Global عربي
KSA عربي
Global عربي
No one likes taxes. But without them, governments can’t fund essential public services, especially things that should be made accessible and affordable, like education and healthcare. Sustainable economies require a sustainable tax policy.
There’s many smart ways to design tax policy, but most countries try to balance between direct taxes, like income tax, and taxes on consumption, like value-added tax (VAT).
Economists often argue that a sustainable tax system integrates both, with VAT ensuring predictable revenue streams, and income taxes maintaining a relatively equitable tax base. Such a balanced system not only helps countries withstand economic shocks, but also creates a healthy society where the burdens are justly shared.
In this post, we’re going to discuss the differences between VAT and income tax, how they’re applied, and what the tradeoffs are.
Read more: Strategies For Tax-Efficient Investing: How to Maximize After-tax Returns?
More than 170 countries implement a VAT, according to the OECD. So what exactly is it?
Unlike a sales tax, where consumers pay a tax only on the final product, VATs are applied to goods and services at every part of the production and distribution chain.
The idea is that, as a good or service moves along the chain, each participant handling it pays a tax on the “value added” at that step.
For example, a table manufacturer will pay a tax on the raw wood they procure, a retailer will pay a tax on the wholesale price of the table, and the consumer will pay a tax on the table’s final price.
Another way to look at this is that businesses charge a VAT on their sales, sometimes referred to as output VAT, and pay a VAT on their purchases, or an input VAT.
Read more: 2026 VAT in the UAE: Frequently Asked Questions
Income taxes are more direct. They’re levied on the money an individual or business earns after subtracting allowable deductions.
For individuals, that typically means taxes taken from salaries, bonuses, investment income, or other income earned from activities like rentals or freelance work. For businesses, taxes are taken from net profits after business expenses are deducted.
Personal income taxes are based on the concept of ability to pay. Usually that means, if you earn more money, you have a greater ability to pay, and thus pay more. Hence the concept of tax brackets, where higher levels of income are taxed at higher rates.
With tax brackets, you typically pay a greater percentage of the money earned as you earn more, or as you enter a higher bracket. Here’s an example of a progressive tax bracket, meaning the rate of taxation gets progressively higher.
- First $0-$10,000 - 0% paid on this portion of income
- $10,001- $25,000 - 10% taxes are paid on this portion of income
- $25,001 - $50,000 - 20% taxes are paid on this portion of income
To calculate the full tax bill owed, you would calculate how much you owe at each bracket. Keep in mind that deductions are taken out before this stage. In other words, the brackets are based on your taxable income after deductions.
VAT and income tax differ in terms of what gets taxed, and how the tax is collected.
- VAT : is linked directly to spending (when a manufacturer spends on materials, they pay). Because of that, a VAT is relatively stable in terms of the revenue it brings in for governments.
- Income taxes: meanwhile reflect the performance of the economy. When times are good, more income is made, and thus more taxes are collected.
Another major difference is how the two types of taxes are filed, so let’s consider each in turn.
A business registers for VAT and files a return, typically through an online tax portal, to calculate the VAT. The return includes:
- Total sales and output VAT collected
- Total purchases and input VAT paid
- The VAT owed is the difference (Output VAT - Input VAT)
Employees typically have income tax withheld from their salary. They can then file a return that includes additional income earned outside of their salary, and also to claim any deductions.
Businesses on the other hand will file yearly tax returns, and those must include the following:
- Total revenues
- Deductible expenses
- Net profits
- Tax owed
VAT is generally considered less fair for lower-income earners. This is simply because the same rate is being applied to everyone, regardless of ability to pay.
Lower earners, in other words, have to pay a higher percentage of their income to cover the same tax on the same good or service, so they’re disproportionately affected.
Some countries offer lower VAT rates for essential goods, or exempt them entirely in some cases, to lighten the load for lower earners.
Income tax is typically considered more fair since it’s structured around how much someone earns, so lower earners face a lighter burden.
But fairness ultimately comes down to how well the system can actually be implemented. With income tax, tax evasion is much easier and more commonplace, allowing higher earners in some cases to pay even less than lower earners.
Most economists argue that a fair system blends both types of taxes. Too much VAT can amplify inequality, but only taxing income can discourage formal employment and investment.
VAT is often called a regressive tax because it imposes a heavier burden on lower earners. Consider the fact that lower earners spend a larger percentage of their income on everyday items like food, transportation, and everyday purchases.
Since VAT can be applied to most of these things, a higher percentage of their income goes to VAT as compared to someone with more income.
In other words, a VAT may look neutral, since everyone pays the same amount, but it hits lower income households much harder.
- Income Tax: The difference between an income tax and a duty is that income taxes target people’s earnings, whereas duties target specific goods and services.
Specifically, income taxes draw from salaries, wages, business profits, and investment and rental income.
- Duties: meanwhile are placed on things like imported goods and certain transactions (like property transfers).
Excise duties, for example, are duties placed on goods considered to come with negative externalities, like tobacco, alcohol, or fuel. Unlike sales taxes, duties are paid by manufacturers and the cost is usually passed on to the consumer indirectly in the form of a higher retail price.
Corporate taxes differ from income taxes in that they’re taken from the profits of companies. Similar to the way individuals can take out deductions, a company’s taxable profit is calculated by subtracting allowable business expenses (e.g. salaries, rent, raw materials) from total revenue.
But unlike personal income tax, corporate taxes tend to be flat, meaning the rate does not scale up as a business earns more profit.
Read more about: Is The UAE No Longer Tax-free?
Disclamer:
This post is for educational purposes only, and does not constitute investment advice or a solicitation to take any financial action. It should not be relied upon when making investment or financing decisions.
