Consumption Tax Definition

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Consumption Tax Definition

What Is a Consumption Tax?

Consumption taxes are levied on the purchase of a product or service. Sales taxes, tariffs, excise taxes, and other taxes on consumed products and services are all examples of consumption taxes.

A consumption tax is also a taxation system in which individuals are charged based on how much they consume rather than how much they contribute to the economy (income tax).

Key Takeaways

  • Consumption taxes are widely used to describe taxes on products and services.
  • A consumption tax is something like a sales tax or a VAT.
  • A consumption tax is levied when consumers spend money, while an income tax is levied when they earn money.

Understanding a Consumption Tax

Retail sales taxes, excise taxes, value-added taxes, usage taxes, taxes on gross company earnings, and import tariffs are all examples of consumption taxes. Consumers pay these taxes by paying a higher retail price for the item or service.

The higher price includes the consumption tax, which the merchant collects and remits to the relevant federal, state, or municipal government. Consumption taxes are often paid at varying rates on different items based on judgments of whether a product is a need (such as food) or a luxury (such as clothing) (such as jewelry).

The consumption tax is not a novel concept. For most of its history, the United States government levied a consumption tax before switching to an income tax. Although the concept was failed, the Bush administration supported a variant of it. The concept proposed for the United States to transition from a mostly progressive income tax system to a national tax system based solely on consumption taxes.

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A well constructed consumption tax system would ideally encourage savers while penalizing spenders. While the United States does not have a national consumption tax, many other nations throughout the globe have some sort of a national consumption tax.

In 1989, Japan, for example, introduced a 3% consumption tax to its income tax. In 1997, the Japanese Consumption Tax (JCT) was raised to 5%. A two-part tax hike to double the tax was enacted in 2012, raising it to 8% in April 2014. It was supposed to grow to 10% in October 2015, but two delays moved it out to October 2019. There are exemptions for food, newspapers, and several other everyday products, which maintain the consumption tax at 8%.

Types of Consumption Taxes

Value-Added Tax

Most European nations and Canada have a VAT, or value-added tax, consumption tax system. The VAT is known as a goods and services tax (GST) in certain provinces and a harmonized sales tax (HST) in others in Canada.

A VAT is a tax on the difference between the price of raw materials and labor paid by a manufacturer and the price of completed items charged by the producer. As a result, this consumption tax is charged on the “value added” to products and services from the point of manufacture to the point of consumption.

Excise Tax

An excise tax is a kind of sales tax that is levied on a particular category of commodities, such as alcohol, cigarettes, fuel, or tourism. Some excise taxes are levied to discourage specific types of behavior or purchases that are deemed to be harmful to the economy. These excise taxes are often known as sin taxes. Other excise taxes are levied on those who profit from a program or infrastructure. Gasoline taxes, for example, are collected from vehicles in order to maintain roads, highways, and bridges.

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Import Duties

Import tariffs are charges placed on products entering the nation by an importer. The importer passes the taxes on to the ultimate customer in the form of increased prices. The amount of this consumption tax that must be paid varies substantially depending on the imported commodity, the nation of origin, and a number of other considerations. Import duties may be determined as a percentage of the value of the imported items or depending on the amount, weight, or volume of the imported goods.

Retail Sales Tax

Ad valorem sales tax is often levied by adding a percentage rate to the taxable price of a transaction. Although the United States has a sales tax, it is a kind of state tax, not a federal tax. Furthermore, state sales taxes exclude all types of expenditure, including food, health care, and housing. Almost all consumption is taxed in countries that have adopted the sales tax as a federal consumption tax.

Consumption Tax vs. Income Tax

When individuals spend money, they are subject to a consumption tax. When persons make money or get interest, dividends, or capital gains from their investments, they are subject to income tax.

Consumption tax supporters claim that it stimulates saving and investment while making the economy more efficient, while income taxes penalizes savers while rewarding spenders. As a result, they claim that it is only fair to tax individuals on what they take from the finite resource pool via consumption rather than what they provide to the pool through income.

Opponents, on the other hand, argue that a consumption tax harms the poor, who must spend more of their income. They claim that since a consumption tax is a regressive tax, the rich spend a lower portion of their income than poorer families.

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