The term consumption tax refers to a tax imposed on the consumption of a good or service. The tax can take the form of a sales tax, tariff, excise tax, or some other form of tax on consumables.
Consumption taxes can also refer to a tax system as a whole in which people are taxed based on how much they consume rather than how much they contribute to the economy.
What You Should Know
- A consumption tax is a tax on goods and services.
- Value-added tax and retail sales tax are examples of consumption taxes.
- Consumers pay a consumption tax when they spend money, while earners pay an income tax.
An overview of consumption taxes
These taxes are borne by consumers who pay a higher retail price for the good or service as a result of consumption taxes such as retail sales taxes, excise taxes, value-added taxes, use taxes, and taxes on gross business receipts.
There is a consumption tax included in the higher price, which is paid to the appropriate state, local, or federal government by the vendor. Different commodities are taxed differently based on perceptions of whether they are considered necessities (such as food) or luxury products (such as jewelry).
Consumption taxes are not new ideas. The U.S. government used a consumption tax for much of its history before replacing it with an income tax. Although the proposal was defeated, the Bush administration backed a version of this. In the proposal, the United States would move to a national tax system based exclusively on consumption taxes instead of a largely progressive income tax system.1
There are several countries in the world that have imposed some form of a national consumption tax in order to reward savers and penalize spenders. The United States does not have a national consumption tax.
Japan, for instance, added a 3% consumption tax to its income tax in 1989. In 1997, the Japanese Consumption Tax (JCT) was raised to 5%. In 2014, a two-part increase to double the tax led to a first increase of 8%, followed by two more delays in October 2015. Originally, it was set to increase to 10% in October 2015, but delays delayed the increase until October 2019. The consumption tax on food, newspapers, and other daily items is kept at 8%.
Consumption taxes: types
Tax on value-added
During the 20th century, a number of European countries and Canada enjoyed a system of consumption taxes, or VATs. In Canada, the VAT is called the goods and services tax (GST) in some provinces, or the harmonized sales tax (HST) in others.
Unlike other consumption taxes, VAT applies to the difference between what is paid to the producer in raw materials and labor, and what is charged to the consumer in the final stage.
Tax on Excise
Sales taxes based on an excise tax are typically imposed on alcohol, tobacco, gasoline, and tourism. These excise taxes, commonly known as sin taxes, are used to discourage behaviors or purchases that are perceived to harm the economy. Other excise taxes are imposed on people who benefit from a particular program or infrastructure. As an example, drivers are taxed on gasoline to maintain roads, highways, and bridges.
Taxes on imports
In importation, duties are levied on importers for goods entering the country. Importers pass these taxes on to their final consumers through higher prices. Consumption taxes vary greatly based on the imported goods, the country of origin, and a variety of other factors. There are two ways to calculate import duties: as a percentage or as a percentage of the value of the goods being imported.
Tax on retail sales
Although there is a sales tax in the U.S., it is a form of state tax, not a federal tax. Sales tax is usually ad valorem, meaning it is calculated by adding a percentage rate to the taxable price. Additionally, state sales taxes exempt almost all consumption, including food, health, and housing. Countries that use the sales tax as a federal consumption tax tax most of their consumption.
Income vs. Consumption Tax
Income and consumption taxes are levied when people earn money or receive interest, dividends, or capital gains. Consumption taxes are when people spend money.
The argument for a consumption tax is that it encourages saving and investment and increases economic efficiency, while income taxes penalize savers and reward spenders. Their argument is that it is only fair that people are taxed on what they consume from the limited resource pool rather than what they contribute.
However, opponents claim that a consumption tax adversely affects the poor, who are forced to spend more money due to necessity. According to them, a consumption tax is a form of regressive tax that causes the wealthy to consume a smaller percentage of their income than the poor.