1. C h a p t e r 16 TAXES ON CONSUMPTION AND SALES
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2. Consumption as a Tax Base
General tax on consumption equivalent to an income tax that allows savings to be excluded from the tax bases
Annual comprehensive consumption is annual comprehensive income minus annual savings
Comprehensive consumption tax, sometimes called an expenditure tax, would work like an income tax that allows exclusion of retirement savings from the tax base
All savings, without limit, no matter for what purpose, would be excluded from income
No tax penalty for withdrawing funds from savings
Tax paid only when funds are converted to cash and spent

3. Consumption Versus Saving
Can be argued that ability to pay more appropriately measured by a person’s basic capacity to earn income
On basis of horizontal equity, two people with equal potential to earn should pay same amount of taxes over their lifetimes
Would be taxed differently according to the way they differ in tendencies to defer consumption
One who saves nothing is taxed entirely on basis of labor income; one who prefers to save pays taxes both on labor earnings and income from accumulated capital

4. Comprehensive Consumption Tax Base
Comprehensive consumption tax base excludes any change in net worth from the tax base
Under consumption tax, measuring realized or unrealized capital gains is unnecessary; would not be taxed until converted to cash and spent
Under consumption tax, inflation not a problem as only current expenditures are taxed
Anything that increases net worth of taxpayer would be excluded from tax base
Savings accounts at financial institutions, business inventories, stocks and bonds

5. Incidence of Consumption Tax
Because capital income excluded from taxation under consumption tax, tax would be borne according to labor earnings
Portion borne by labor income could be shifted to consumers if workers adjusted work hours in response to tax
Consumption tax likely to be more regressive with respect to income than income tax
Though tax rate structure could be modified to achieve collectively chosen distribution of burden

6. Sales Taxes
Few sales taxes implemented to conform to comprehensive consumption tax base
Levied mostly on tangible goods, excluding things like professional services, haircuts, transportation, etc.
Many states exempt certain basic goods regarded as necessities
Food, grocery items, prescription drugs
Many consumption taxes levied on purchase of capital goods
Automobiles, consumer durables

7. Retail Sales Tax
Ad valorem levy of fixed percentage on dollar value of retail purchases made by consumers
Levied on consumption at its final stage, collected from businesses that make retail sales
Usually added to retail price of goods and services
Broadening sales tax base can increase revenue

8. Issues in Sales Taxation
Services initially exempt from taxation for administrative reasons
As services command more and more of consumption, states in financial crisis forced to consider taxing services
Aging population can adversely affect states’ sales tax revenue while services exempt
As percentage of population over 65 increases, consumption more weighted to services, pharmaceuticals, etc., now exempt
Most states do not tax purchases by government agencies and nonprofits
E-commerce presents challenges in state sales taxation

9. Excise Taxes
Selective taxes levied on certain types of consumption activities
Distort choices among goods and services, result in efficiency losses to economy
Some designed to raise revenue, others intended to discourage particular consumption activities
Excise taxes on tires are to raise revenue; excise taxes on liquor largely to discourage consumption
Many consumption activities taxed are alleged to generate negative externalities or are considered luxury goods and services

10. Incidence of Sales, Excise Taxes
Argued that they are regressive with respect to income
Annual consumption expenditures, as percentage of annual income, higher for low-income taxpayers than high-income taxpayers
This has led many states to exempt certain items, such as food
Distribution of tax burden between buyers and sellers varies from state to state, ranges from 28% to 89% of burden borne by buyers

11. Turnover Taxes
Multistage sales taxes levied at some fixed rate on transactions at all levels of production
Effective tax rate conditioned by number of stages of production
Extremely productive levy, producing high, stable yields at low rates
Low rate believed to discourage tax evasion
Studies have shown it to be somewhat progressive
Effective rates on many food items lower than those on clothing and other manufactured goods

12. Value-Added Tax (VAT)
General tax on consumption levied on the value added to intermediate products by businesses at each stage of production
Value added is difference between sales proceeds and purchases of intermediate goods and services over a certain period
Value Added = Total Transactions – Intermediate Transactions
= Final Sales = GDP
= Wages + Interest + Profiles + Rents + Depreciation
Very popular in Europe
Not currently used by U.S. federal government
General tax on value added equivalent to tax on national product

13. Administration of VAT VAT typically rebated on export sales
Goods of nations that use the tax more competitive in international markets when they are exported to nations where there is no national sales tax
Imported products subject to VAT, increasing prices to domestic consumers
A criticism of VAT is that costs of administration and compliance high compared to other taxes
Estimated that administrative and compliance costs for new VAT in U.S. could be $8 billion per year