Consumption and Sales Taxes

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Consumption and Sales Taxes

• Professor Jane H. Leuthold
• Department of Economics
• University of Illinois

Econ 214
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Topics for today

• US Consumption taxes
• excises
• retail sales tax
• import duties
• Should the US adopt a national consumption tax?
• Cash-flow tax
• Value-added tax (VAT)
• Flat Tax

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Consumption taxes in the US

• Excise taxes
• selective taxes on certain types of consumption
  activities
• liquor consumption, gasoline, cigarettes, customs
  duties
• Retail sales tax
• used by 45 of the 50 states as an important
  revenue source
• 26 states (including Illinois) exempt food from
  the retail sales tax
• Customs duties
• taxes on imports

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Illinois taxes
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Excise taxes
Price
ST

• Partially shifted forward to buyer depending on
  elasticities
• Causes an excess burden to the economy
• Regressive if demand is inelastic or supply is
  elastic
• Used to raise revenue or discourage undesirable
  consumption
• May be benefit tax

D
S
PG
Pe
PN
Q1 Qe
Quantity
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Problem 1
Price
ST

• What is the tax per unit?
• What is the revenue from the tax?
• What is the excess burden?
• What is the efficiency-loss ratio?
• What share of the tax is borne by the consumer?

D
.50
S
4 mil
1.30
1.00
.80
.125
8 10
Gasoline(millions ofgallons)
.60
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Sumptuary sin excises
Price
D
S Tax
Is a tax on beer shifted? Is it likely to deter
un-desirable con-sumption? Does it raise a lot of
revenue?
S
PG
Revenue
Pe
PN
Qe
Q1
Beer
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Retail sales tax
S(1.075)
Price
Who bears the burden of this tax? Does it have
an excess burden?
D
S
PG
Pe
PN
Retail sales
Qe
Q1
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Disadvantages of sales tax

• May be regressive unless food is exempted
• Discriminates against consumers of taxed items
• It may encourage people to shop in low tax states
  or catalog or internet shop
• It may discourage labor more than an equal yield
  income tax

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Effect of tax free e-commerce
P
S T
S
D
PPG
Seller
PN
S2
S1
Retail store sales
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Effect on labor
Wage
D
Substituting a consumption tax for an income tax
increases the excess burden in the labor market.
S
D-TY
D-TC
Labor
Le
LC
LY
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Advantages of a sales tax

• Good source of state revenue
• Easy to collect
• As with other consumption taxes, it may encourage
  saving when compared with an equal yield income
  tax that taxes interest income

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Effect on saving
Interest rate
D
S
D-TY
Substituting a consumption tax for an income tax
results in a gain in efficiency.
Saving
Se
SY
TY income tax
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Customs duties or tariffs

• Tariffs raise prices for consumers, reduce
  imports, and subsidize domestic producers
• They also provide revenue for the federal
  government

Price
S
D
PW
X1 X4
X1X4 imports before tariff X2X3 imports after
tariff
Automobiles
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National consumption taxes

• Cash-flow tax -- direct tax on consumption
• Value added tax -- tax on the differences between
  sales and purchases at each stage of the
  production process
• Flat tax tax on wage and business income that
  is equivalent to a consumption tax

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Cash-flow tax
Consumption Income - Saving
Taxpayers would set up qualified accounts (like
IRAs) and deduct their contributions into their
qualified accounts. Withdrawals from qualified
accounts would be taxed. Deductions, exemptions,
and graduated tax rates would be applied, much
like the current personal income tax.
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Value-added taxes
Value added Sales - Purchases VAT t (Sales -
Purchases) tSales - tPurchases
Purchases materials, equipment, capital
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Example
What rate on the retail sales tax would raise the
same revenue as this 20 VAT?
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Advantages of a VAT

• Good source of revenue
• Provides an audit trail VAT tS - tP
• Popular tax in almost all countries of the world
  except the United States

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A VAT for the US?

• Better than a retail sales tax?
• Interference with State taxation of consumption
• More expensive to administer than a retail sales
  tax because it must be collected from many more
  firms

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Flat-Tax

• Taxes individuals on wage income
• Taxes businesses on sales minus wages and
  purchases
• Sometimes called the postcard tax because it
  would simplify the tax system so that taxpayers
  could file with a postcard

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Postcard tax
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Similarities with a VAT
Individual tax t x wages Business tax t
(sales - wages - purchases) Total flat tax
Individual tax Business tax t (sales -
purchases) VAT
The flat-tax is very similar to a value-added tax.
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Soap Box
For the Soap Box this week, let's hear it on the
issue of a tax free Internet.  Do you think
Internet sales should be free from sales taxation
and tariffs?  Try to make a good economic
argument either for or against taxing Internet
sales.
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Next time
Tuesday Nov 28 Income taxes Thursday Nov 30
Wealth taxes (Papers Due)
HAPPY THANKSGIVING!