Wednesday, December 17, 2008

Consumption Taxes

Consumption Taxes

Some people advocate replacing income taxes with taxes on consumption. These might include a national sales tax, additional excise taxes on particular products, a value-added tax (VAT), or customs duties on imports or exports. Proponents of consumption taxes claim income taxes reduce people’s incentive to work, but consumption taxes do not. Instead, consumption taxes discourage consumption and thus encourage saving. Increased savings provide more financial resources that can be used for economic investment by businesses or the government. Increased economic investment generally leads to higher economic growth. Thus, consumption taxes do not distort incentives for the economy to save and invest. This should lead to greater economic growth.

Prior to the creation of the current income tax system in 1913, the U.S. relied heavily on import duties and excise taxes to finance federal government expenditures. Taxation of imports and exports reduces the volume and benefits of trade and may reduce a country’s welfare. Consequently, many consumption tax proponents favor value-added taxes. A value-added tax (VAT) is a type of consumption tax that is based on the additional value of a product added at each stage of the production process. The VAT differs from traditional sales taxes because it is collected from producers rather than retailers. It is collected from the factory that makes the product, not the stores that sell it. And unlike sales taxes, the VAT is included in the prices of products instead of being added onto the sales price at the time of purchase. The U.S. is the only major industrialized country without a value-added tax. A VAT has been proposed numerous times in the U.S. Congress, but has never received any significant support.

A national sales tax is another type of consumption tax. Sales taxes are quite common in the U.S. at the state and local level. Some people advocate creating a national sales tax to replace some or all or the federal income tax. If the U.S. relied on a national sales tax as a primary source of revenue for the federal government, the tax rate might need to be 25%. This means that every time a consumer made a purchase, 25% of the price would be added to support the federal government. Critics of a national sales tax complain about the regressive structure of such a tax. The imposition of a national sales tax would shift much of the tax burden away from the wealthy to middle and low income Americans.

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