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A national consumption tax: How would it change things?

By HELEN HUNTLEY
Published March 5, 2005


Is it better to pay taxes when you make money or when you spend it? That's the fundamental question underlying talk about a "consumption tax."

Federal Reserve chairman Alan Greenspan raised the issue this week in testimony before the President's Advisory Panel on Tax Reform.

The committee, chaired by former Sen. Connie Mack of Florida, is listening to a lot of ideas, and will be in Tampa Tuesday as part of that process. The next step is to settle on some favorites and present several proposals for tax reform to Treasury Secretary John Snow the end of July. At least one of those alternatives is likely to involve a consumption tax, so you can count on hearing more about the subject. Greenspan said Thursday the best idea might be a combination of an income tax and a consumption tax.

Here's a primer on consumption taxes to give you a little background:

What are consumption taxes?

Any tax paid at the point of purchase qualifies, such as sales taxes, gasoline and alcohol taxes, hotel room taxes, airport taxes and the like. Many people support a national sales tax that would be added to the state and local sales taxes we pay.

Another type of consumption tax is the value-added tax, widely used in Europe. This is a tax applied at each stage of production of a product or delivery of a service, based on the increase in value at that stage. It ultimately is paid by the consumer as part of the increased price of the product or service.

Some conservatives also define a variation on the income tax as a type of consumption tax. They would make most or all savings and investment accounts tax free, similar to deductible individual retirement accounts, so money would not be taxed until it is withdrawn, presumably to be spent.

How high would a consumption tax be?

That would be up to Congress. The answer depends partly on whether the consumption tax would be a partial or complete replacement for other taxes. For example, one proposal (www.fairtax.org) is for a national sales tax of 30 percent to replace income and payroll taxes. That's equivalent to a 23 percent tax on income.

Among members of the European Union, the standard value-added tax ranges from 15 to 25 percent.

What are the advantages of a consumption tax?

More people pay taxes if you collect them at the point of sale. That includes drug dealers, some business owners and others who don't file income tax returns or who structure their affairs to pay minimal taxes. A sales tax is easier to understand and collect than the income tax.

Greenspan says a consumption tax would help the economy because people would be encouraged to save and invest instead of spending.

How does saving help the economy?

Money that is put in the bank or invested becomes a pool of capital that businesses can tap by borrowing, selling shares of stock or issuing bonds. At least in theory, if businesses spend the money to expand, they create jobs; if they spend it on new equipment, they increase productivity and wages rise.

Would anything be exempt from a consumption tax?

The tax could include exemptions, just as there are exemptions from state and local sales taxes for food, drugs and services.

What are the disadvantages of a consumption tax?

A consumption tax mainly benefits the wealthy, who can afford to save more of their income. Exemptions on food and medicine partly address this. Another approach, part of the FairTax proposal, is to tax everything, but give every household a refund equivalent to the sales tax on a basic level of expenditures.

If it replaces the income tax, a consumption tax takes away the ability of the government to use taxation to promote social and economic goals. If there is no income tax, there are no deductions for mortgage interest and charitable contributions.

How difficult would it be to implement a consumption tax?

In theory, a national sales tax would be relatively easy to put in place since retailers are accustomed to collecting sales taxes. A value-added tax would require a new tax collection structure. However, retailers hate the idea of a national sales tax or value-added tax, and claim that instituting either one would cripple the economy.

The National Retail Federation says the high cost of goods would have a profound psychological effect, prompting consumers to stop spending on anything except necessities for a long period of time, which would put companies out of business and workers out of jobs. Even if there would be long-term economic benefits, they say the transition cost is too high.

The federal government also would be horning in on territory traditionally reserved for state and local governments. The combined state and local tax rate in the United States is 8.587 percent, according to Vertex Inc. If higher tax rates slow spending, state and local revenues would suffer.

A compromise approach would be to keep the income tax and add a modest consumption tax.

Helen Huntley can be reached at huntley@sptimes.com or 727 893-8230.

[Last modified March 5, 2005, 00:41:15]


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