Consumption Tax What Is It, Examples, Vs Income Tax

It is a type of indirect tax that is paid by the consumer along with the cost of the product at the time of purchase. These taxes takes form in sales tax, excise duties, and other taxes on goods and services. But one system looks like it taxes capital gains at the same rate as ordinary what is the progressive consumption tax income, while the other looks like it doesn’t tax capital gains at all. In theory, a flat tax on wage income is identical to a flat tax on consumption.

This system levies higher tax rates on those with greater incomes, thereby aiming to reduce income inequality and provide funding for essential public services. The rationale behind progressive taxation is rooted in the principle of equity, where those who benefit more from the economic system contribute a fairer share towards its maintenance and development. Reforming the current income tax system toward a consumption tax system would support rising living standards and economic growth. Combined with a simpler system of providing tax credits for individuals and children, such a reform could reduce the economic, administrative, and compliance costs imposed by the current tax system. As such, an income tax system double taxes or places a higher tax burden on future or deferred consumption.

In the long run, the plan has a positive economic effect and is approximately revenue neutral on a conventional basis. After posting your comment, you’ll have a ten-minute window to make any edits. Please note that we moderate comments to ensure the conversation remains topically relevant. We appreciate well-informed comments and welcome your criticism and insight.

The Incalculable Costs of Corrupt Statistics

But Harvard’s Lawrence Summers – a former US Treasury Secretary and a towering figure in public finance – has argued that such estimates are wildly optimistic. When taxable income falls within a particular tax bracket, the individual pays the listed percentage of tax on each dollar that falls within that monetary range. If we put the imprecision of language aside — and stop putting so much weight on what label can be applied to what policy — the actual distributive stakes of a consumption tax are fairly straightforward. Because consumption taxes take more dollars from the rich than the poor, they are generally good, especially since the public programs they help finance tend to provide at least as much benefit to the poor as the rich. But insofar as other kinds of taxes — like income and wealth taxes — take even more dollars from the rich than the poor, those taxes are better than consumption taxes, holding all else equal. Is reducing the VAT on electricity by 14 percentage points progressive or regressive?

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. Despite this, the downside of these taxes is that they are regressive because lower-income earners and households tend to spend more of their income than they save. A consumption tax system would shift the time of collection from when money is earned to when money is spent. To minimize economic distortions, there is ideally only one standard rate that is levied on all final consumption, with as few exemptions as possible.

Application Forms

• Two commonly cited concerns when moving to a consumption tax are the distributional impact and transition.
• And can you imagine presidential and governor’s campaigns in which all the candidates have to “translate” their new proposed entitlements/political plans into an increase (or, most unlikely, a decrease) of the VAT rate?
• Whereas an income tax is levied when you earn money, a consumption tax is levied when you spend money.
• Let us understand the features of a national consumption tax through the discussion below.
• And that intuition is probably linked in some way to our intuition that this investment option wasn’t available to average people.

Additionally, some provinces levy a completely separate retail sales tax that is not a VAT. Now, again, there’s a way to insulate them from that by giving each household cash payments, but no country in the world actually does that. So in the real world, consumption taxes end up being more regressive than income taxes, although Len and I or anyone else could design a consumption tax on paper that wasn’t like that.

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Moreover, a great strength of a consumption tax system is that it does not tax saving, and also gives firms more incentive to invest. An income tax is a tax on the money a person earns while working. If a government requires a progressive income tax, a person in the bottom one-third of earners in the country might pay 10 percent in taxes.

• Many high earners continue working hard despite high tax rates, suggesting other motivations matter too—career advancement, professional satisfaction, social status.
• Let us understand the advantages of the national consumption tax through the discussion below.
• Opponents of progressive taxes argue that these taxes are inherently unfair because they demand more from those who earn more.
• If we put the imprecision of language aside — and stop putting so much weight on what label can be applied to what policy — the actual distributive stakes of a consumption tax are fairly straightforward.

How can consumption taxes be made progressive?

The other $4.16 is not lost by the economy in any sense, as the $4.16 is what the government would make in interest, if it had invested its tax revenue in the same investment. If the initial invested amount is not taxed when earned, but the earnings are taxed thereafter, the cumulative taxes paid are the same, but are spread more evenly across the period. These results are primarily sensitive to the rate of return; for example, with a three percent return most of the tax receipts come from the tax on the initial dollar. “Another idea is to get rid of a modern (big) (screwed up) (tyrannical) government.

The states that don’t collect a sales tax are Alaska, Delaware, Montana, New Hampshire, and Oregon. Japan, for example, added a 3% consumption tax to its income tax in 1989. In 2012, a two-part tax increase to double the tax raised it first to 8% in April 2014.

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The very low rate, basic income tax on only high incomes is just a possibility for an even more progressive system. You can keep the same entitlements actually in place (Social Security and Medicare included). Afterall, the idea that you finance your own retirement thru your payroll contributions is pure “financial fiction”. Actually, I think it is politically wonderful that the “thru size” of the government can be grasp just by looking at the VAT rate. And can you imagine presidential and governor’s campaigns in which all the candidates have to “translate” their new proposed entitlements/political plans into an increase (or, most unlikely, a decrease) of the VAT rate? (With an independent technical body verifying their claims since, you know, politicians tend to lie) And sure, you can keep Pigouvian taxes and a property tax financing local governments, without affecting the simplicity and beauty of the “only VAT + rebate” scheme.

The Benefits of a Progressive Consumption Tax

These compute the tax either as the tax on the bottom amount of the bracket plus the tax on the marginal amount within the bracket; or the tax on the entire amount (at the marginal rate), minus the amount that this overstates tax on the bottom end of the bracket. Higher tax revenues from the wealthy can fund essential services like education, healthcare, and infrastructure. Investing in these areas can improve overall well-being, boost human capital, and strengthen the economy. Also, a consumption tax could utilize progressive rates in order to maintain «fairness». Value added tax is a consumption based tax and is levied each and every time the value of a good gets increased in the process of manufacturing to the point of sale.

Other types of progressive taxes

Taxes are used to fund the government and its programs and services. The idea behind progressive tax is that people with higher incomes can afford to pay a higher percentage of their earnings than people with lower incomes. With a wage tax, you prepay taxes on your future investment income before the money is even invested. With a 401k approach, you pay the tax in the future when the money is withdrawn and spent on consumption.

But Saez and Zucman have held their ground, arguing that much depends on the resources the US Internal Revenue Service is given to implement the tax. Regardless, both sides agree on the objective, and the general direction of the debate foreshadows what to expect if a progressive like Warren wins the US presidency. So try not to get yourself too worked up about each and every fiscal policy measure and whether, and under what meanings, that measure is progressive or regressive. A withholding system may be put into place in order to approximate the average tax liability, smoothing payments. It is difficult for many taxpayers to pay no tax all year, only to face a large year-end tax bill.