Taxes on Consumption and Sales

1
Chapter 16

• Taxes on Consumption and Sales

2
Consumption as a Tax Base

• Consumption can be an alternative to income as a
  measure of ability to pay.
• Comprehensive consumption Income-Savings

3
Comparing a Tax on Income to a Tax on Consumption

• Assumptions
• Two equally situated 18 year olds with no
  physical capital
• Wages 30,000 per year
• Interest rates 10
• Flat rate tax for either consumption or income of
  20.
• Two earning periods.

They have equal ability to pay taxes over their
lifetime so they should pay equal taxes over
their lifetime.
4
Comparing a Tax on Income to a Tax on
ConsumptionStep 1 An Income Tax

• IA IB 30,000
• SA 0
• SB 5,000
•  
• TA 6,000 6,000/(1.1)
• 6,000 5,455 11,455
• TB 6,000 6,100/(1.1)
• 6,000 5,545 11,545

5
Comparing a Tax on Income to a Tax on
ConsumptionStep 2 A Consumption Tax for the
Non-Saver

• Income Consumption Consumption Tax Savings
•  
• First and Second Year
• IA CA TA SA
• 30,000 CA .2CA 0
• CA 25,000
• TA 5,000
• SA 0
• Present Value of All Taxes
• TA 5,000 5,000/(1.1)
• 5,000 4,545.45 9,545.45
•  

6
Comparing a Tax on Income to a Tax on
ConsumptionStep 2 A Consumption Tax for the
Saver

• First Year
• IB CB TB SB
• 30,000 CB .2CB 5,000
• CA 20,833.33
• TA 4,166.66
• SA 5,000

• Second Year
• IB Proceeds from Saving
• CB TB
• 35,500 CB .2CB
• CA 29,583.33
• TA 5,916.67

Present Value of All Taxes TB 4,166.66
5,916.67/(1.1) 4,166.66 5,378.79
9,545.45
7
Comparing a Tax on Income to a Tax on Consumption

• Under an Income tax, savers pay more in tax than
  non-savers.
• Under a consumption tax, they pay the same
  present value of taxes.

8
A Comprehensive Consumption Tax Base

• Inflation is no longer a concern with capital
  gains.
• Taxing Durables becomes a problem as this would
  add substantially to the price of a car or home.

9
A Cash-Flow Tax

• A Cash-Flow Tax would operate like the current
  income tax, except that the amount placed in
  qualified accounts would be deductible. Assets
  that increased in value would not be taxed unless
  cash was removed from the accounts.

10
Substituting a Consumption Tax for an Income Tax

• To be revenue neutral Tax Revenue tiI tcC
• Where
• ti income tax rate
• tc consumption tax rate
• I income
• C consumption

11
Figure 16.1 Substituting a Comprehensive
Consumption Tax for a Comprehensive Income Tax
Investment Market Effects
12
Figure 16.2 Substituting an Equal Yield
Comprehensive Consumption Tax an Income Tax
Labor Market Effects
13
Impact of a Sales Tax on the Efficiency in Labor
Markets

• A substitution of a consumption tax for an income
  tax (with equal yields) would require a higher
  tax rate because of savings.
• The net efficiency change depends on whether the
  gain in the investment market is greater than the
  loss in the labor market.
• Estimates suggest such a change would have a
  positive impact on GDP.

14
A Sales Tax

• A retail sales tax is typically a fixed
  percentage on the dollar value of retail
  purchases.
• Sales taxes are a major source of tax revenue for
  state and local governments. Some state rates are
  as high as 7 with local governments adding an
  additional 3 on top of that.
• Often food and medicine are exempt.

15
An Excise Tax

• An excise tax is a selective tax on particular
  goods.
• In the United States excise taxes exist on car
  tires, long-distance telephone service, airline
  tickets, gasoline, and many other goods.

16
The Incidence of Sales and Excise Taxes

• Generally, sales taxes are regressive when food
  and medicine are not exempt.
• A national sales tax would be borne by labor
  income and would lack the progressive rate
  structure of the personal income tax.

17
Impact of a Sales Tax on the Efficiency in Labor
Markets

• A substitution of a consumption tax for an income
  tax (with equal yields) would require a higher
  tax rate because of savings.
• The net efficiency change depends on whether the
  gain in the investment market is greater than the
  loss in the labor market.
• Estimates suggest such a change would have a
  positive impact on GDP.

18
A Value-Added Tax

• A value-added tax (VAT) is a consumption-based
  tax levied at each stage of production.
•  
• Value Added Total Transactions Intermediate
  Transactions
• Final Sales
• GDP
• Wages Interest profits Rents
  Depreciation
•  
• Tax Liability Tax on Payable Sales Tax Paid
  on Intermediate Purchases
• t(sales) t(purchases)
• t(sales purchases)
• t(value added)

19
Implications of a VAT
A complete substitution of all income and payroll
taxes for a VAT would

• keep compliance costs high,
• encourage saving, and
• encourage barter and other evasion/avoidance.

20
The VAT in Europe

• The VAT accounts for about 20 of EU member
  nation revenue.
• The average rates within the EU are between 15
  and 20.
• Different rates apply to different types of
  goods, with luxury items facing the highest rate
  and necessities facing the lowest.
• The tax applies to services as well as goods
  (unlike most sales taxes in the U.S.).
• Economists find the VAT a good alternative to an
  income tax because it does less to discourage
  savings and investment.