Taxing consumption: a multitude of approaches

It is widely argued by contemporary legal scholars and economists that taxing consumption is the preferred alternative to income tax.[1] This approach has become popular since income tax is seen as draining taxpayers’ savings and because it is perceived as a ‘mechanism’ which discourages investment.[2] Allegedly, by taxing consumption, a fairer system is imposed as this form of taxation does not treat taxpayers differently: it rather taxes their expenditures/consumer habits and it simultaneously encourages economic growth.[3]


Whilst taxing consumption might seem relatively simple, different mechanisms exist, with many countries taking various approaches when taxing consumers. The most common ways of consumer taxation are the following: VAT (value added tax), retail sales tax and excise taxes.



Value added tax


VAT was implemented in the post IIWW France as an indirect tax mechanism (cf. with income tax which is a direct form of taxation) and has since expanded globally.[4] Empirical studies on VAT show that it has enriched states’ revenues, and it has even decreased the rates of income and excise taxes in many countries.[5] Its popularity can be attributed to the fact that it operates ‘in a neutral and transparent manner’[6] and many claim that it showcases the ‘most effective instrument for generating government revenue’ because its administrative costs are ‘lower’ in comparison to other tax mechanisms.[7]


The transparency of VAT is such that it creates ‘an audit trail’ which in turn operates as an incentive which discourages the occurrence of fraud in the market.[8] VAT is structured as a ‘staged collection mechanism’ where the subsequent taxpayers ‘deduct’ the ‘input tax’ of their ‘purchases’ and report the output tax of their transactions.[9] The effect of VAT is that the tax paid to the state reflects the tax paid by the end-purchaser.[10] The efficiency of this system is advocated by many because it enables tax collection as early as by the stage of production, thus securing state interest. The security that VAT provides contrasts with the efficiency of the other types of taxation on consumption e.g., if there is evasion but a retail sale tax has been imposed, then the result is that ‘all tax is lost’.[11]


Academic commentary provides that the VAT system is seen as ‘ideal’, only if it has a broad base ‘single standard rate’ with, perhaps, a few exceptions.[12] The imposition of variable rates, though, diminishes this ‘ideal’ operation of VAT because the existence of multiple rates renders VAT confusing and increases its complexity for both taxpayers and state authorities’ administration costs.[13] Different VAT rates also fuel legal uncertainty in disputes concerning ‘similar products’ and their classification e.g. for food like ‘teacakes’,[14] as well as encourage fraud e.g. instances where the products have consciously been ‘misclassified’.[15]


Many even argue that VAT is ‘the preferred alternative’ to custom duties in international trade: VAT has been described as a mechanism that ‘dismantles trade barriers’ and facilitates ‘trade liberalisation’.[16] This occurs because at international trade VAT is imposed only at one stage: on imports and not on exports.[17] That way, cross-border trade is encouraged especially at the export stage as VAT is deductible, meaning that it enforces the return of the ‘corresponding input tax’ imposed on the goods at the stage of production or subsequent transaction prior their exportation.[18]


Some, however, disagree with this approach and have suggested that in fact zero rate VAT is prone to ‘fraud and evasion due to abuse of the credit and refund mechanism’ and have suggested the abolition of the zero rate VAT to avoid the occurrence of fraud and the subsequent corrosion of the system.[19] Nevertheless, the prevalent perception among economists is that VAT encourages growth and investments, due to its unique structure, especially when comparing it with income tax.[20]


Retail sales tax


The imposition of retail sales taxation is the alternative to VAT, and the type of consumption tax that can be found in the US,[21] but has a narrower base. [22] Unlike VAT which is a type of tax collected at? different stages: from the stage of production onwards until it reaches the consumer; a retail sales tax is, rather, a tax that is only collected when the goods reach the buyer/consumer who pays the levied tax to the merchant/seller, who will, then, pay the requisite tax to the authorities.[23]


Retail sales tax is seen as a ‘destination-based levied tax’ e.g., even in the case of imports, retail sales tax will be levied on the purchaser, i.e., the consumer.[24] The prevalent approach is that VAT is more easily enforceable because as a system it is more transparent. Therefore, an attempt to evade is more difficult because the seller will have to disclose the purchases they made from other suppliers while ‘claiming credit on the tax inputs’ they incurred.[25]


Conversely, as the retail sales tax is collected only at the final stage it is asserted that if the seller opts to evade then it can easily do so because no linked accounts exist (there are no invoices).[26]


Excise taxes

Excise taxes are ‘special taxes’ levied on selected goods that are described by ‘inelastic demand’ in the domestic and global marketplace and are commodities that ascribe the element of ‘luxury’ (e.g., alcohol, tobacco, vehicles, etc.).[27]


Excise taxes, however, usually impose high rates with sometimes no uniform tax rate bases (e.g. levying them under ‘specific rates or ad valorem’ interchangeably) with the occurrence of instances where the levied tax sometimes exceeds the actual price of the good itself.[28] This, in particular, renders the regulation of excise tax important, and many support the imposition of custom like procedures since the stage that such goods leave production to enter the marketplace to tackle the problems such as smuggling.[29]


Thoughts


Income tax may still be the most common type of taxation today, but this does not mean that it is suitable for modern economies. A tax on consumption seems to be a better option, as it does not differentiate among taxpayers but rather taxes everyone on equal rates; the difference is that the tax is levied based on the taxpayers’ choices and not on their income.[30]


A great advantage of VAT is that it places the task of its administration on a limited amount of assigned taxpayer ‘collectors’ - the sellers, without the burden on each individual to calculate or report their part, whereas income tax is seen by many as a ‘tax burden’ that ensues ‘complexity’ by taxing individuals unfairly based on their behaviour, as self-reported, through the system.[31] The reduced administration costs VAT brings on the table cannot be ignored because it significantly reduces tax evasion and fraud, something that is not the case with the retail sales taxes and income tax.[32]


To conclude, the ‘self-tracked’ nature of VAT and its very mechanism - taxing consumption instead of taxpayer gains - make it the best option available to accommodate justice and equality when taxing the people of contemporary legal systems.





Endnotes

[1] Daniel S. Goldberg 'The Death of the Income Tax' (Oxford University Press 2013) 139. [2] Ibid 139,144. [3] Ibid 140; Reuven S. Avi-Yonah, 'The Three Goals of Taxation' (2006) 60 Tax L Rev 1. [4] More than 130 countries have enforced it; Ian Crawford, Michael Keen and Stephen Smith ‘Value Added Tax and Excises in Dimensions of Tax Design: The Mirrlees Review’ (Oxford University Press, 2010) 293. [5] Alain Charlet and Jeffrey Owens 'An International Perspective on VAT' Tax Notes Int’l 2010, 943. [6] Ibid. [7]Ibid 944; Alain A. Tait, ‘Value Added Tax International Practice and Problems’ (International Monetary Fund 1988) 5. [8] Charlet and Owens (n5) 944; Tait (7) 5. [9] Ibid; Crawford et al (n4) 292,293. [10] Crawford et al (n4) 295. [11] Charlet and Owens (n5) 944. [12] Ibid 944,949,951. [13]Ibid 949,951. [14]ECJ Marks & Spencer plc v. Commissioners of Customs and Excise, C-309/06 Apr. 10, 2008. [15] Charlet and Owens (n5) 951; Crawford et al (n4) 290,291. [16] Charlet and Owens (n5) 944. [17] Zero rate tax is imposed on exports: Crawford et al (n4) 292. [18] Charlet and Owens (n5) 944. [19] Crawford et al (n4) 311-316. [20] Charlet and Owens (n5) 944. [21] David F. Bradford 'Untangling the Income Tax' (Harvard University Press 2013) 72. [22] Ibid 74; Tait (n7) 7. [23] Bradford (n21) 72; Crawford et al (n4) 295. [24] Bradford (n21) 74. [25] Ibid 72,73. [26] Ibid 73. [27] Victor Thuronyl ‘Comparative Tax Law’ (Kluwer Law International 2003), 328; Crawford et al (n4) 316,318. [28] Ibid. [29] Thuronyl (n27) 329. [30] Goldberg (n1) 140. [31] Bradford (n27) 75. [32] Charlet and Owens (n5) 944; Richard M. Bird and Pierre-Pascal Gendron, 'Is VAT the Best Way to Impose a General Consumption Tax in Developing Countries?' (2006) Georgia State University Working Paper 06-17, 33


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