Can Consumption Tax Replace Income Tax?

Last updated on October 15, 2021

Is it time to go back to the times when the U.S. taxes were principally based on consumption? That is the question many ask because paying of income tax has become a burden difficult to carry for middle and lower-class taxpayers. Maybe it is time to look for alternatives.

What is Consumption Tax?

Consumption tax is a tax that is charged on articles of consumption. When taxpayers buy things, they are required to pay a certain amount in taxes. Sales tax and value added tax are indirect consumption taxes. If consumption tax topples income tax, taxpayers will need to pay taxes on all they buy. Also, under a consumption tax, they would pay tax on money they borrowed. That means they will not be paying tax on dividends, capital gains, interest etc.

Advantages of Consumption Tax

A major advantage of consumption tax is that it limits excesses on its own. Consumption becomes less if duties are too high. It was as far back as in 1974 that one of the first proposals for a personal consumption tax was put forward.

Another strong point in favor of consumption tax is that even with a progressive tax system in place i.e. income tax system, when many high-income taxpayers are paying merely 15 percent taxes, it does not help matters much. The super-rich and the rich get it easy under this progressive tax system while middle-income groups pay the bulk.

Under consumption tax, necessities are taxed at a low rate while luxury items are taxed higher. As the level of consumption and the kind of articles bought determines how much taxes a taxpayer pays, there will be greater fairness.

Challenges of Implementing Consumption Tax

Although it is simple to ask for the usurpation of income tax in favor of consumption tax, the practicality of how to implement the change needs to be looked into.

At present, the countries that have consumption tax also have income tax. In Europe, the value added tax is in addition to income tax. It is not being used as a replacement. To replace consumption tax with income tax, each article of consumption will need to be recorded and taxed. Even at state level, it will become very hard to implement.

Another concern is of those taxpayers who have retired. The veterans had paid taxes on their income when they were in service. If consumption tax is brought in and income tax done with, they will need to pay taxes multiple times higher than what they pay at present on things they buy.

The fact that high-income groups save more than low and middle-income groups also raises questions on how effective consumption tax will be. If the rich and super-rich are ultimately paying less taxes than the lower and middle-income group, why the change?

With American taxpayers burdened with tax, it is only natural to look for alternate methods of tax collection that can broaden the tax base and introduce more equality.