Consumption Taxes

While the United States relies heavily on income taxes, a radically different approach is consumption taxes, which are taxes on purchases of goods and services rather than on income. The rationale is that people should be penalized for what they use rather than what. they produce. Sales taxes are the most familiar example of consumption tax. The United States has no national sales tax, although there. are a number’ of federal use taxes on specific commodities such as cigarettes; alcohol, and gasoline. Sales and excise taxes are generally regressive because they consume a larger fraction of the income of poor families than of high-income families.

The advocates of consumption taxes argue that the country is currently saving and investing less. than is necessary for future needs and that by substituting consumption taxes for income taxes, the national savings rate would increase. Critics of consumption taxes respond that such a change is undesirable because sales taxes are more regressive than today’s income tax. The flat tax, discussed earlier, is actually equivalent to a highly simplified system of personal consumption taxation. This approach would set all marginal-tax rates at a uniform low rate (around 20 percent) and eliminate most deductions and tax-exempt fringe benefits. such as for health care and mortgage interest (see question 9).

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