The New Palgrave Dictionary of Economics Online

A value-added tax (VAT) is a tax on the value created in goods or services during production, distribution, and sales. VATs are generally constructed as consumption taxes. In principle, a consumption VAT is neutral in its treatment of savings and consumption. In practice, VATs are often designed with exemptions and zero-ratings that generate consumption distortions. An important issue for VATs is their implementation in a federal system. A number of modifications of the basic VAT structure have been proposed to strike a balance between the efficiency of a common rate across political units and the desire for country-specific VAT rates.