Consumption Taxes: An Overview (CRS Report for Congress)
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| Release Date |
Revised Jan. 24, 2023 |
| Report Number |
R44342 |
| Report Type |
Report |
| Authors |
Jeffrey M. Stupak, Research Assistant; Donald J. Marples,Specialist in Public Finance |
| Source Agency |
Congressional Research Service |
| Older Revisions |
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Summary:
Commentary abounds suggesting the current U.S. income tax code is overly complicated, unfair, a drag on the economy, and in need of reform. One option for tax reform would fundamentally change how taxes are collected in the United States, and tax consumption instead of income. Multiple proposals have been introduced in the 114th Congress to shift revenue collection away from income and toward consumption. H.R. 25 and its companion legislation in the Senate, S. 155, would replace the income tax with a national retail sales tax, often referred to as a "fair tax." H.R. 1040 would offer taxpayers the ability to opt into a consumed-income tax.
Within the current income tax structure, an individual's tax liability is determined as a function of total income. Under a consumption tax, however, an individual's tax liability would be determined as a function of total expenditures on goods and services. Consumption taxes can take many different formsâwhich differ in when the tax is collected, how the tax is calculated, and who is responsible for remitting the taxâbut they all share the common tax base of consumption. Common consumption tax designs include a value added tax (VAT), a national sales tax (NST), and a consumed-income tax.
Taxes are necessary for the government to raise revenue to provide necessary and desired goods and services. However, taxes also tend to introduce distortions into a market economy and can hinder economic efficiency. Proponents of consumption taxes argue that a broad-based consumption tax could replace the federal income tax, raising requisite revenue while improving economic efficiency, and increasing economic output.
Broadly, taxes tend to distort individual decisions by altering price signals within the economy. Taxes can affect individual behavior in a number of ways, including labor participation decisions, and saving and investment decisions. As discussed in the report, the effects on labor supply from switching to a consumption tax are expected to be small, if any. However, there is evidence that transitioning to a consumption tax may increase individual saving. Increased individual savings could contribute to increased economic output.
Effects on the distribution of the tax burden are also often considered in tax policy debates. When comparing a hypothetical pure consumption tax to a hypothetical pure income tax, consumption taxes place a greater tax burden on lower income individuals. Additionally, in this stylized comparison, consumption taxes place a greater tax burden on younger and older individuals, especially retired individuals drawing down their savings.
