the source of a specific bit of arithmetic that trips almost everyone: removing VAT from a price is not subtracting the VAT percentage. Both halves — the system and the maths — below. (The VAT calculator does the arithmetic both directions; this is what it's doing.)

What VAT is

VAT is a consumption tax collected in slices along the supply chain. At every sale — mill to baker, baker to café, café to you — the seller charges VAT on the full price but forwards to the government only the tax on the value they added, reclaiming the VAT they themselves paid on inputs. The slices sum so that the state ends up with exactly the rate times the final consumer price, no matter how many hands the product passed through.

The chain: who pays what

A worked chain at 20%: a mill sells flour to a baker for €100 + €20 VAT; the baker sells bread to a café for €300 + €60 VAT but remits only €40 (€60 minus the €20 reclaimed); the café sells sandwiches for €700 + €140 VAT and remits €80. Government total: €20 + €40 + €80 = €140 — exactly 20% of the final €700. The elegance is enforcement: every business's reclaim requires its supplier's invoice, so the chain audits itself — which is precisely why VAT invoices have formal requirements, and why only the final consumer, with nobody to reclaim from, truly pays.

The maths: adding and removing VAT

Adding is the easy direction: at 20%, multiply the net by 1.20 (€50 → €60); at 6%, by 1.06. Removing VAT from a gross price is where everyone stumbles: you must divide by 1.20, not subtract 20%. A €120 gross price contains €100 net + €20 VAT — and €20 is a sixth of €120, not a fifth. The general forms: gross = net × (1 + r) and net = gross ÷ (1 + r). Handy divisors: at 20% the VAT inside a gross price is 1/6 of it; at 10%, 1/11; at 25% (Scandinavia), 1/5.

The 20%-off trap

Why doesn't subtracting 20% work? Because the 20% was charged on the net, but subtracting takes 20% of the gross — a bigger base. Take €120 minus 20% and you get €96, not €100: you've removed €24 of "VAT" when only €20 was ever there. It's the same asymmetry as percentage increases and decreases generally — up 20% then down 20% never returns home. Anyone invoicing across the VAT line, or reclaiming business VAT from till receipts, hits this weekly; the calculator exists so the division habit doesn't have to be remembered under deadline.

VAT vs sales tax

US sales tax taxes only the final retail sale — one collection point, and shelf prices are quoted before tax, so the register surprises you. VAT collects in slices with displayed prices including tax, so the sticker is the price. The practical differences: VAT's invoice-credit chain makes evasion harder (a missing link betrays itself), while sales tax concentrates all enforcement on retailers; and VAT handles business-to-business sales cleanly (reclaimed automatically) where sales-tax systems need exemption certificates. Economists mostly prefer VAT's mechanics; travellers mostly prefer knowing the register total in advance.

Rates around the world

• EU: standard rates 17–27% — Luxembourg lowest, Hungary highest — with reduced rates on food, books, medicine.
• UK: 20% standard, 5% reduced, 0% on most food and children's clothing.
• Elsewhere: Japan 10%, Australia's GST 10%, Canada's federal GST 5% plus provincial add-ons, Singapore 9%; "GST" is VAT wearing a different acronym.
• Malaysia runs a sales-and-service tax (SST) instead, having tried and repealed a 6% GST — one of the few countries to go backwards.
• Tourist refunds: many countries refund VAT on goods you export in your luggage — keep the invoices, find the airport desk, mind the minimums.