Consumption tax is a tax levied on the purchase of goods and services.
How Does Consumption Tax Work?
Consumption tax is a tax imposed on goods and services that are consumed or purchased. Specifically, consumption tax is charged when you spend money rather than earn it, as in the case of income taxes.
Consumption tax was first introduced in the United States in the 19th century and has since become an integral part of the tax system. However, consumption tax has a stronger presence globally and is considered a very common way to generate revenue for governments. The United States is unusual in that there is no federal consumption tax on goods and services; it is up to local and state entities to determine that.
However, consumption taxes do play a role in government revenue collection in the United States. In the U.S., consumption taxes are typically designed to be sales taxes, use taxes, and taxes on imported goods.
Example of Consumption Taxes
In the United States, a specific tax – namely a consumption tax – is imposed on tobacco products. Because of the taxes imposed by the government, the price of a pack of cigarettes in a convenience store is higher than it would be without this tax. These tax rates depend on the state you live in, and local consumption taxes are often applied as well.
In New York, for example, the state consumption tax rate is $4.35 for a pack of 20 cigarettes, and the local consumption tax in New York City is $1.50 for the same quantity. This means you will pay $5.85 in taxes on top of the retail price, raising the retail price to around $10 for a pack of cigarettes.
Other examples of consumption taxes include value-added tax, sales tax, and import taxes.
Types of Consumption Taxes
Consumption taxes come in several forms, including excise taxes, sales taxes, value-added taxes, and import taxes. Let’s delve into how each one works.
Excise Taxes
Excise taxes – also known as “sin taxes” – are imposed on specific categories of goods or services. Excise taxes can be levied on manufacturers, retailers, or consumers and are often used to deter behaviors deemed harmful. Tax rates vary by state. Examples of excise taxes include those on alcohol, tobacco, coal, and gambling.
Sales Taxes
Sales taxes are imposed on the retail sale of goods or services. Unlike excise taxes, sales taxes are not intended to target vices. In the United States, sales taxes are a significant revenue stream for state governments, and many local governments, counties, and municipalities are allowed to add their own separate taxes to the state rate as well. Some governments exempt certain taxes from taxes on essential goods like food.
Value-Added Taxes
Value-added tax, or VAT, is a very common consumption tax in European countries. VAT is quite similar to sales tax in that the tax is ultimately applied at the retail level. However, the tax is assessed by calculating the value added at each stage of the product’s production.
Import Taxes
Tariffs are imposed on goods or services imported from one country to another. Tariffs are usually paid on raw materials at the production level or on final goods at the distributor level. Tariffs differ from consumption taxes, which are paid by retail consumers on imported goods.
Benefits of Consumption Taxes
The U.S. government generates most of its revenue through income taxes, payroll taxes, and corporate taxes. In other words, most revenue is generated on earned money. This model poses several problems.
First,
Income is difficult to measure, especially when considering complex financial calculations such as capital gains and depreciation. However, consumption taxes are relatively easy to measure: any time an individual spends money, a portion of that expenditure is redirected to the government.
A consumption tax can also encourage saving. Under the current income-based model, individuals and families are taxed whether they are careful about allocating money for the future or not. This consumption tax model reflects that pattern, as the tax is only imposed upon spending, which encourages people to spend less and save more.
Consumption tax may be fairer than income tax. Given the difficulty in measuring income, it is easier to hide income and avoid potential taxation on it. Consumption is more difficult to hide, and since wealthy individuals generally spend more on goods and services, they are responsible for paying more taxes.
Criticism of Consumption Taxes
Consumption tax can also have several drawbacks. For example, many people with very low incomes pay income taxes based on the current exemption limit. If a consumption tax is implemented, low-income individuals would suddenly have to pay taxes with every purchase.
Since low- and middle-income households spend a larger portion of their income than wealthy households, a consumption tax may be considered unfair. Research suggests that even with a shift to a consumption model, savings may not significantly increase.
Frequently Asked Questions (FAQs)
What is an example of a consumption tax?
Sales tax is a common example of a consumption tax. Many states and local governments impose sales taxes, which are a percentage of the purchase price for various goods and services.
What does consumption tax mean?
Consumption taxes are taxes you pay when you buy goods and services. The purpose of a consumption tax is to tax you when you spend money rather than an income tax that taxes a portion of your wages. Consumption taxes can be targeted at specific products, such as excise taxes that tax alcohol, tobacco, and gambling.
Source: https://www.thebalancemoney.com/what-is-a-consumption-tax-5199340
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