The Choice Between Income and Consumption Taxes: A Primer

The amount of this consumption tax payable varies greatly depending on the imported good, the country of origin, and several other factors. Import duties can be calculated as a percentage of the value of the goods being imported, or based on the quantity, weight, or volume of the goods being imported. A consumption tax can also refer to a taxing system as a whole in which people are taxed based the gross profit on how much they consume rather than how much they add to the economy (income tax).

If, in the absence of taxes, one dollar of savings is put aside for retirement at nine percent compound interest, the balance grows to $7.91 after twenty-four years. Alternatively, by assuming a thirty-three percent tax rate, the same dollar is take-home point reduced to about sixty-seven cents after taxes when earned. The effective interest rate, thereafter, is reduced to six percent, since the rest of the yield is paid in taxes. Bankrate.com is an independent, advertising-supported publisher and comparison service. We are compensated in exchange for placement of sponsored products and services, or by you clicking on certain links posted on our site.

1. Understanding the concepts of consumption tax, the different types, and how it compares to income tax is essential for everyone, whether you’re an individual taxpayer or a business owner.
2. In other words, prioritizing a tax code that is simple and pro-growth can raise revenues for government spending priorities while boosting living standards relative to the tax system we have today.
3. We find a consumption tax reform would reduce the economic, administrative, and compliance costs of the U.S. tax system, leading to increases in employment, wages, output, and incomes while improving the long-term well-being of American families and children.
4. These taxes are borne by consumers who pay a higher retail price for the good or service.

Alternatively, fringe benefits could be taxed at the source, meaning firms would not deduct the cost of fringe benefits and households would not pay tax on fringe benefits, and could be subject to payroll taxes. Embedding much of the social safety net in the income tax code, however, creates complexities for families and limits the effectiveness in providing support to households who do not file taxes. The heightened salience of the VATs may help create political pressure to keep rates from rising. Because Taxpayer B does not immediately consume her earnings, she would not face an initial tax, instead saving all $100 of her earnings.

Economic, Revenue, and Distributional Effects of a Tax on Business Profits and Household Compensation

In a world with a 20 percent income tax, Taxpayer A would owe $20 and be able to immediately consume the remaining $80 compared to $100 in a world with no taxes. The income tax reduces her consumption by 20 percent relative to the internal audit definition no-tax situation. However, it does impose a federal excise tax when certain types of goods and services are purchased, such as gas, airline tickets, alcohol, and cigarettes.

Background on Consumption Taxes

The concept advocated for the United States to change the tax system to a national consumption tax. Currently, even though the U.S. imposes sales taxes and excise taxes, it does have a national income tax system. In addition to being applied to your money at different times, income and consumption taxes also differ in how they affect taxpayers. In other words, the percentage of your income you pay increases as your income increases. For example, the policy of full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs.

Sales tax

Since low- and middle-income households spend more of their income than wealthy households, the consumption tax can prove regressive. Research further suggests that even with a switch to a consumption model, savings would not increase significantly. For example, many people with very low incomes pay no income tax under the current system because of the current threshold. If a consumption tax were to be implemented, low-income people would suddenly have to pay taxes on every purchase.

It has now been nearly three decades since the publication of two important volumes that laid out many of the details of how one might implement a progressive consumption tax (Institute for Fiscal Studies, 1978; U.S. Treasury, 1977). But much of what we „know“ is not part of the general policy discussion and there are important issues that the literature has recognized but still not resolved. The aim of this paper is to lay out the key economic issues involved in deciding whether and how to adopt a consumption tax and to discuss what theory and evidence have told us and could tell us about these issues. A group of House Republicans is looking to raise sales taxes with the FairTax Act, which would abolish the Internal Revenue Service and replace income tax and other levies with a national sales tax.

Sin taxes, are a type of excise tax imposed on items that are considered harmful to society, in an effort to decrease their consumption by increasing their prices. Laws may allow sellers to itemize the tax separately from the price of the goods or services, or they may require it to be included in the price. The Brookings Institution is a nonprofit organization based in Washington, D.C. Our mission is to conduct in-depth, nonpartisan research to improve policy and governance at local, national, and global levels. October 2011 – Republican presidential hopeful Herman Cain’s recently proposed “9-9-9” tax plan features a consumption tax.

Embedding support in the tax system creates additional difficulties for low-income families. Unlike other relief programs that provide monthly payments, the refundable tax credits are lump sum payments. Research indicates the credits supply about 9 to 13 percent of income for lower-income households,67 meaning some families receive the largest single share of their annual income at tax filing time. Taxes can be structured in many different ways with varying economic, administrative, and compliance costs.