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What Are the Advantages and Disadvantages of a Consumption Tax?

A consumption tax could impose higher rates on "sin" items such as alcohol.
Savings would be excluded from a consumption tax.
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  • Written By: Sherry Holetzky
  • Edited By: Bronwyn Harris
  • Last Modified Date: 11 March 2014
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Those who advocate a consumption tax to replace income taxes make several points that seem appealing to the average taxpayer. Rather than paying a tax on earnings, people would only be required to pay taxes on goods and services that they consume. This seems like a good idea on the surface, especially since it would level the playing field in regard to tax evaders. Those who make money through illegal means or who are paid under the table, would no longer have a tax advantage. They too would have to pay sales taxes each time they purchased goods or services, which may well be the biggest advantage of instituting this type of tax.

Another perceived advantage to implementing a consumption tax rather than a tax on earnings is that it does not tax savings; it only applies to monies spent. This sounds good too, until one considers the economic dilemma that will likely be created when people save more of their money instead of spending and putting it back into the economy. It would likely be more difficult for the government get enough money when people save more of their cash in order to lessen the amount of taxes they are paying. The rate of taxation may have to be raised to make up the difference.

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As with anything else, there are pros and cons to all aspects of a consumption tax. One might claim that such taxes are not forced to be paid in the way that income taxes are. This is true, but the same or perhaps an even greater rate of taxation will be required if consumers intend to continue enjoying the lifestyle to which they have become accustomed. Again, the government is going to get its revenue.

Under such a tax system, a potential disadvantage is that some consumer goods or services could be taxed at a higher rate than others, based on arbitrary rules such as one item being seen as a luxury or by way of a “sin tax.” Alcohol, for example, could be taxed at an exorbitant rate to discourage purchasing it. Such use could be abused even further, and used politically to undermine a particular industry or company. Businesses cannot simply soak up higher costs or pass the burden to the consumer without overpricing their goods, and if their products are taxed at a rate far higher than that of other companies, they won’t be able to compete. The cost of materials will be also be taxed at a higher rate, causing manufacturing costs to go up.

While a consumption tax would seem a more fair method of taxation in an ideal world, the world isn't ideal. Overall, it could prove to be the better system if abuse could be controlled. On the other hand, there are those who express a desire to reduce taxes — and therefore government — across the board, rather than simply changing methods from tax on earnings to consumption.

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Discuss this Article

cafe41
Post 4

Mutsy- With a consumption tax, businesses would flourish because people would have more disposable income and could afford more goods and services.

They could also budget for luxury purchases and know how much they would need to save. For example, if you are buying a car that will have a surcharge of 20% you will most likely buy a cheaper car and maybe finance the difference so that it would not impact you as much.

It would take some time to getting used to but I think most people would like it. Also, foreigners would actually be paying our taxes as well so the burden would not be so high on the American family because these sales tax rates would be higher.

mutsy
Post 3

Moldova- I agree that a consumption tax is fair. This is really the only way to even out the playing field with respect to taxes because only those that consume certain things would pay taxes.

Usually food would be exempt so it would not impact the poor all that much. I think that the progressive tax unfairly punishes small business owners and stifles creativity among entrepreneurs because it causes a higher tax burden to these people.

Moldova
Post 2

Mars0987-I agree that the consumption tax trends would actually create more revenue for the federal government because the United States is a consumption based society.

Also, there would be no escape to these taxes as you pay as you consume which is fair. In Europe there is a VAT consumption tax which is a value added tax added to goods and services.

However, this tax is in addition to their exorbinent income taxes of about 70% that many Europeans already pay.

The consumption tax vs. income tax really causes a lot of debate. Proponents of the consumption tax say that it is fair because everyone pays taxes. Currently 50% of Americans pay no income taxes which seems unfair to the other half of Americans.

Critics say that the consumption tax causes an undue burden on the poor because they lack the disposable income that middle class or wealthier class of people has. This proportional tax would be a regressive tax that will surely affect the poor more and become a burden tax to them.

mars0987
Post 1

actually savings are a form of capital accumulation and that really is the one of the sources of economic growth.

it also favours investments, like if you earn money on an investment, you may reallocate it without being taxed. It means higher productivity, employment, growth and so on.

Also, it increases the tax base, as everyone who spends will be taxed, not only those who work or invest.

Thus in real terms, it does not have to decrease revenue, especially since our culture is one of consumption and bad habits are not easily gotten rid of.

Even more important you should consider that it is impossible to change the education and mentality of generations regarding consumption.

what you have mentioned about luxury goods and so on, is already a reality which we are facing, thus emphasizing it so much seems irrelevant.

It is also a relatively neutral tax. It will not affect the consumption of certain goods or rather the demand for them as much as an income based tax system.

It also may track more closely and accurately long term average income, as people tend to spend according to how much they earn.

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