10.1 Consumption Tax Definition
The relationship between consumption, income, and savings is straightforward: Consumption equals individual income minus personal savings. An ideal (theoretical) consumption tax would broad and applied to all consumption. However, such a tax would be challenging to identify, collect, and enforce, making it impractical from a financial administration perspective.
In reality, consumption taxes tend to be narrower in scope as they are typically limited to certain goods or services. These taxes can be collected at various stages of production, including the resource supply stage (such as mining or farming), during manufacturing, at the wholesale level, or at the point of retail.
There are various types of consumption taxes, each differing in how and when they are applied throughout the production process. A single-stage tax is applied at one point in the process. Examples of this include the retail sales tax, which is imposed at the point of sale to consumers, and the manufacturers tax, which can discourage production or prompt businesses to shift production to other states to avoid the tax.
A multi-stage tax, by contrast, applies to multiple points in the production process. The turnover or gross receipts tax is an example where a tax is levied on sales at each stage, leading to cascading effects as the tax accumulates through the production chain. The value-added tax (VAT) is also a multi-stage tax but is non-cascading, i.e., the tax is based on the value added at each stage, preventing the overall tax burden from increasing with each transaction.
Excise taxes, which are typically imposed on a single commodity, are generally single-stage taxes. They apply specifically to one type of product, such as gasoline or tobacco, and are collected at one point in the production or distribution process.
More on the History of Taxes can be found on the website of the Tax Foundation.
Let us next look at the difference between a retail and a wholesale tax. In this setup, the wholesale price of a product is $10, while the retail price is $20, which represents a 100% markup over the wholesale price. Under a retail sales tax of 10%, the price paid by the consumer would be $22. This amount includes $20 for the item itself and $2 as the sales tax. The government would collect $2 in revenue from the retail sales tax. Alternatively, if a wholesale tax of 10% is applied instead, the price at the wholesale level would be $11, which includes the $10 item price and $1 in wholesale tax. With a 100% markup applied to this wholesale price, the price to the consumer would still be $22. However, in this case, the government would collect only $1 in revenue from the wholesale tax. Note that this is a simplified example assuming that the producer can shift the entire tax burden to the consumer, an assumption which is unlikely to be true.
The tax base for consumption taxes varies depending on the type of tax. In the case of general sales taxes, the aim is to tax all personal consumption at a uniform rate. However, due to equity concerns, certain types of goods, such as food or energy, are often subject to reduced rates or are entirely exempt from taxation. Excise taxes, which target specific commodities, can differ significantly depending on the product being taxed. For instance, federal and state fuel taxes are higher than a plastic bag tax, reflecting variations in the nature and perceived societal cost of the goods being taxed.
A notable development in the tax landscape came with the U.S. Supreme Court’s ruling on June 21, 2018, in the case of South Dakota v. Wayfair, Inc, et al. (see Supreme Court Ruling). This decision had a significant impact on the collection of sales taxes by online retailers, allowing states to require sellers to collect and remit sales taxes even if the seller does not have a physical presence in the state. This ruling addressed the growing issue of tax compliance in the digital economy.