When you buy $1,000 worth of a mutual fund, that $1,000 doesn't get taxed again. But any additional money you get will eventually be taxed. One source is dividends, which become part of your tax bill when you receive them. Another is growth of equities, which are not taxed until you sell them. With bonds, you report bond income on your taxes.
At Vanguard, "specific lot identification" acts like a menu. When you sell, you get to decide which purchase(s) correspond with this sale. If you sell 200 shares, you might pick 100 shares from this year and 100 shares from several years ago. Vanguard shows all the shares you haven't selected before, and tells you how much growth (or loss) is available. So you can minimize taxes each time you sell, based on how you match each sale with each purchase.
It may help to put numbers on this. Right now Vanguard Total Stock Market ETF ("VTI") has a 1.9% dividend. If you buy $10,000 worth of VTI, over the course of a year you would expect $190 in dividends. Most people are in the 15% bracket for dividends, so you'd owe $27 tax on the dividends in a year. The dividend can change, but that's the current information. Still, it's worth pointing out that $27 is a rather small fraction of $10,000. When you don't sell, a total stock market ETF (or mutual fund) can be very tax efficient.