Thursday, April 28, 2011

Consumption taxes

After the income tax, the other main form of tax is the consumption tax: a tax on items actually purchased. The most common form of this tax in the U.S. is the sales tax; in the European Union (EU) and many other countries it is the Value Added Tax (VAT). The main difference between them is the way the taxes are collected.

In a sales tax, the tax on a particular item (or service) is calculated and assessed only on the end-user. The manufacturer, wholesaler and retailer pay nothing, only the final consumer or purchaser pays. Of course, the "middlemen" – manufacturer, wholesaler, retailer e.g.—must have government documents to show that they are not end-users. (The middlemen may have to pay income taxes on their profits, of course.) The retailer must then collect the sales tax from the customer and send it to the government.

In the case of a VAT, each middleman pays the previous middleman for an item, then does something to increase the value of the item (hence the name "Value Added Tax"), then sells the item at the increased price, which includes tax, to the next in line. Each middleman then pays the government the tax charged for the “improved” item less the tax paid by the previous middleman. Thus, each middleman ends up paying the government only the tax on the value that his/her contribution added to the item. Since the final consumer has now paid the full price on the total value of the item (to the last intermediary), and resells to no one, the consumer owes the government nothing. In effect, the government is collecting the same total in taxes as with the sales tax, but is paid by the intermediaries -- who are paid stepwise by each other and, finally, by the end-user or consumer.

For more details and numerical examples of how this works, see the Wikipedia article on VATs.

Since only the consumer under a sales tax pays the government, the intermediates have no stake in whether the next person pays tax or not. With a VAT, however, everyone pays tax (unless they illegally falsify their records) and so the intermediates need to keep track of input and output in order to justify paying the government just the difference in taxes (they have already payed the intermediate preceding them).

Thus, VATs and sales taxes are really not that different in terms of money collected, but the VAT may be an improvement in the integrity or honesty of collection -- although it has been argued that its complexity may make up for that. The VAT is certainly more effective in collecting taxes on Internet sales since these taxes are all collected before the item is sold on the Web.

Both sales taxes and VATS vary a lot from country to country, and from state to state in the U.S. (and some cities also). The EU has certain ground rules for its member nations, though a considerable amount of flexibility is still permitted. There are no national rules in the U.S. on states' taxes, but most are deductible, at the present, from federal taxes.

The problem with consumption taxes is that they tend to be regressive; that is, their burden falls heaviest on lower income people, and lightest on the very rich. The reason, as is so often the case, relates to disposable income. Everyone must eat, drink, obtain shelter and medical care, and be able to get around; to do this, people usually have to make purchases: food, clothing, medicines, houses and cars, for example. For lower income families, these necessities require a large percentage of income -- sometimes all; taxing them creates quite a burden on a family's financial resources. Wealthy people, on the other hand, have a lot of income above what they need to live, even if they have expensive tastes. This income is only subject to a consumption tax when and if it is spent: it is discretionary or disposable. Thus, the consumption tax burden on these affluent families tends to be much lighter than on poorer ones.

A lot of the variation in consumption taxes results from the desire to mitigate this regressive nature. Certain basics such as food, shelter and medicines may be taxed at lower rates or not at all. For example, the EU excludes charities, health and education from the VAT, while Massachusetts doesn't tax food, clothing and medical care in its sales tax.

The regressive nature of consumption taxes may also be partially neutralized by fixed lump-sum payments to all taxpayers, or by combining VATs, say, with a highly progressive income tax (i.e. one that has much higher tax rates for those with high incomes).

An interesting example is Denmark, which has a very high but fairly progressive income tax, combined with the highest VAT in Europe: 25%. The result is the highest combined tax rate in the world, a good part of which is the regressive VAT, to which there are hardly any exceptions. Yet, Denmark also has one of the most financially egalitarian economies in the world. This is because the high taxes are used in a very progressive way: on social spending, retirement security, and medical coverage. It is exactly that segment of Danish society which is hit so hard by the regressive VAT that benefits most from this spending. The Danes believe, and with good reason, that their government is part of the solution and not the problem. Of course, it is their government and they have created it to be progressive and humanitarian: they don't fight very many wars, and have been at the forefront of development of agricultural products and wind power.

How then should we react to suggestions that the U.S. introduce some sort of VAT? At this point in our history, when the "cut-the-deficit-by-any-means" forces are rampant, I think it would be very dangerous to create anything so inherently dangerous to economic democracy as a federal consumption tax. The political armies of the reactionary right, consisting of the know-nothing Tea Screamers and the Chamber of Commerce and Club For Growth, as well as the beneath-contempt Republicans, seem more likely to do true mischief to most poor and middle-class Americans than can be countered by the confused and divided Democrats. Sufficient unto the day is the unfair tax policy thereof.

In any case, here's a litmus test for any consumption or VAT tax that may be proposed. Does it contain a Financial Services or Securities Transfer tax (see my blog on the Parasite Tax) on the purchase and sale of stocks and bonds? If it doesn't, you can be sure that it is a stalking horse for yet more regressive taxes that favor the rich.

1 comment:

  1. Most Republicans are against a VAT tax as well. But since we still have a massive deficit, is your solution to cut it just to raise federal tax rates on the top 5 or 10% plus remove the ceiling on the Social Security cap?