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What Is a Consumption Tax?

Malcolm Tatum
Updated Feb 09, 2024
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Consumption taxes are any type of taxation imposed by a local, state, or national tax agency on the purchase of certain goods and services such as clothing, gasoline, or a restaurant's prepared food. This approach to taxation is common in a number of nations around the world, and may be used in place of, or in addition to, an income tax; an ongoing debate exists over the pros and cons of replacing the income tax with taxes on purchases only. The collection of a consumption tax has a long history, and is often used today as a means of raising money to improve the local community in various ways, such as generating revenue that can be used to enhance the operations of schools located within a city. Different variations of the tax exist — sales tax, value added tax (VAT), and excise tax — and some countries charge more than one type of consumption tax to citizens, depending on the situation.

Worldwide Variations

In the US, a consumption tax is commonly referred to as a sales tax and is typically charged to the consumer when the product or service is bought. The seller collects the tax, which is later collected by the local government to be used for improvements within the community. The rate may vary between states, and is usually decided upon by the local government. It is not unusual for a sales tax to be referred to in a manner that describes what the collected tax revenue is intended to support, such as a local school tax.

In the United Kingdom, the value added tax, a type of consumption tax, is applied in situations involving goods that are purchased with the intent of resale. Essentially, in addition to taxes paid when purchasing goods, any added value that the original buyer gains by later selling the product is also taxed when the product is sold. For example, if a man buys a pair of shoes for $50 US Dollars (USD)he is taxed for that purchase, and if later he sells them for $75 USD, he created an added value of $25 USD. He will be charged a VAT on the added value amount of $25 USD, and the person buying the shoes will be charged a VAT on the entire $75 USD.

In some cases, a consumption tax is not charged directly by a government, but instead by a third party — this is referred to as an excise tax. This third party may change the price of a product to increase or decrease the amount of tax revenue being forwarded to the government. Some examples of products that include excise taxes are gasoline, alcohol, and tobacco. Consumers pay a type of consumption tax on these products, but the price of the product can fluctuate, depending on the necessary tax rate. Also, consumers do not pay the tax directly to the government, and often, the rate is included in the price of the product. This type of tax is implemented in the US, India, and Canada, to name a few.

Consumption Versus Income Tax

The idea of a consumption tax is somewhat different than that of an income tax. A tax based on purchases focuses solely on how much money is spent paying for certain items and services. In contrast, the income tax focuses not on the spending habits of citizens, but the amount of wealth they accumulate asincome from employment and other means. Many countries, such as the US and Australia, charge income tax and at least one type of tax on purchases. Many citizens argue that moving to a tax system that charges citizens on purchases only, and not on income, is beneficial because it would encourage citizens to save money and create a more efficient economy; however, some argue that such a system could be difficult for some, such as the lower class and retirees living on a fixed income, and may create more problems for society as a whole.

WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.
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Malcolm Tatum
By Malcolm Tatum
Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing to become a full-time freelance writer. He has contributed articles to a variety of print and online publications, including WiseGeek, and his work has also been featured in poetry collections, devotional anthologies, and newspapers. When not writing, Malcolm enjoys collecting vinyl records, following minor league baseball, and cycling.
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Malcolm Tatum
Malcolm Tatum
Malcolm Tatum, a former teleconferencing industry professional, followed his passion for trivia, research, and writing...
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