Taxation based on the value of the assessed asset.
Ad Valorem Details
The Roman Empire's dominance in the Ancient Era left a legacy that seems to be impervious against time. The Romans controlled most of Ancient Europe and used Latin as the primary language. As a result, Latin became deep-rooted within most Europeans and persists until the modern era. "Ad" in Latin means "at" or "towards." Valorem means "value."
If we combine those two words, we get the meaning "towards value." Value as in the monetary value of assets such as cars, houses, furniture, land, etc. The term Ad Valorem is primarily used in financial jargon as the basis for the type of taxation, which is the asset's assessed value. The assessed value is the value given by the government assessor for tax calculation purposes.
The real estate and auto industry often use Ad Valorem as the tax basis. The Ad Valorem tax enforces equality for people. People who are rich and have many high-value items will be taxed more than the middle-lower class people with moderate-value items. Ad Valorem tax also reduces the wealth inequality in the country.
Example of Ad Valorem
The formula to calculate Ad Valorem tax is:
Annual Ad Valorem tax = (Assessed Value / 100) x tax rate
Let's say you bought a shiny new house that costs $200,000. The government assessor visits your new house and began calculating the assessed value. The assessed value is based on many factors such as land size, home features, market condition, construction quality, and surrounding neighborhood. The government assessor declares that the assessed value is $180,000.
The assessor also told you that the local real estate tax rate is 1.2%. The real estate tax rate can change depending on the city and state regulations. We now have all the required data; we can begin the annual Ad Valorem tax calculation.
Annual Ad Valorem tax = (180,000 / 100) x 1.2
= 1,800 x 1.2
The Ad Valorem tax for your new house is $2,160 per year or $180 per month.
Types of Ad Valorem
The first and most dominant type of Ad Valorem tax is Value-Added Tax, commonly known as VAT. Whenever a product undergoes a process that adds value, such as raw material purchase, refinement, packaging, or transporting, a VAT is charged to the product. The VAT is collected at the end of the supply line, where a customer buys the product. A typical VAT rate is somewhere between 10-20% for each product, depending on the nation's policy.
The second type of Ad Valorem tax is Stamp Duty Land Tax (SDLT). The Stamp Duty Land Tax is a tax collected on property purchases or payment documents such as receipts, marriage licenses, and land transactions. The rate, collection method, and collector vary depending on the nation's policy. In Australia, Stamp Duty Land Tax is collected by the state, not the government, and the rate differs depending on each state. In the United Kingdom, properties or transactions above €500,000 receive a 5% to 12% SDLT tax rate.
The third type of Ad Valorem tax is Insurance Premium Tax (IPT). The Insurance Premium Tax is imposed upon general insurance premiums such as car insurance, home insurance, and pet insurance. The standard Insurance Premium Tax rate is 12% and 20% on higher rate industries such as travel insurance, electrical appliance insurance, and high-value car insurance.
Significance of Ad Valorem
Taxation is the primary way for countries to generate revenue. With the tax money, the country could invest in multiple sectors such as trade, production, defense, or social welfare to create a thriving society. Value-Added Tax (VAT) is the most critical tax type since it covers 80% of its traded goods. A tiny misconfiguration on the Value-Added Tax rates could significantly impact a country's economy.