Consumption Tax

Consumption Tax Definition:

A consumption tax is a tax paid by a consumer on expenditure on goods and services. This is also known as expenditure tax or consumed income tax or cash-flow tax. It generally taxes on what individuals spend rather than what they earn.

Operation of Consumption Tax

Consumption tax is usually considered as indirect tax. But it can also function as direct tax which is income less savings.

Consumption Tax formula

Income = consumption+ savings
Therefore consumption = income – savings

Consumption Tax Trends

As an indirect tax it exists as sales tax, goods and services tax, VAT. Consumption taxes are a good source of revenue for the government. Now they account for more than 30% of overall taxation. The money obtained from these taxes is spent by the government to finance a larger share of public spending like schools social security and the like.  The main reason for levying these taxes is increased competition in international markets. This also improves economic efficiency and protects employment by increased competitiveness worldwide. In most of the countries consumption tax accounts for more than 15 percent of total taxation.

Consumption Tax Types

There are two ways to levy tax on consumption.

Taxes which are levied on the goods and services which is generally referred to as VAT or goods and service tax.

Excise duties on items like vehicle fuels, tobacco and alcoholic drinks And import duties on goods coming into the country. This is called as Customs tax.

VAT:

Value added tax or popularly known as VAT is an amount of money levied on the cost of a product. The first country to apply this VAT was France. From its inception, VAT was levied on all products. This gave a substantial share to the government’s revenue. The value added tax system is absolutely transparent at every stage of transaction. So it makes the tax system quite simple. It has an advantage over the sales tax that, the sales tax paid by the producer at every stage is refunded by the supplier.

VAT Rates in India

0% for essential commodities
1% on bullion and precious stones
4% on industrial and capital goods and items of mass consumption
Other items 12.5%

In Some of the European Union Countries

  VAT Standard Rate            VAT Reduced Rate
Austria 20% 10%
Belgium 21% 6%
Denmark 25% 25%
Finland 22% 8%
Germany 19% 7%
Other countries within EU 19% 7%

Sales Tax

The other type of consumption taxation is Sales tax.  This tax is levied at the point of purchase of goods and services from the market. This is a guaranteed source of permanent income for the government since there is no scope to avoid sales tax on registered items.

A tax on vehicles entering a state is referred to as Octroi duty.  It is levied when goods enter and leave the state.

Excise Tax

An excise tax is the tax on the good produced within the country. Normally the producer of the good is required to pay a duty to the government. In other words it is a tax which is passed on to the other. The tax burden is bared by the final customer. Excises are imposed in addition to VAT or Sales tax. It generally differs from VAT or sales tax by three ways.

It is applied to narrow range products
It is heavier and specific.
Like it measures some x amount for a unit of measure.

Some examples of excise duty are
Duty on tobacco, on medical and toilet preparations, an excise duty on textile production of silk/wool or man-made filaments
And duties on mineral products like motor-spirit, kerosene, and diesel
All the money collected from these will go to the government.
Excise duties are comparatively different from those duties which are levied on import of goods. The taxes on importation of goods are called as Customs taxes. These are also called as border taxes.

Some examples of customs duties are
 A tax on importing live animals, natural honey, vehicles or any other movable property.

Tax Reforms:

Three approaches to tax reform are suggested by the economists.
The first approach reforms the existing tax system rather than replace it. Like broadening the tax base, increasing fairness, reducing the money lost from tax evasion also known as tax gap, increasing tax-preferred savings.

The second is the replacing the current tax system with a new system. This is often referred as fundamental tax reform. This is suggested to be done with consumption taxation.

Economists globally are advising a shift of taxation from income tax to consumption tax. In other words, instead of taxing an individual by earnings it is good to levy a tax on his spending. There are three major reasons which are it is a simple way of taxation; it is efficient; and it is also fair.

 Simplicity means, in the current system of taxation (levying a tax on the income or income tax) it is difficult to measure how much a person earns. A consumption tax would eliminate that problem.

Income taxes are more progressive and consumption taxes are more conducive and simpler.

Contrary to the mentioned reasons shifting to consumption tax may have an unexpected effect on the money supply. Since a consumer would purchase less quantity of the good and consequently reduce his expenditure.
The third is combining income tax and consumption tax. This would include both the features.

This is the current taxation policy in U.S.