A consumption tax is a tax levied on consumption spending on goods and services. The tax base of such a tax is the money spent on consumption. Consumption taxes are usually indirect, such as a sales tax or a value-added tax. However, a consumption tax can also be structured as a form of direct, personal taxation, which is known as an expenditure tax.
Tax rate by country Here are consumption tax rate by country/state for OECD countries:
+Consumption tax rate by country for OECD countriesCountryConsumption Tax(VAT/GST %)Australia10Austria20Belgium21Canada5Chile19Czech Republic21Denmark25Estonia22Finland25.5France20Germany19Greece24Hungary27Iceland24Ireland23Israel18Italy22Japan10Korea (South Korea)10Luxembourg17Mexico16Netherlands21New Zealand15Norway25Poland23Portugal23Slovak Republic20Slovenia22Spain21Sweden25Switzerland8.1Turkey20United Kingdom20+Consumption tax rate by state of the United StatesStateConsumption Tax(VAT/GST %)Alabama4Alaska0Arizona5.6Arkansas6.5California7.25Colorado2.9Connecticut6.35Delaware0Florida6Georgia4Hawaii4Idaho6.25Illinois7Indiana6Iowa6.5Kansas6Kentucky6Louisiana6Maine6Maryland6.25Massachusetts6Michigan6.875Minnesota6.25Mississippi4.225Missouri6Montana0Nevada6.625New Hampshire5New Jersey4.75New Mexico4New York5.75North Carolina5.75North Dakota6.25Ohio6.5Oklahoma0Oregon6.25Pennsylvania7Rhode Island6South Carolina6South Dakota6.25Tennessee4
Types Value-added tax A value-added tax applies to the market value added to a product or material at each stage of its manufacture or distribution. For example, if a retailer buys a shirt for twenty dollars and sells it for thirty dollars, this tax would apply to the ten dollar difference between the two amounts.
A simple value-added tax is proportional to consumption but is regressive on income at higher income levels, as consumption tends to fall as a percentage of income as income rises. Savings and investment are tax-deferred until they become consumption. A value-added tax may exclude certain goods to make it less regressive against income. It is common in European Union countries.
Value added tax is a consumption based tax and is levied each and every time the value of a good gets increased in the process of manufacturing to the point of sale.
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.
Sales tax Sales tax is a consumption tax applicable to sales of goods and services. A sales tax typically applies to the sale of goods, and sometimes includes the sales of services. The tax is applied at the point of sale. The tax amount is usually ad valorem, that is, it is calculated by applying a percentage rate to the price of a sale. When a tax on goods or services is paid to a governing body directly by a consumer, it is usually called a use tax. Often, laws provide for the exemption of certain goods or services from such taxes.
Laws may allow sellers to itemize the tax separately from the price of the goods or services, or they may require it to be included in the price.
Excise tax An excise tax is a sales tax that applies to a specific class of goods, typically alcohol, tobacco, gasoline (petrol), or tourism. The tax rate varies according to the type of good and quantity purchased and is typically unaffected by the person who purchases it.
Sin taxes, are a type of excise tax imposed on items that are considered harmful to society, in an effort to decrease their consumption by increasing their prices.
Expenditure tax A direct, personal consumption tax may take the form of an expenditure tax, that is, an income tax that deducts savings and investments, such as the Hall–Rabushka flat tax.The Flat Tax , By Robert E. Hall and Alvin Rabushka, Hoover Institution A direct consumption tax may be called an expenditure tax, a cash-flow tax, or a consumed-income tax and can be flat or progressive. Expenditure taxes were briefly implemented in the past in India and Sri Lanka.
This form of tax applies to the difference between an individual's income and any increase/decrease in savings. Simple personal consumption taxes are regressive with respect to income. However, because this tax applies on an individual basis, it can be made progressive. Just as income tax rates increase with personal income, progressive consumption tax rates increase with personal consumption. Economists from Milton Friedman to Edward Gramlich and Robert H. Frank supported a progressive consumption tax.
History Consumption taxes, specifically excise taxes, have featured in several notable historic events. In the United States, the stamp tax, the tax on tea, and whiskey taxes produced revolts, the first two against the British government and the latter against the federal government. In India, an excise tax on salt led to Mohandas Gandhi's famous Salt March, a major event in the Indian Independence Movement.
United States In the early United States, taxes were levied principally on consumption. Alexander Hamilton, one of the two chief authors of the anonymous The Federalist Papers, favored consumption taxes in part because they are harder to raise to confiscatory levels than income taxes. In The Federalist Papers (No. 21), Hamilton wrote:
Although personal and corporate income taxes provide the bulk of revenue to the federal government, consumption taxes continue to be a primary source of income for state and local governments. One of the first detailed proposals of a personal consumption tax was developed in 1974 by William Andrews.Andrews, William D. "A Consumption-Type or Cash Flow Personal Income Tax", 87 Harv. L. Rev. 1113 (1974)
Japan The Liberal Democratic Party government of Masayoshi Ōhira attempted to introduce a consumption tax in 1979. Ohira met opposition within his own party and gave up on his attempt after his party suffered badly in the 1979 election. Ten years later, Noboru Takeshita successfully negotiated with politicians, bureaucrats, business, and labor unions to introduce a consumption tax,The Daily Yomiuri Website Reflections on Leadership – 2 / Leaders should build network of contacts, keep enemies close Retrieved on July 4, 2012 which was introduced at a rate of 3% in 1989.
In April 1997,The Daily Yomiuri Is the "cash payout plan" the most effective solution for stimulating the economy? Retrieved on July 4, 2012 under the government of Ryutaro HashimotoNews Channel Asia Aso says raising consumption tax will not aid Japan's economy Retrieved on July 4, 2012 the rate increased to 5%.Bloomberg website "Japan’s Kan Tackles Sales Tax ‘Taboo’ That Obama Won’t Touch" Retrieved on July 4, 2012 The 5% is split between the national and local governments, which receive 4% and 1%, respectively.JETRO website Section 3. Taxes in Japan – 3.6 Overview of consumption tax Retrieved on July 4, 2012 Shortly after the tax was introduced Japan fell into recession,East Asia Forum Japan’s aging population and public deficits Retrieved on July 4, 2012 which was blamed by some on the consumption tax increase, and by others on the 1997 Asian financial crisis.
Prime Minister Junichiro Koizumi said he had no intention of raising the tax during his government, but after his massive victory in the 2005 election, he lifted a ban on discussing it.Electronic journal of contemporary Japanese studies Can the Democratic Party Finally Raise Japan’s Consumption Tax? Retrieved on July 4, 2012 Over the following years LDP politicians discussed raising it further, including prime ministers Shinzō Abe, Yasuo Fukuda,The Financial Express Fukuda Vows To Continue Reform In Japan Retrieved on July 4, 2012 and Tarō Asō.Reuters Japan PM Aso says consumption tax hike unavoidable Retrieved on July 2012
The Democratic Party came to power in the August 2009 elections with a promise not to raise the consumption tax for four years.Asashi Shimbun DPJ’S Governing Fiasco: Party never challenged Finance Ministry Retrieved on July 4, 2012 The first DPJ prime minister, Yukio Hatoyama was opposed, but Naoto Kan replaced him and called for the consumption tax to be raised. The following prime minister, Yoshihiko Noda "staked his political life" on raising the tax.Forbes magazine For PM Noda: A Week of Political Drama and the Challenge Ahead Retrieved on July 4, 2012 Despite an internal battle that saw former DPJ leader and co-founder Ichirō Ozawa and many other DPJ diet members vote against the bill and then leave the party; on June 26, 2012, the lower house of the Japanese diet passed a bill to double the tax to 10%.Asahi Shimbun Update: Lower House passes bills to double consumption tax Retrieved on July 4, 2012
Despite considerable opposition and an attempted no-confidence motion from minor opposition parties the bill was successfully passed through the upper house on August 10, 2012, with the result that the tax increased to 8% in April 2014 and to 10% in October 2019 (twice postponed from the original date of October 2015).Bloomberg website Abe Postpones Japan's Sales-Tax Hike Until Late in 2019 Retrieved on March 25, 2017
Savings effect
To the extent that taxing something results in less of it (whether income or consumption), taxing consumption instead of income should encourage both work and capital formation, which increases economic growth, while discouraging consumption. Secondly, the tax base is larger because all consumption is taxed.
Flat consumption taxes are regressive (shift the tax burden to the less well-off). The ratio of tax obligation to income tends to shrink as income increases because high-earners tend to consume proportionally less of their income.Gilbert E. Metcalf. "The National Sales Tax: Who Bears the Burden?" An individual unable to save will pay taxes on all his income, but an individual who saves or invests a portion of his income is taxed only on the remaining income.
Practical considerations Many proposed consumption taxes share some features with income tax systems. Under these proposals, taxpayers are typically given exemptions and/or a standard deduction in order to ensure that the poor do not pay any tax. In a flat consumption tax, these other deductions are not permitted.
A withholding system may be put into place in order to approximate the average tax liability, smoothing payments. It is difficult for many taxpayers to pay no tax all year, only to face a large year-end tax bill.
Andrews notes the inherent problem with housing. Renters necessarily "consume" housing, so they would be taxed on the expenditure of rent. However, homeowners also consume housing in the same way, but as they pay down a mortgage, the payments are classified as savings, not consumption (because equity is being built in an asset).
The disparity is explained by what is known as the imputed rental value of a home. A homeowner could choose to rent the home to others in exchange for money, but instead chooses to live in the home. Therefore, the homeowner is also consuming housing by not permitting renters to pay for and occupy the home. The amount of money that the homeowner could receive in rent is the imputed rental value of the home.
A true consumption tax would tax the imputed rental value of the home (which could be determined in the same way that valuation occurs for property tax purposes) but not the increase in the asset value (the home). Andrews proposes to ignore this method of taxing imputed rental values because of its complexity. In the United States, home ownership is subsidized by the federal government by permitting limited deductions for mortgage interest expense and capital gains. Therefore, treating renters and homeowners identically under such a consumption tax may not be feasible there.