What are the Advantages and Disadvantages of a Consumption Tax?

In Australia, Canada, India, New Zealand and Singapore, it is instead called a "Goods and Services Tax." In Canada, it is also called Harmonized Sales Tax when it is combined with a provincial sales tax. Bankrate follows a strict editorial policy, so you can trust that our content is honest and accurate. Our award-winning editors and reporters create honest and accurate content to help you make the right financial decisions. The content created by our editorial staff is objective, factual, and not influenced by our advertisers. Our goal is to give you the best advice to help you make smart personal finance decisions. We follow strict guidelines to ensure that our editorial content is not influenced by advertisers.

• In India, an excise tax on salt led to Mohandas Gandhi's famous Salt March, a major event in the Indian Independence Movement.
• That is why the reform reduces hours worked, even as it results in higher economic output, investment, and wages through its reduction in the cost of capital.
• Reducing the economic cost of taxes can lead to increases in employment, wages, output, and, ultimately, after-tax income.
• So, if anything, the state, the experience that the states have with the sales tax tell us that it’s very hard to actually implement a clean simple broad based consumption tax.

When the burden of a consumption tax is measured as a share of current income, studies tend to show lower-income people pay a higher share of their income than higher-income people. That is primarily because lower-income households tend to consume a relatively larger share of their income than higher-income households, while higher-income households save a larger share of their income. Embedding support in the tax system creates additional difficulties for low-income families. Unlike other relief programs that provide monthly payments, the refundable tax credits are lump sum payments. Research indicates the credits supply about 9 to 13 percent of income for lower-income households,[67] meaning some families receive the largest single share of their annual income at tax filing time.

Economic, Revenue, and Distributional Effects of a Value-Added Tax and Rebate

In years past, married taxpayers could opt to file jointly on their federal tax return and individually on the state return, which allowed some individuals to avoid paying surtax. The state also passed a tax reform package that was largely retroactive to 2023 but included a stepped increase in the child and dependent tax credit, from $330 to $440, in 2024. Supporters of consumption taxes point to several advantages relative to an income tax. In addition, a broad-based consumption tax can generate a significant amount of revenue at a relatively low tax rate. Compared with income taxes, a consumption tax can produce a more stable stream of revenue, and it is relatively easy to administer. In July 2000, Australia cut personal income taxes and abolished several harmful excise and sales taxes and replaced them with a 10 percent Goods and Services Tax (GST, another name for a VAT).

• With TurboTax Live Full Service, a local expert matched to your unique situation will do your taxes for you start to finish.
• House Bill 236 extends the one-year special unemployment insurance tax rates for another year.
• In recent years, Nebraska has made a concerted effort to make competitive, pro-growth, tax reform a priority.
• Consumption taxes are generally assumed to have a regressive distribution.

Similarly, use taxes may apply if you made a purchase while visiting a different state and paid a lower sales tax or no sales tax. Sales taxes are a flat-rate tax—a set percentage of the purchase amount—that many people in the U.S. are already familiar with and pay. Read on to learn about the types of consumption taxes and how they work. The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.

Consumption taxes are taxes that you have to pay based on what you buy. The taxes might be added to your purchase amount—which is the case with sales tax—or they may be included in the sticker price you see. While income tax targets your earnings, consumption tax takes into account your spending habits. Some believe that consumption tax is fairer as it puts the onus of taxation on those who choose to spend more. On the other hand, income tax is often progressive, meaning it taxes higher earners at a higher rate to provide a more equitable system.

Savings effect

Most European countries and Canada have a consumption tax system in the form of VATs, or value-added taxes. In Canada, the VAT is referred to as a goods and services tax (GST) in some provinces, and a harmonized sales tax (HST) in others. A consumption tax can also refer to a taxing system as a whole in which people are taxed based on how much they consume rather than how much they add to the economy (income tax).

Income Tax Versus Consumption Tax

Alternative approaches to increasing the progressivity of consumption taxes such as blanket exceptions for necessities or the imposition of luxury taxes are either self-defeating or introduce unnecessary distortions. General exemptions on categories of essential goods provide relatively less relief to the taxpayers they are supposed to help. Both general exemptions and luxury taxes distort consumer and business spending patterns, decreasing the efficiency of resource allocation.

The Current U.S. Hybrid Tax System and Its Effects

The law consolidated the state’s seven tax brackets for individual income into two and reduced the top marginal rate from 6.75 percent to 6.5 percent. Additionally, individual taxpayers will be required to use the same filing status on both federal and state returns. This relief is capped for individuals earning $150,000 or more, or married couples earning $300,000 or more. The biennium budget also raises the EITC to 40 percent of the federal credit, up from 30.5 percent, and seniors will benefit from expanded exemptions for certain pensions and annuity earnings.

Corporate Tax Rates around the World, 2023

It creates a wedge between the amount of money a person earns from labor and how much consumption a person can afford after tax, which leads to a reduction in hours worked. That is why the reform reduces hours worked, even as it results in higher economic output, investment, and wages through its reduction in the cost of capital. Replacing the current income tax system with a consumption tax would create transitional effects for people currently holding capital by affecting asset values.

The Pros and Cons of a Consumption Tax

We use the Tax Foundation General Equilibrium Tax Model to estimate the impact of tax policy changes in terms of economic, budgetary (tax revenue), and distributional effects. Economic impact measures include GDP, wages, employment, capital stock, investment, consumption, saving, and the trade deficit. Dynamic revenue estimates consider incremental synonyms & antonyms both behavioral and macroeconomic effects of tax policy on revenue. Our revenue and distributional estimates do not include the impact of the proposed tax changes on non-filers. Nevertheless, measured as a share of current income, moving to a consumption tax would likely be less progressive than the income tax system we have today.