Consumption tax is a tax on 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, such as an expenditure tax.

Consumption tax is applicable on the consumption of any type of good or service. This particular tax is based on consumption and not on income or labor. The Consumption Tax can be regarded as a sales tax, as this tax is also regressive in nature like the other pure sales taxes. However, there are some remedies by which the Consumption Tax can be made progressive in nature. Some of the methods for reducing the regressive trait of this tax include use of exemptions, deductions, graduated rates, or rebates. This will in other terms allow accumulation of savings exempting the tax burdens.

A consumption tax is a tax on spending rather than on income; income is taxed when spent (consumed), not when it is saved.

Consumption tax formula—

Income = Consumption + Savings

Thus, Consumption = Income – Savings

History of the Consumption Tax:

The Consumption Tax is more of a western concept than gaining grounds in the eastern countries. In the United States for consumption of goods and services, this tax was levied. The Consumption Tax was very popular out in the American countries as they are difficult to bring up at the levels of confiscation compared to that of the income tax. 

Features of the Consumption Tax:
From the practical aspects, the features of the Consumption Tax are a lot similar to those of the present income tax systems. Some of the main characteristics of the tax on consumption are –

  • All those who are paying this tax would be subjected to certain exemptions and a standard deduction such that those categorized, as the poor do not have to pay any tax.
  • All those who are liable to pay the Consumption Tax, will not enjoy any other deductions as this would not be allowed since their all savings are already subjected to deduction.
  • In order to estimate the total liability of the Consumption Tax there might be withholding of the system, however this poses problems for the taxpayers. This creates trouble, as they had to pay no tax throughout the year to receive a huge tax receipt at the termination of the assessed year.
  • All those paying the Consumption Tax enjoys the exemption of being taxed on all incomes placed in some investment projects, this is because this tax is only concerned with consumption.
  • In order to transform the regressive nature of the Consumption Tax and to make it a progressive tax, all the taxpayers should expend more on consumption such that they are liable to pay more taxes on consumption.

Generally, Consumption Taxes are more favored than the income taxes, as these taxes do not depend on the investment rates. For the taxpayer, in order to buy one investment when he sells another investment, there is no extra tax imposed on the profit. This implies that the Consumption Tax in general favors investment policies and in turn this would increase the capital stock, productivity, and the size of the economy as a whole.

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