CHAPTER 16- TAXES ON CONSUMPTION AND SALE

8/14/2019 CHAPTER 16- TAXES ON CONSUMPTION AND SALE

1/22

1

Chapter 16

Taxes on Consumption and Sales


2/22

2

Consumption as a Tax Base

Consumption can be an alternative to income as

a measure of ability to pay.

Comprehensive consumption:

Income-Savings

Note that capital gains would not be taxed if it

were not spent.


3/22

3

An Expenditure Tax

An expenditure tax would have the same

practical impact as an income tax.

Taxpayers would add all sources of income

and deduct additions to savings accounts.


4/22

4

Comparing a Tax on Income to a Tax on

ConsumptionAssumptions:

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.


5/22

5


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)/(1+.1)

= $6,000 + $5,545 = $11,545


6/22

6


ConsumptionStep 2 A Consumption Tax for the Non-Save

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


7/227


ConsumptionStep 2 A Consumption Tax for the SaverFirst Year

IB

= CB

+ TB

+ SB

$30,000 = CB+.2C

B+ $5,000

CA

= $20,583.33

TA= $4,166.66

SA

= $5,000

Second Year

IB

+ Proceeds from Saving

= CB+ T

B

$35,500 = CB+ .2C

B

CA= $29,583.33

TA

= $5,916.67Present Value of All TaxesT

B= $4,166.66 + $5,916.67/(1+.1)

= $4,166.66 + $5,378.79 = $9,545.45


8/228


Consumption

Under an Income tax, savers pay more intax than non-savers.

Under a consumption tax, they pay thesame present value of taxes.


9/229

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.


10/2210

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.


11/2211

Substituting a Consumption Tax for an

Income TaxTo be revenue neutral Tax Revenue = t

iI= t

cC

Where

ti= income tax rate

tc=consumption tax rate

I=income

C=consumptionIf people save 20% of income then t

iI= t

c(.8)Iwhich means that

1.25ti= t

c. That is, when people are saving, in order to be revenue

neutral, the tax rate on consumption must be higher than the tax

rate on income.


12/2212

Figure 16.1 Substituting a Comprehensive Consumption

Tax for a Comprehensive Income Tax: Investment Market

Effects

Gain in Efficiency

Yie

ld(Per c

ent )

Investment per Year0

FrN

Net Return underthe Income Tax

S

E

Q1

r*

G

D

rG*


13/2213

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 thegain in the investment market is greater than the

loss in the labor market.

Estimates suggest such a change would have apositive impact on GDP.

Fi 16 2 S b tit ti E l Yi ld C h i


14/2214

Figure 16.2 Substituting an Equal Yield Comprehensive

Consumption Tax an Income Tax: Labor Market Effects

Wag

es

Labor Hours per Year0 L1

SL

WO

D = WG

B

WG1

L2

WN1

WG(1 t1)

A

C

WG2

L3

WN2

WG(1 t

C)

A'

C'


15/2215

A Sales Tax

A retail sales tax is typically a fixed percentageon the dollar value of retail purchases.

Sales taxes are a major source of tax revenue forstate and local governments. Some state rates areas high as 7% with local governments adding an

additional 3% on top of that.

Often food and medicine are exempt.


16/2216

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.


17/2217

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.


18/2218

Turnover Taxes

Turnover taxes are multistage taxes levied atsome fixed rate on transactions at all levels of

production.

The effective rate of tax depends on the numberof times the good is sold during the production

process.

This creates a significant bias toward verticalintegration (where all production stays within thesame firm).


19/22


20/2220

Implications of a VAT

keep compliance costs high, encourage saving, and

encourage barter and other

evasion/avoidance.

A complete substitution of all income andpayroll taxes for a VAT would


21/22

21

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 itemsfacing 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.


22/22

22

Sales Taxes with Mail Order and the Internet

A 1967 Supreme Court case declared it unconstitutional for a state toinsist on sales tax collections for sales to residents of other states (whenthere is no outlet for the good in the customers state).

This is because of the destination principle, which states that aconsumption tax should be imposed on the consumer wherever

consumption takes place; the state in which the purchase occurred wouldhave no way to determine where consumption takes place.

Some states have imposed use taxes (at the same rate as their own salestaxes)on the customer because local retailers claim they are at adisadvantage relative to mail order.

There has been a general moratorium on new taxes for sales over theinternet. This does not apply to businesses that have local counterparts(like Dell and Gateway) but to internet only retailers.

The moratorium is less important than it might seem, because a largevolume of internet sales are business to business, which is not taxedanyway.

Documents

CHAPTER 16- TAXES ON CONSUMPTION AND SALE