What is a 'Consumption Tax'

A consumption tax is a tax on the purchase of a good or service. Consumption taxes can take the form of sales taxes, tariffs, excise, and other taxes on consumed goods and services.

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).

BREAKING DOWN 'Consumption Tax'

Examples of consumption taxes include retail sales taxes, excise taxes, value added taxes, use taxes, taxes on gross business receipts, and import duties. These taxes are borne by consumers who pay a higher retail price for the good or service. The higher price includes the consumption tax which is collected by the vendor and remitted to the appropriate federal, state, or local government. Consumption taxes are often levied at different rates on different commodities according to perceptions of whether a commodity is considered a necessity (such as food) or a luxury (such as jewelry).

The consumption tax is not a new idea. It was used by the U.S. government for much of our history before being replaced with an income tax. The Bush administration backed a version of this in 2003, although the proposal was defeated. The proposal called for the United States to shift from a mainly progressive income tax system to a national tax system that utilizes consumption taxes exclusively. Ideally, a properly designed consumption tax system would reward savers and penalize spenders. While the U.S. does not have a national consumption tax, many countries in the world have imposed some form of national consumption tax.

Value-Added Tax

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 VAT is a tax on the difference between what a producer pays for raw materials and labor and what the producer charges for finished goods. Hence this consumption tax is levied on the “value added” to goods and services from the production stage to the final consumption stage.

Excise Tax

An excise tax is a sales tax that applies to a specific class of goods, typically alcohol, tobacco, gasoline, or tourism. Some excise taxes are charged to discourage a behavior or purchase of certain goods that are thought to be detrimental to the economy. These excise taxes are more commonly known as sin taxes. Other excise taxes are applied to people who benefit from a program or infrastructure. For example, taxes on gasoline are collected from drivers to maintain roads, highways, and bridges.

Import Duties

Import duties are taxes levied on an importer for goods entering the country. The taxes are passed on by the importer to final consumers through higher costs. The amount of this consumption tax payable varies greatly depending on the imported good, the country of origin, and several other factors. Import duties can be calculated as a percentage of the value of the goods being imported, or based on the quantity, weight, or volume of the goods being imported.

Retail Sales Tax

The sales tax is usually ad valorem, that is, it is calculated by applying a percentage rate to the taxable price of a sale. Although there is a sales tax in the U.S., it is a form of state tax, not federal tax. In addition, the state sales taxes exempt all sorts of spending, such as food, health, and housing. Countries that have implemented the sales tax as a federal consumption tax, tax almost all consumption.

Consumption Tax vs. Income Tax

A consumption tax is charged to people when they spend money. An income tax is levied on people when they earn money or when they receive interest, dividends, or capital gains, from their investments. Proponents of a consumption tax argue that it encourages saving and investment and makes the economy more efficient, while income taxation penalizes savers and rewards spenders. Thus, they argue that it is only fair that people are taxed on what they take out of the limited resource pool through consumption, rather than what they contribute to the pool using their income.

On the other hand, opponents maintain that a consumption tax adversely affects the poor who, by necessity, spend more of their income. They state that since consumption tax is a form of regressive tax, the wealthy population consume a smaller fraction of their income than do poorer households.

RELATED TERMS
  1. Sales Tax

    A sales tax is a consumption tax imposed by the government on ...
  2. Direct Tax

    A direct tax is a tax paid directly by an individual or organization. ...
  3. Effective Tax Rate

    The effective tax rate is the average rate at which an individual ...
  4. Tax Base

    A tax base is the amount of assets or income that can be taxed.
  5. Tax Expense

    A tax expense is a liability owed to federal, state/provincial ...
  6. Tax Fairness

    Tax fairness is a tax system that aims to create a system of ...
Related Articles
  1. Taxes

    The History of Taxes in the U.S.

    America's first citizens enjoyed few to no taxes. Then taxes were added, increased and occasionally repealed to give us our current tax regime.
  2. Taxes

    Taxes: Who Pays And How Much?

    When it comes to taxes, the debate is endless on who pays what, especially in Congress. With no new initiatives in sight, let's take a look at who is paying now.
  3. Taxes

    5 State Tax Issues For When You Leave the Military

    When you're budgeting for post-military life, certain state tax issues need to be considered.
  4. Taxes

    Why America's Taxes Are Too Low

    The solution to America's economic woes may not be in lowering taxes further, but may, in fact, lie in increasing them.
  5. Taxes

    Comparing Regressive, Proportional and Progressive Taxes

    Learn about the basic differences between three common tax systems.
  6. Taxes

    Which Countries Have High Taxes on High Incomes?

    For high earners in these countries, the tax rate percentage on income exceeding a certain threshold can reach into the high 50s and low 60s.
  7. Taxes

    Tax Haven Vs. Tax Shelters: Is There a Difference?

    Learn about the difference between tax havens and tax shelters, and how both are used to reduce tax liability or avoid paying taxes altogether.
  8. Insights

    How Fortune 500 Companies Avoid Paying Income Tax

    President Donald Trump is not alone in not paying taxes.
  9. Taxes

    Do Canadians Really Pay More Taxes Than Americans?

    We look at the difference in tax rates and services offered on both sides of the border.
RELATED FAQS
  1. What are the differences between regressive, proportional, and progressive taxes?

    Learn the three basic types of tax systems--regressive, proportional, and progressive--used in the U.S., and how they affect ... Read Answer >>
  2. What is the difference between a state income tax and a federal income tax?

    Learn the difference between state income tax and federal income tax based on tax rates, deductions, tax credits and taxable ... Read Answer >>
Trading Center