Cascade Tax Definition

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Cascade Tax Definition

What is a Cascade Tax?

A cascade tax, also known as a cascading tax, is a system that levies sales taxes on items at each level of the production chain, from raw material to consumer purchase. Each customer in the supply chain pays a price based on its cost, which includes any prior tax or taxes levied.

Key Takeaways

  • A cascading tax is levied at each step of a product’s journey through the supply chain.
  • A cascading tax raises the cost of a product by stacking the impact of taxes on top of taxes. As a consequence, the actual tax rate is greater than the official rate.
  • A value-added tax or a goods-and-services tax are two alternatives to a cascading tax.

Understanding the Cascade Tax

A cascade tax is essentially a charge on top of another tax. A cascade tax has a compounding impact, with items having numerous manufacturing phases paying more and more tax as they travel through the supply chain to the ultimate customer. As a consequence, the actual sales tax rate is greater than the official sales tax rate.

Overall, nations with cascading taxes may find it difficult to compete in overseas markets. This is due to the fact that such a tax regime causes inflationary pricing in compared to those of overseas rivals.

Example of How a Cascade Tax Works

Take, for example, the present wrapping industry. It all begins with a tree, which is felled and sold to a paper mill. The wood is pulped, flattened, dried, and cut into sheets and rolls at the facility. A firm that creates and produces elegant paper in huge numbers and sells it wholesale buys these rolls. The distributor then offers it in individual rolls to retail outlets throughout the country. Finally, a customer purchases it.

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Each of the ownership transactions is a taxable transaction, and each transaction involves sales tax. The transaction’s total cost is based on the overall company expenses, including the sum of all taxes levied for each preceding transaction.

How Cascade Taxes Compound

As previously stated, a cascade tax has a compounding effect, resulting in more tax receipts than a single-stage tax. This is the same sort of mathematical compounding that we see in investment, but this type ultimately affects the customer.

Assume the government imposes a 2% cascading tax on all products created and delivered. A firm offers a $1,000 stone slab to an artist for a tax-inclusive price of $1,020 ($1000 + 2%). A sculpture is created by the artist. He expects to earn $2,000 from the sale to an art broker. The art dealer will pay $3,020 plus sales tax, for a total of $3,080 ($3020 + 2% tax). Because the art dealer wants $5,000 for the sculpture, the price at the art gallery is $8,080 plus sales tax, for a total of $8,242.

In all, the government has collected taxes of $20 + $60 + $162 = $242, resulting in an effective tax rate of $242/$8,000, or 3.025%.

Alternatives to a Cascade Tax

A single-stage tax, such as the value-added tax (VAT), often known as a goods and services tax, is the primary alternative to a cascade tax (GST).This is a tax that is only paid on the value that the most recent seller has added to the goods. As a result, the tax is based not on the whole worth of the product, but on the value contributed to it by the most recent firm in the chain.

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A VAT tax results in lower total taxes than equivalent rates applied in a cascading system. A VAT tax does not raise the price of completed items.

A value-added tax system is used in over 160 nations. Most notably, European Union member countries levy a VAT tax. As of 2021, the minimum tax was 15%, with member countries allowed to increase it.

Opponents of the VAT tax contend that it is a regressive tax that disproportionately affects the poor. Some countries have sought to respond to this criticism by exempting purchases of commodities considered necessary, such as groceries and pharmacy purchases.

How a GST Tax Works

When a jurisdiction applies a GST tax instead of a VAT tax, it combines many taxes into a single tax. Central taxes such as sales tax, excise duty tax, and service tax may be included, as well as state-level taxes such as entertainment tax, admission tax, transfer tax, and luxury tax. These are combined into a single tax.

As a result, when a product is sold, each vendor in the supply chain may subtract the tax paid from the tax received and submit the difference to the government. The ultimate customer pays the entire tax rate, not a multiple of it, regardless of how many times the goods changes hands. Mexico has VAT taxes while Canada has GST charges.

Tax Methods in the United States

There is no federal sales tax in the United States. The states levy sales taxes at rates that they choose. They may also be imposed by localities, which can charge an additional 1% or 2% on top of the state rate on certain or all items bought.

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A Delaware buyer will not pay tax on a California avocado, but the avocado may have been taxed many times along the way from farm to wholesaler to retailer.

The specifics are also determined by state legislation. A state may charge sales tax on apparel but not on food, unless it is candy, chewing gum, or sugary beverages.

Five states do not have a sales tax. Alaska, Oregon, Delaware, Montana, and New Hampshire are the states as of February 2021. California had the highest state sales tax, at 7.25%, while Indiana, Mississippi, Rhode Island, and Tennessee were all close behind with 7% rates. When municipal taxes are included in, most states’ aggregate sales taxes will be greater than the state-level rate.

As a consequence, a Delaware buyer will pay no sales tax while buying a California avocado, but the avocado’s price may reflect many sales tax transactions along the way from farm to wholesaler to retailer.

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