10 Pros and Cons of Consumption Tax

It’s been said that there are two guarantees in life: death and taxes. How we approach taxes on an individual level is often in a way to protect our best interests. One new approach to taxation, called a consumption tax, would allow individuals to control how much tax they pay each year by controlling how many things they actually purchase. Think of it like a sales tax, but on a much larger scale.

The consumption tax is an idea that is slowly gaining some traction in the United States, especially since the idea has been endorsed by former Fed Chairman Alan Greenspan. Here are some of the pros and cons to consider for this idea.

What Are the Pros of a Consumption Tax?

1. Households could avoid paying most taxes every year.
Assuming there is an exemption for the purchase of used goods for a consumption tax, a household could potentially go throughout a full tax year without paying much, if anything, in taxes. This could help more people be able to put money away for retirement, vacations, or other purposes.

2. It would increase the overall tax base.
Everyone gets taxed in a consumption tax. Even people in the country illegally are getting taxed whenever they make a purchase. Illegal cash would even theoretically be taxed during a transaction. This could help to shore up some of the budget shortfalls that have been being seen as of late.

3. It could increase worker productivity.
In the United States, you receive a higher tax rate when you make more money. By introducing a consumption tax, workers are only taxed why they consume something and the tax rate is the same. This gives people the opportunity to improve their standing in life if they wish.

4. No new taxes would be placed on investments.
This would benefit the wealthy class because they would have fewer tax responsibilities on what is typically their largest portion of income. In the consumption tax theory, this would encourage more job creation so that even more money could be made.

5. It could reduce national debt.
The United States is trillions of dollars in debt, with many internal obligations contributing to that debt. With the increased funding that is potentially available, those debts could be reduced or even potentially eliminated.

What Are the Cons of a Consumption Tax?

1. To replace traditional tax structures, it would need to be quite high.
Most estimates for the inclusion of a consumption tax in the United States peg the estimated rate to be at 23-34% on the purchases of all qualifying goods. If your $100 item suddenly costs $134, that might discourage people from making a purchase.

2. For a consumption tax to actually work, it must tax everything.
Nothing is off-limits for a consumption tax, with the exception of used goods. This means food, water, and other basic essentials also get that huge tax. Homeowners would be taxed on their mortgage interest. Students would be taxed on their student loans. People would get more money, but they’d have to spend more money as well.

3. It places a higher level of burden on the poor for tax revenues.
Poor households don’t typically have investments. This means their income is subjected to a higher overall percentage of taxation because they’re paying taxes on items they need. If a family making $20k per year pays $2,000 in taxes and so does a household making $200,000 per year, they might pay the same amount, but the poor family is paying 10% of their income in taxes and the wealthier family is paying just 1%.

4. The cost of used goods will explode.
This is a basic supply and demand principle. If new products are subjected to a tax of up to 34%, more people will look at purchasing used goods to avoid that tax. This will cause the price of used goods to rise because more people want them. In the end, more money winds up changing hands, but everyone ends up paying more to get the same things they need.

5. Some retirees could be taxed twice.
Some retirement income, like in a Roth IRA, has already been taxed. Upon withdrawal, under a consumption tax, those same funds would be taxed again for the same purpose.

The pros and cons of a consumption tax show that a careful balance must be achieved in order for it to be successful. How do you feel about the implementation of a consumption tax? We’d love to hear some of your thoughts and opinions about this type of tax.