Consumption tax 1913132 225811039 2008-07-15T14:48:58Z 138.163.0.44 /* Origins */ {{Cleanup|date=August 2006}} {{globalize/USA}} {{public finance}} A '''consumption tax''' is a [[tax]] on the purchase of a good or service. The term "consumption tax" refers to a system whose tax base is consumption (as opposed to income or labour). While this can be structured like a pure [[sales tax]], many proposals for a consumption tax make adjustments to decrease [[regressive tax|regressive]] effects. Using exemptions, graduated rates, deductions or rebates, a consumption tax can be made less regressive or [[progressive tax|progressive]], while allowing savings to accumulate tax-free.<ref name="greenspan">{{cite news | url=http://www.nytimes.com/2005/03/04/politics/04tax.html | title=Fed's Chief Gives Consumption Tax Cautious Backing | last=Andrews | first=Edmund L. | publisher=[[The New York Times]] | format=HTML | date=2005-03-04 | accessdate=2008-02-05}}</ref><ref name="consumptiontax">{{cite news | url=http://online.wsj.com/article/SB112492381500022421.html | title=A Consumption Tax | publisher=[[The Wall Street Journal]] | last=Auerbach | first=Alan J | date=2005-08-25 | accessdate=2008-02-05}}</ref> ===Origins=== Throughout most of [[American history]], taxes were levied principally on consumption. [[Alexander Hamilton]], one of the two chief authors of the anonymous [[Federalist Papers]], favored consumption taxes in part because they are harder to raise to [[Confiscation|confiscatory]] levels than incomes taxes.<ref name="Bartlett">{{cite web|last=Bartlett |first=Bruce| url=http://www.townhall.com/columnists/BruceBartlett/2002/04/05/the_founders_and_the_consumption_tax | publisher=Townhall.com |title=The Founders and the consumption tax |date=2002-04-05 |accessdate=2007-08-09}}</ref> In the [[Federalist Papers]] ([[Federalist No. 21|No. 21]]), Hamilton wrote: {{quotation|It is a signal advantage of taxes on articles of consumption that they contain in their own nature a security against excess. They prescribe their own limit, which cannot be exceeded without defeating the end proposed—that is, an extension of the revenue. When applied to this object, the saying is as just as it is witty that, "in political arithmetic, two and two do not always make four." If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds. This forms a complete barrier against any material oppression of the citizens by taxes of this class, and is itself a natural limitation of the power of imposing them.<ref>[http://www.conservativetruth.org/library/fed21.html Federalist Paper No. 21]</ref>}} One of the first detailed analyses of a consumption tax was developed in 1974 by William Andrews.<ref>Andrews, William D. A Consumption-Type or Cash Flow Personal Income Tax, 87 ''Harv. L. Rev.'' 1113 (1974)</ref> Under this proposal, people would only be taxed on what they consume, while their savings would be left untouched by taxation. For this reason, the tax can be called a consumption tax, a cash-flow tax, an expenditure tax, or a consumed-income tax, to name a few. Former senior editor of Fortune magazine Al Ehrbar notes that proponents of a consumption tax argue its superiority to the income tax based on an economic principle called "temporal neutrality".<ref>Ehrbar, Al. Consumption Tax, ''[http://www.econlib.org/library/Enc/ConsumptionTax.html The Concise Encyclopedia of Economics]''</ref> He observes that a tax is "neutral" if it does not "alter spending habits or behavior patterns and thus does not distort the allocation of resources." In other words, taxing apples but not oranges will cause apple consumption to decrease and orange consumption to increase. The temporal neutrality of a consumption tax, however, is that consumption itself is taxed, so it is irrelevant what good or service is being consumed in terms of allocation of resources. The only possible effect on neutrality is between consumption and savings. Taxing only consumption should, in theory, cause an increase in savings.<ref name="greenspan"/> William Gale, Co-director of the Urban-Brookings Tax Policy Center, offers a simplified way to understand a consumption tax: Assume that our current tax system remains the same, but remove limitations to contributing to and removing funds from a traditional [[Individual retirement account|IRA]]. Thus, a person would essentially have a bank account where they could place tax-free earnings at any time, but unsaved (or consumed) withdrawals would be subject to taxation. Having an unrestricted [[Individual retirement account|IRA]] under the current system would approximate a consumption tax at the federal level.<!-- This is not an accurate statement of Gale's contentions. --> ===Example=== In his article, Andrews also explains the power of deferral, and how the current income tax method taxes both income and savings. For example, Andrews offers the treatment of retirement income under the current tax system. If, in the absence of taxes, $1 of savings is put aside for retirement at 9% compound interest, this will grow into $8 after 24 years. Under our current system, assuming a 33% tax rate, a person who earns $1 will only have $0.67 to invest after taxes. This person can only invest at an effective rate of 6%, since the rest of the yield is paid in taxes. After 24 years, this person is left with $2.67. But if, like in an [[Individual retirement account|IRA]], this person can defer taxation on these savings, she will have $8 after 24 years, taxed only once at 33%, leaving $5.33 to spend on her retirement. It is also mathematically irrelevant when the tax is imposed, for if this same person is taxed on the dollar she earns, but is never taxed again, the $0.67 she invests will grow to $5.33 in 24 years.{{Fact|date=June 2007}} Timing the taxation in this way is much like a [[Roth IRA]]. This is the primary concept of the consumption tax- the power of deferral. Even though the person in the above example is taxed at 33%, just like her colleagues, deferring that tax left her with twice the amount of money to spend in retirement. Had she not saved that dollar, she would have been taxed, leaving $0.67 to spend immediately on whatever she wanted. Harnessing the power of deferral is the most important concept behind a consumption tax. ===Concerns=== In the above example, the equation for the government is the opposite as it is for the taxpayer. Without the IRA tax benefits, the government collects $5.33 from the $1 saved over 24 years, but if the government gives the tax benefits, the government collects only $2.67 over the same period of time. The system is not free. Regardless of political philosophy, the fact remains that a government needs money to operate, and will have to get it from another source. The upside of the consumption tax is that, because it promotes savings, the tax will encourage capital formation, which will increase productivity and economic activity.<ref name="greenspan"/><ref name="consumptiontax"/> Secondly, the tax base will be larger because ''all'' consumption will be taxed. Some critics argue that sales and consumption taxes can shift the tax burden to the lower to middle class. The ratio of tax obligation shrinks as wealth grows because the wealthy spend proportionally less on consumables.<ref>Gilbert E. Metcalf. "The National Sales Tax: Who Bears the Burden?" http://www.cato.org/pubs/pas/pa-289.html</ref> Setting aside the question of rebates, a working class individual who must spend all income, will find his expenditures and therefore his income base taxable at 100%, whereas wealthy individuals who save or invest a portion of their income will only be taxed on the remaining income. This argument assumes that savings or investment is never taxed at a later point when consumed (tax-deferred). Further, average citizens cannot take advantage of tax-avoidance avenues, such as offshore purchases. A working class individual cannot realistically purchase, say, a Mercedes or Lexus offshore, thereby avoiding domestic tax. However, when purchases are made offshore, the buyer is subject to the tax laws in that country, using the example of Mercedes or Lexus - buyers would be subject to the VAT tax (the VAT is removed on exports and would not be charged if purchased domestically) and buyers may be additionally subjected to import taxes at [[customs]]. Moreover, the argument that consumption taxes can be avoided by offshore purchases implicitly assumes that the consumption tax is levied at the point of sale. There are methods of implementing the tax (such as the Hall-Rabushka model) that would tax a citizen's consumption regardless of where the consumption occurs. ==Practical considerations== Many proposed consumption taxes share some features with the current [[income tax]] systems. Under these proposals, taxpayers would be given exemptions and a standard deduction in order to ensure that the poor do not pay any tax. In a completely pure consumption tax, other deductions would not be permitted, because ''all savings would be deductible''.<ref name="greenspan"/> A withholding system might also be put into place in order to estimate the total tax liability. It would be difficult for many taxpayers to pay no tax all year, only to be faced with a large tax bill at the end of the year. A consumption tax could also eliminate the concept of basis when computing the value of investments. All income that is put in investments (such as property, stocks, savings accounts) is tax-free. As the asset grows in value, it is not taxed. Only when the proceeds from the asset are spent is any tax imposed. This is in contrast with the current system where, if you buy land for $10,000 and sell it for $15,000, you have a taxable gain of $5,000. A consumption tax only taxes consumption, so if you sell one investment to buy another investment, no tax is imposed. In Andrews' article, he notes the inherent problem with housing. Renters necessarily "consume" housing, so they will 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 his or her home to others in exchange for money, but instead, the homeowner chooses to live in the home to the exclusion of all possible renters. 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) and would not tax the increase in the value of the asset (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 a deduction for mortgage interest expense, and by exempting a significant increase in value from the capital gains tax. Therefore, treating renters and homeowners identically under a consumption tax may not be feasible in the United States. Lastly, a consumption tax could utilize progressive rates in order to maintain "fairness." The more someone spends on consumption, the more they will be taxed. The rate structure could look like the current bracket system, or a new bracket system could be implemented. == Economics == * Economists and tax experts generally favor consumption taxes.<ref name="money">{{cite news| url=http://money.cnn.com/2005/09/06/pf/taxes/consumptiontax_0510/| last=Regnier| first=Pat| title=Just how fair is the FairTax?| work=| publisher=Money Magazine| date=[[2005-09-07]]| accessdate=2006-07-20}}</ref> * Consumption taxes are neutral with respect to investment.<ref name="greenspan"/> Depending on implementation (such as treatment of depreciation) and circumstances, income taxes either favor or disfavor investment. (On the whole, the US system is thought to disfavor investment.<ref name="greenspan"/>) By not disfavoring investment, a consumption tax ''might'' increase the capital stock, productivity, and therefore increase the size of the economy.<ref name="greenspan"/><ref name="consumptiontax"/> * Consumption more closely tracks long run average income.<ref name="consumptiontax"/> An individual or family's income often varies dramatically from year to year. The sale of a home, a one time job bonus, and various other events can lead to temporary high income that will push a low or middle income person into a high tax bracket. On the other hand, a wealthy individual may be temporarily unemployed and will pay no taxes. == Consumption tax proposals in the United States == [[Image:TaxbaseStability.png|thumb|right|414px|Stability of the Tax Base: A comparison of [[Personal Consumption Expenditure]]s and [[Adjusted Gross Income]].]] === Hall-Rabushka === Designed by economists at the [[Hoover Institution]], [[Hall-Rabushka]] is a fully developed [[flat tax]] on consumption.<ref>[http://www.hoover.org/publications/books/3602666.html The Flat Tax], By Robert E. Hall and Alvin Rabushka, Hoover Institution</ref> Loosely speaking, Hall-Rabushka accomplishes this by taxing income and then excluding investment. An individual could file a Hall-Rabushka tax return on a postcard. In the United States, extensive tax reform has not taken place since the [[Tax Reform Act of 1986]], and like other tax reform, the flat tax has not advanced far in the U.S. political process. However, Eastern Europe has enthusiastically embraced the flat tax after the fall of the iron curtain. Robert Hall and Alvin Rabushka have consulted extensively in designing these flat taxes. === National sales tax === Since the 1990s, the idea of replacing the [[income tax]] with a national sales tax has been floated in the [[United States]]; many of the actual proposals would include giving each household an annual rebate, paid in monthly installments, equivalent to the percentage of the tax (which varies from 15% to 23% to 30% in most cases) multiplied by the [[poverty level]] based on the number of persons in the household, in an effort to reduce the sales tax's inherent regressivity. While some political observers consider the chances remote for such a change, the ''[[FairTax|Fair Tax Act]]'' has attracted more cosponsors than any other fundamental tax reform bill introduced in the [[US House of Representatives|U.S. House of Representatives]]. ==See also== * [[Income tax]] * [[Pigovian tax]] * [[Value added tax]] * [[Fair tax]] == Notes == <references /> ==External links== *[http://www.oecd.org/department/0,3355,en_2649_33739_1_1_1_1_1,00.html OECD Center for Tax Policy and Administration] *[http://econblog.aplia.com/2007/10/should-government-tax-consumption-or.html?showComments=false Why do consumption taxes encourage saving?] [[Category:Personal taxes]] [[ja:消費税]]