The term “Consumption Tax” refers to a tax on the purchase of goods and services rather than the income earned by the individual or corporation. The consumption tax is a popular economic theory because it has the potential to be more fair and just, unlike other types of taxes that are often considered regressive in nature.
In this article, we will delve into the many different aspects of the consumption tax. We will explore its various forms, its advantages, disadvantages, and how it can affect different sectors of society. We will also consider the impact of the current tax reform efforts and touch on the consumption taxes being implemented throughout the world.
Forms of Consumption Tax
There are generally two main types of consumption taxes: the Value-Added Tax (VAT) and the Sales Tax. The VAT is a proportional tax that is paid by the final consumer on goods and services, and it is levied at every stage of the production process. Meanwhile, the sales tax is only levied at the final stage of production, when the good or service is sold to the consumer.
The United States and Japan have implemented sales taxes, while many European countries have adopted the VAT. There has been a long-standing debate on the advantages and disadvantages of these two types of consumption taxes.
Advantages of Consumption Tax
One of the main advantages of a consumption tax is that it is a more proportional tax, meaning that it impacts people in accordance with their ability to pay. This is because, as a consumption tax is levied at the point of sale, it will only be paid by those who choose to purchase the good or service.
Furthermore, consumption tax promotes savings, a vital component of any well-functioning economy. As the tax is imposed on the consumption of goods and services, there is an inherent incentive to save money instead of consuming more. This promotes the country’s growth and development.
Moreover, a consumption tax is one of the more reliable sources of generating revenue for the government. It is a dependable revenue source as it is based on actual spending. Additionally, it is even more stable than income taxes during recessionary periods.
Disadvantages of Consumption Tax
While there are several advantages of a consumption tax, it is not without its criticisms. It is often criticized as being a regressive tax, meaning that it has a greater impact on lower-income individuals and families, as these individuals spend more on necessary goods and services. The implementation of a progressive consumption tax could resolve this issue.
Another criticism is that the implementation of the consumption tax could result in an increase in prices—this would be because businesses would have to factor the cost of the tax into their overall pricing strategy. This will also inadvertently increase the cost of commodities.
Additionally, a consumption tax may also lead to reduced demand and lower economic activity, particularly in sectors that are particularly price-sensitive and those where discretionary spending is high.
Current Market Scenario
The new US tax reform’s legislative bill, resulting in the Tax Cuts and Jobs Act of 2017, has implemented several changes in the tax structure. Under the new structure, taxpayers are given a choice between either itemizing their deductions or opting for an increased standard deduction.
Furthermore, the Act has increased the standard deduction limit. This means that taxpayers in the US are much more likely to avoid paying income tax as a result of this increase.
However, although the Act offers many benefits, it also affects certain key sectors, such as real estate and healthcare, where certain deductions have been removed or reduced. Nevertheless, the legislation is expected to accelerate growth in the country by promoting a more consumption-driven economy.
Global Consumption Tax
Several countries have implemented consumption tax with VAT being the more favored system. For example, the EU has adopted the VAT system, with the tax rates being set by the member states. VAT also is collected on imports from outside of the EU.
In Canada, the Federal GST is a consumption tax of five percent, with some provinces adding a specific Provincial Sales Tax (PST) or the Harmonized Sales Tax (HST) in addition to the GST. In many countries, consumption tax is a critical source of revenue for the government, as it helps to fund government programs and accounts for the bulk of government revenue.
Conclusion
In conclusion, while consumption tax can provide a more proportional tax structure that encourages savings, there will be societal changes such tax implementation will create. It is essential at times of change, to ensure that the tax reform is structured to align with the objectives of the economy.
As with the US Tax Cuts and Jobs Act, the changes implemented have not been without its criticisms. Nevertheless, the impact of such changes is complex and requires clear evaluation. Thus, it is essential that the government has an open and transparent dialogue with various stakeholders before implementing any significant changes.
Consumption taxes have been utilized throughout the history of the United States. In fact, Alexander Hamilton was a big proponent of consumption taxes, rather than income taxes, because the tax burden could be distributed more fairly between all tax payers.
In other words, taxpayers could effect the outcome of their tax burden by changing their consumption habits. The lower and middle class could lower their tax burden because they consume less than the wealthy. Yet, there is controversy associated with the probability of an equal distribution of consumption taxes. Simply taxing items based on a percentage of price, actually places an unfair tax burden on individuals that have lower incomes. Consumption taxes are paid as a higher percentage of lower salaries. The only way to have an equal consumption tax, is to tax high end items at a higher percentage.
It is not likely that consumption taxes will be utilized to replace income taxes because of the difficulties associated with enforcing the taxes. Yet there would be many benefits to most taxpayers if a consumption tax were to replace income taxes. It is believed that a lack of income taxes would encourage investments and savings. First, that money would not be taxed but consumers could also control their spending of purchased items that would incur a consumption tax. One of the fears the government has sighted with consumption taxes is that they would loose tax revenue.
However, it is not likely that most consumers would limit their purchases based solely on a consumption tax. The ripple effect would allow consumers to save money, which in the long term would allow them to increase their spending. In addition, increased savings would decrease the need for many social programs, such as welfare, which would lessen the tax burden on taxpayers. Deferring an individuals tax responsibility, until they can afford to pay that tax, increases the overall financial health of the nation.
The controversy, however, also includes arguments against replacing income taxes with consumption taxes. While each individual taxpayer would be able to defer their tax responsibilities, the government would likely experience a larger deficit because they would not be paid immediately.
It is questionable as to whether or not there would be a benefit of replacing certain types of taxes with a consumption tax. The many benefits include added tax revenue from tourists and non legal residents, but it is doubtful that revenue would replace the immediate loss from the average tax payer. Long term, the tax reform movement sees many benefits for taxpayers and the government when a consumption tax replaces income taxes. However, the short term deficit would leave the government unable to function.
