What is a Tax on Consumption?
A consumption tax is a tax imposed on the acquisition of a product or service. Consumption taxes can include sales taxes, tariffs, excise, and other levies on consumable goods and services.
A consumption tax can also refer to an entire tax system in which people are taxed based on how much they consume as opposed to how much they contribute to the economy (income tax).
Understanding a Consumption Tax
Retail sales taxes, excise taxes, value-added taxes, usage taxes, taxes on gross business earnings, and import tariffs are examples of consumption taxes. These taxes are paid by customers, who pay a higher retail price for the product or service as a result.
The vendor collects and remits the consumption tax, which is reflected in the higher price. Consumption taxes are frequently applied at different rates on different goods based on whether a good is perceived as a need (such as food) or a luxury (such as jewelry).
Consumption tax is not a novel concept. Before replacing it with an income tax, the United States government utilized a consumption tax throughout the majority of its existence. The Bush administration supported a variant of this concept, but it was ultimately defeated. The concept advocated for the United States to go from a predominantly progressive income tax system to an exclusive consumption tax system.
A well-structured consumption tax system would ideally reward savers and punish spendthrifts. While the United States does not have a national consumption tax, the vast majority of countries throughout the world do.
In 1989, Japan, for instance, introduced a 3% consumption tax to its income tax. In 1997, the Japanese Consumption Tax (JCT) increased to 5%.
In 2012, a two-part tax hike to double the tax elevated it to 8% in April 2014, and then to 12% in April 2016. It was slated to increase to 10% in October 2015, but two delays pushed it to October 2019 instead.
There are exemptions for food, newspapers, and a few other daily products in order to maintain the 8% consumption tax on these things.
Types of Consumption Taxes
Value-Added Tax
The majority of European nations and Canada impose a consumption tax in the form of value-added taxes, or VATs. In certain Canadian jurisdictions, the VAT is known as a goods and services tax (GST) and in others as a harmonized sales tax (HST).
A VAT is a tax on the difference between what a producer pays for raw materials and labor and what he or she charges for the finished product. Consequently, this consumption tax is charged on the “value-added” to goods and services from manufacturing to final consumption.
Excise Tax
An excise tax is a sales tax that applies to a certain category of commodities, generally alcoholic beverages, cigarettes, gasoline, or tourism. Some excise taxes are levied to discourage economic-damaging behavior or the purchase of specific products. These excise taxes are generally referred to as sin taxes. Other excise taxes are imposed on beneficiaries of a program or infrastructure. For instance, drivers pay taxes on gasoline to maintain roads, highways, and bridges.
Import Duties
Import tariffs are levied against the importer for products entering the country. The importer passes on the taxes to ultimate customers in the form of increased prices. The amount of this consumption tax due varies significantly based on the imported good, its country of origin, and a number of other variables. Import duties can be computed as a percentage of the value of the imported products, or on the basis of the amount, weight, or volume of the imported items.
Retail Sales Tax
Typically, ad valorem sales taxes are determined by applying a percentage rate to the taxable price of a sale. There is a sales tax in the United States, however, it is a state tax, not a federal tax. Moreover, state sales taxes exempt all types of expenditures, including food, healthcare, and housing. Almost all consumption is taxed in nations that have implemented the sales tax as a federal consumption tax.
Consumption Tax vs. Income Tax
People incur a consumption tax when they spend money. When individuals make money or receive interest, dividends, or capital gains from their investments, they are subject to income tax.
Proponents of a consumption tax claim that it encourages saving and investment and increases the efficiency of the economy, whereas income taxation penalizes savers and rewards spenders. Thus, they believe that it is only fair that individuals are taxed on what they consume from the limited resource pool, rather than what they contribute to the pool through income.
On the other hand, people who are against a consumption tax say that it hurts the poor because they have to spend more of their income. They assert that because a consumption tax is a sort of regressive tax, the wealthy consume a lesser percentage of their income than poorer households.
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