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Consumptipn Taxes

An analysis of the various forms of consumption tax and the consideration of a consumption tax as an alternative to the traditional income tax. By: David Popko 24 May 2010

Consumption Tax

A tax on what people spend rather than what they earn. Economist Robert Hall states: while taxing income taxes what people put into the economy, taxing consumption taxes what people take out of it. Usually levied either in the form of sales tax or value added tax

Sales Tax

a consumption tax charged at the point of purchase for certain goods and service Sales tax burden is borne entirely by the consumer at the point of sale. Calculated by adding a percentage to the taxable sale price

The Value Added Tax

a general, broadly based consumption tax Tax is applied to all goods and services that are bought and sold for consumption purposes in a community. a consumption tax because it is borne by the final consumer. It is not a charge on businesses. charged as a percentage of price, at each stage of production Paid to the revenue authorities by the seller of the goods, but it is actually paid by the buyer to the seller as part of the price.

Continued

Paid as a fraction of the value added at each stage of production collected fractionally, whereby taxable persons (i.e., VAT-registered businesses) deduct from the VAT they have collected the amount of tax they have paid to other taxable persons on purchases for their business activities The standard way to implement a VAT involves assuming a business owes some percentage on the price of the product minus all taxes previously paid on the good

Differences From A Sales Tax

Value Added Tax is a form of indirect tax that is imposed at different stages of production on goods and services Sales tax is the percentage of revenue imposed on the retail sale of goods. In a VAT, the same tax is charged to each member involved in the production of the goods and services, on the value addition at every stage of production

Example
Sales Tax(10%)

VAT Tax(10%)

Vendor pays an orange farmer $1.00 for oranges, with no taxes,as the vendor is not a final consumer. The orange juice vendor charges the retailer in a store $1.20 for orange juice, giving the vendor a profit margin of $0.20. The retailer charges the consumer $1.65 ($1.50 + ($1.50 x 10%)) and pays the government $0.15, leaving a profit margin of $0.30.

Vendor pays farmer $1.10 for the oranges($1.00+(1.00x10%) and the farmer pays $0.10 to the government. The vendor charges the retailer $1.32 ($1.20 + ($1.20 x 10%)) and pays the government $0.02 ($0.12 minus $0.10), leaving the same gross margin of $0.22. ($1.32 $1.10 = $0.22), and profit margin of $0.20. The retailer charges the consumer $1.65 ($1.50 + ($1.50 x 10%)) and pays the government $0.03 ($0.15 minus $0.12), leaving the gross margin of $0.33 ($1.65 - $1.32 = $0.33).

Benefits of Consumption Tax

Environmentally friendly, discourages consumption, leading to a conservation of resources. The removal of an income tax encourages saving and investing, which is the key to job growth. Individuals would have an extra incentive to work hard and earn income, while those with established, inherited wealth are unable to avoid taxation. Tax rates can be targeted to encourage or discourage the consumption of certain items. A consumption tax would be a much simpler system, eliminating the need for individuals to comply with complex tax reporting requirements and freeing up all the money & time lost on the income tax process. It would allow a greater collection of tax money from those carrying out illegal transactions, since their income is hid from the income tax system but will be taxed when they spend it in a sales tax Consumer prices of certain items would fall since labor and tax compliance costs would be cheaper to businesses

Refutation of Perceived Cons

Consumer prices of many items would go up by a much greater rate than the sales tax rate since raw materials would also be taxed The transition costs of such a change would be extremely expensive A sales tax would be a regressive tax; i.e. low-income individuals would pay a much higher share of their incomes than wealthy individuals.