US Consumption Tax vs Income Tax Reform: Details & Analysis

An important concern is potential impact on individual work decisions. Two possible impacts are known as income effect (taxes reduce the real value of work) and substitution effect (changes in relative value of work in relation to other activities). Renters necessarily “consume” housing, so they would be taxed on the expenditure of rent.

  • Consumption taxes, like other taxes, alter individual decisions away from optimal choices.
  • Looking at families with children, we estimate that on a conventional basis, after-tax income increases by 4.0 percent for the bottom 20 percent of income earners and by 2.1 percent on average overall.
  • Whether and how this trend continues is yet to be seen, but evidence from the past three years indicates that many states understand and value the importance of creating and maintaining a stable, pro-growth, and competitive tax code.
  • Therefore, for 2024, the rates will range from 0.1 percent to 5.4 percent.

Similarly, traditional IRAs exempt contributions but tax the returns to contributions when withdrawn. An origin-based consumption tax is the reverse, as it offers no export exemption and levies no import tax. An origin-based tax is like a Roth IRA, as it applies tax immediately at the source of production in the U.S. but does not tax returns from investment abroad in the form of imports. Likewise, Roth IRAs tax contributions immediately but do not tax returns to those contributions when withdrawn. Perhaps a reflection of the high improper payment rate, auditA tax audit is when the Internal Revenue Service (IRS) conducts a formal investigation of financial information to verify an individual or corporation has accurately reported and paid their taxes.

Excise Tax

This sounds good too, until one considers the economic dilemma that will likely be created when people save more of their money instead of spending and putting it back into the economy. It would likely be more difficult for the government get enough money when people save more of their cash in order to lessen the amount of taxes they are paying. Local and state sales taxes are consumption taxes that you might regularly pay if you live in a state that has sales tax. But there are also other types of consumption taxes, including some types of taxes that don’t exist in the U.S. or that you might pay without realizing it. Depending on implementation (such as treatment of depreciation) and circumstances, income taxes either favor or disfavor investment. The sale of a home, a one-time job bonus, and various other events can lead to temporary high income that will push a lower or middle income person into a higher tax bracket.

  • A simple value-added tax is proportional to consumption but is regressive on income at higher income levels, as consumption tends to fall as a percentage of income as income rises.
  • One state, Kansas, will significantly reduce its grocery sales tax rate.
  • In the long term, wealthier taxpayers consume more than poorer ones do, moderating the supposed regressive element of consumption taxes.
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  • For consumers, focusing taxation on consumption shifts the burden of determining what is owed to businesses, further consolidating the points at which this must be done.

Florida passed a tax reform package that includes a reduction in the tax rate on business rent from 5.5 percent to 4.5 percent, effective December 1, 2023. Colorado citizens voted down Proposition HH in November 2023, prompting the governor to call a special legislative session to address the impending statewide increases in property taxes. That session yielded SB23B-001, which reduces the assessment on residential property from 6.765 percent to 6.7 percent and increases the exemption on a home’s value from $15,000 to $55,000. The legislation continues to require the state to backfill lost revenue to local governments resulting from property tax relief.

Sources of U.S. Tax Revenue by Tax Type, 2023

Mars0987-I agree that the consumption tax trends would actually create more revenue for the federal government because the United States is a consumption based society. While a consumption tax would seem a more fair method of taxation in an ideal world, the world isn’t ideal. Overall, it could prove to be the better system if abuse could be controlled. On the other hand, there are those who express a desire to reduce taxes — and therefore government — across the board, rather than simply changing methods from tax on earnings to consumption. Use taxes are generally state taxes that apply to the purchase, use or storage of products and services that are subject to sales tax but that you didn’t pay sales tax on. With either type of tax, there may also be different tax rates or exemptions depending on the type of income or purchase.

Income Tax System vs. Consumption Tax System

The state aims to reduce this rate further to 6 percent, subject to revenue triggers. For 2024, the top individual income tax rate will be reduced to 4.8 percent, down from 4.95 percent. In 2022, Kansas lawmakers authorized the Department of Revenue to reduce the corporate income tax rate about federal income taxes withheld on wages provided certain conditions were met. This occurred in 2023 and the Secretary of Revenue has reduced the corporate income tax rate from 4 percent to 3.5 percent beginning in January 2024. The surtax rate (3 percent), which applies to corporate income over $50,000, remains unchanged.

Consumption tax vs. income tax

Families at different income levels would experience different changes in their net benefits under the proposed reforms. For example, under current law, a single parent with $5,000 in income and one child dependent would qualify for nearly $2,100 of tax credits. The same family would qualify for $2,625 under the proposed reform, without facing the complexities of the current tax credit system. Families with no incomes would newly qualify for full benefits under the reform, whereas currently they receive none. While the current income tax code reduces material hardship, primarily for working taxpayers with children, it falls short on simplicity and efficiency grounds.

Cigarette Taxes and Cigarette Smuggling by State, 2021

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If the initial invested amount is not taxed when earned, but the earnings are taxed thereafter, the cumulative taxes paid are the same, but are spread more evenly across the period. These results are primarily sensitive to the rate of return; for example, with a three percent return most of the tax receipts come from the tax on the initial dollar. Now, again, there’s a way to insulate them from that by giving each household cash payments, but no country in the world actually does that. So in the real world, consumption taxes end up being more regressive than income taxes, although Len and I or anyone else could design a consumption tax on paper that wasn’t like that. Transitioning to a pure consumption tax at the federal level in the U.S. would pose challenges.