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.
- Upon care carefully observing the MRP (maximum retail price) of any product, the break up for the taxes can be seen. Whenever a consumer purchases a product or service in an economy, he/she pays a certain price for the same. This price is inclusive of taxes levied by the government. Value-added tax, sales tax, customs tax, and GST is included in the bill, these are considered as a consumption tax. It is also known as cash flow tax or expenditure tax.
- While income tax is the tax paid on the earned income, this is the tax on the expense. This tax is regressive in nature and accumulation along with deduction will only increase the purchasing power of the consumer.
- Each individual who is paying a consumption tax will get a certain amount of exemption and deductions. This is to benefit the poor who have lower consumption power and they don’t have to pay the taxes.
- As individuals eligible to pay taxes will not get any sort of deductions as they have the capacity to 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?
- This is a concept from west slowly making its way in the east. The vendor will collect these taxed from the consumer by charging a higher retail price for the product or service. This tax rate is different for different products. It is less for basic necessity products and the percentage is higher for luxury products and services.
- The idea is to help the poor who cannot pay taxes or higher retail prices. The accumulated higher taxes from the luxury products are nullified against the lower tax rates on basic products. This will not only benefit the needy but also make sure the government is collecting the same amount of tax. The overall gist is that it favors the savers and taxes the spenders.
- 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
- Consumption tax is an indirect tax, taxed on purchase of any goods or service whereas income tax indirect tax applied on the income earned.
- Consumption tax is also called cash-flow tax or expenditure tax, Income tax is simply on the basis of total income.
- Consumption tax is different for a different type of products and services, whereas income tax bracket is the same for all individuals.
- No doubt both are revenue to the government but consumption tax has to be designed in a way such that, neither it is a burden to taxpayers nor does it reduce the revenue of the government.
- Consumption tax is levied at the time of purchase of product or service, income tax is filed by the payee before the deadline given by the government to pay the taxes.
- Poor is not burdened by the heavy taxes on the products as it is compensated by the higher taxes on luxury items.
- Since more spending results in paying more tax, it encourages the activity of saving in the economy.
- Tax neutrality can be achieved effectively if this tax is levied appropriately across the economy.
- It is easy to estimate the spending in the economy and to calculate GDP using the expenditure method.
- In this, everyone pays a similar amount as tax for products coming under the same genre. There is no disparity in the tax amount paid.
- This 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. This can lead to a reduction in demand.
- To make this work, everything and anything being sold in the economy has to be taxed. This 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 actually afford. This can be because of its bad execution.
- 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 basically taxes individuals who can afford more and gives the benefit to the poor by taxing basic necessity products less.
- It is a concept of west slowly making its way into the east. Having said that in this tax, each and 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. This has to be executed carefully in a particular economy to reap the advantages.
This has been a guide to What is Consumption Tax & its Definition. Here we discuss the features of consumption tax and how does it work along with an example and difference from income tax. You can learn more about from the following articles –