How is Value Added Tax (VAT) typically applied?

Value Added Tax (VAT) is designed to be levied at each stage of production and distribution, which is why the choice stating it is applied at each stage is the correct one. This means that whenever value is added to a product—be it during manufacturing, wholesaling, or retailing—a VAT charge is applied. Each business along the supply chain collects VAT on its sales, while also paying VAT on its purchases. This mechanism allows for a cumulative tax that captures the value added at each step without causing tax-on-tax distortions, as businesses can reclaim the VAT they have paid on inputs.

The method of applying VAT in such a manner encourages compliance and ensures that the tax burden is distributed evenly throughout the supply chain rather than being concentrated at the final sale point. This structure ultimately aids in maintaining a transparent and efficient tax system.

The other choices reflect misunderstandings of how VAT functions. For instance, applying VAT only at the point of sale fails to capture the comprehensive nature of the tax, and only taxing final consumption overlooks the intermediate stages where value is added. An approach calling for a flat rate on all goods and services also does not recognize the nuances of VAT implementation, where rates may vary based on the nature of goods and services involved.