Consumption Tax

What is a Consumption Tax?

Consumption tax is the tax levied on spending by the consumer for purchasing products or services. It is a type of indirect tax which is paid by the consumer along with the cost of the product at the time of purchase.

Explanation

Consumption Tax

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Features

  • Each individual who is paying a consumption tax will get a certain amount of exemption and deductions. It is to benefit the poor who have lower consumption power, and they don’t have to pay the taxes.
  • Individuals eligible to pay taxes will not get any sort of deductions as they can save, and these savings would have been already subjected to deductions.
  • The tax payee will be getting exemption from tax on all the incomes placed via investments as the consumption tax only taxes the amount spent or consumption made.
  • Under this, people are taxed based on their consumption patterns and how much they consume instead of how much they contribute to the economy.

How does it Work?

Example

  • It has to be seen from the economy’s point of view. The government will have to collect the appropriate tax from its consumers. While designing the tax rates for each product type, it has to make sure it doesn’t burden or hamper the purchasing power of the consumers.
  • Likewise, basic necessity products are taxed less, and this compensated by taxing luxury products is a higher rate. Suppose a consumer wants to buy a sports car, the car is levied a hefty luxury tax and higher registration amount. In the same economy, if a below poverty line consumer wants to buy his daily needs, the tax is relatively lower.
  • No doubt, if the consumer buying the car will also get his daily needs at the same price but would have paid higher taxes for luxury items.

Consumption vs. Income Tax

Advantages

Disadvantages

  • It can discourage consumer spending as it taxes more on spending more in and economy.
  • To report and track, it is difficult from the government perspective compared to the income tax.
  • Consumption tax on luxury products is very high; this will increase the price of the products in the market. It can lead to a reduction in demand.
  • To make this work, everything and anything being sold in the economy has to be taxed. It will just increase the price and decrease the demand, ultimately reducing the spending in the economy.
  • Retired individuals could be taxed twice because of this tax, which is a burden on the individual.
  • In some scenarios, even the poor will end up paying more taxes than they can afford. It can be because of its lousy execution.

Conclusion

  • Consumption tax is a tax levied on spending in an economy. The idea is to neutralize the effect of tax on basic products by taxing luxury products more. In this way, the poor can be benefited from an economy. It is taxes individuals who can afford more and gives the benefit to the poor by taxing basic necessity products less.
  • It is a concept of the west slowly making its way into the east. Having said that in this tax, every product has to be taxed separately and appropriately so that it doesn’t burden the poor and also doesn’t damage the demand for the products. The ideology is to keep the government revenue intact without disturbing the economies of products. It has to be executed carefully in a particular economy to reap the advantages.

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