While much debate and deliberation occurs about “taxes” in general, it’s important to remember that not all taxes work the same way. Broadly speaking, most taxes can be categorized as being either income taxes, property taxes or consumption taxes. Personal income taxes, corporate income taxes, estate taxes and capital gains taxes are examples of income taxes. Property taxes are assessed simply for owning certain property (like your home or car). Consumption taxes, though, are sometimes less obvious because consumers pay them passively without completing any paperwork.
The major forms of consumption taxation are explored below.
The simplest and most readily understood forms of consumption taxes are sales taxes. These are taxes added to the purchase prices of goods and services, and each state (and local jurisdiction) decides what percentage its sales tax will be applied. TaxAdmin.org offers an updated list of the sales tax percentages being charged by each state as of 2010. Food and inexpensive clothing are sometimes exempted from state sales taxes in order to make it less costly on the less affluent. Other states, including Hawaii, Idaho, Kansas, Oklahoma, South Dakota and Wyoming, do tax food at the state level but offer rebates or income tax credits to poor households. Alaska, Delaware, Montana, New Hampshire, Oregon are notable exceptions in that they do not charge any sales taxes at all.
Sales taxes (like other consumption taxes) are often described as being “regressive” in nature. Since poorer individuals tend to spend higher portions of their yearly income on taxable consumption items, sales taxes fall harder on them than on more affluent segments of society. The above mentioned exemptions of food and clothing from sales taxes are attempts to make the tax less regressive.
Some products are singled out for unique consumption taxes of their own. Cigarettes, fuel and alcohol are examples of such products. USA Today maintains a helpful chart of the cigarette taxes per pack charged in each state. As of December 2009, the lowest tax per pack was $0.07 in South Carolina, while Rhode Island levied the highest tax at $3.46 per pack. USA Today went on to note that cigarette taxes are “gold rushes” for the states, many of which have raised taxes on smokers since 2008 in order to plug budget holes. There is also a federal cigarette tax of $1.01 on top of normal state sales taxes.
Fuel taxes operate in a similar manner. In addition to the $0.24 federal fuel tax, each state levies its own taxes on the sale of fuel. The Tax Foundation tracks each state’s fuel taxes as of February 2010. These range from as little as $0.08 per gallon in Alaska to as much as $0.46 in California. Some states (though not all) also impose normal state sales taxes in addition to federal and state fuel taxes on each gallon purchased. The American Petroleum Institute found that the mean state fuel tax was 27.2 cents per gallon in the first quarter of 2009.
Alcohol, too, is singled out for unique consumption taxes. As the Tax Foundation shows, states actually levy different taxes per gallon on spirits, wine and beer. Taxes on spirits tend to be higher than taxes on wine, which tend to be higher than taxes on beer. What cigarettes, fuel and alcohol have in common is that they are all demand inelastic. There are few substitutes and people tend to buy them in equal amounts regardless of price changes. This makes them prime candidates for their own consumption taxes.
Value Added Taxes
Value added taxes (or VAT) do not yet exist in the United States, but are frequently collected in Europe. In essence, a VAT functions as a more comprehensive sales tax. Rather than being assessed on the finished product (as American sales taxes presently are) a VAT is assessed at each stage of an item’s production. A common example is how a VAT would apply to a simple loaf of bread.
Assuming a 10% VAT rate, the wheat farmer sells $0.20 of wheat to a baker for $0.22. The $0.02 (which is 10% of $0.20) is tax and gets paid by the farmer to the government. The baker, in turn, sells the loaf of bread to a grocery store for $0.60 plus an extra six cents of tax, which gets paid by the baker to the government. Finally, the grocery store sells the bread to customers for $1.10, with the $0.10 being the VAT. The baker and grocery store receive credits of $0.02 and $0.04, respectively, for the VAT they already paid at earlier stages.
The touted benefit of value added taxes versus traditional sales taxes is higher compliance. While merchants can attempt to conceal sales (and thus avoid sales taxes), it is considerably harder to do this when the parties before you have already paid and reported taxes on the items sold. Like sales taxes, the full amount of VAT is ultimately paid by consumers.
The common ground shared by all consumption taxes is that they are paid at points of sale. Unlike income and other taxes, consumption taxes can be avoided simply by not purchasing goods or services on which they are assessed.