US Consumption Tax vs Income Tax Reform: Details & Analysis

If lawmakers excluded certain categories of goods or services from the VAT base, it would require a higher tax rate to generate the same revenue as the option we simulated. Appendix Table 2 illustrates one such example of a narrow tax base. Within the 10-year budget window, the reform would reduce federal revenue by slightly more than $1 trillion on a conventional basis.

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While increased economic growth and material living standards do not make up the entirety of human well-being, material prosperity is strongly correlated with better outcomes for people across a variety of alternate measures. Because Taxpayer B does not immediately consume her earnings, she would not face an initial tax, instead saving all $100 of her earnings. She would face the 20 percent tax when she consumes her $110 in the future, yielding $88 of consumption and a 20 percent effective tax rate. According to income tax rules and laws, each individual can avail tax benefit of standard deduction of Rs.40,000 if your annual income is Rs.540,000. After the standard deduction, you have to pay tax only for an annual income of Rs.500,000.

The Current U.S. Hybrid Tax System and Its Effects

1. A lump sum credit of $600 per filer and $2,400 per dependent would replace the eliminated credits.
2. A consumption tax can also refer to a taxing system as a whole in which people are taxed based on how much they consume rather than how much they add to the economy (income tax).
3. It is likely the value of most existing capital falls at least somewhat, meaning shareholders face a one-time tax burden on their wealth (their existing saving) at the time of transition.
4. The same family would qualify for $2,625 under the proposed reform, without facing the complexities of the current tax credit system.
5. An income tax, in contrast, is imposed when you earn money, a consumption tax is imposed when an you spend money.

While the U.S. does not have a national consumption tax, many other countries have imposed some form of a national consumption tax. Improvements in the long-run standard of living largely depend on peoples’ willingness to work and to invest in capital. Tax policy has a significant effect on decisions to work and to invest by changing the after-tax benefits of both. In the long run, the plan has a positive economic effect and is approximately revenue neutral on a conventional basis. As a responsible citizen of India, you should always pay income tax as a sacred duty, not considering it as a burden. It not only improves the quality of your life but of all Indian citizens.

Compliance costs are particularly important for entrepreneurs and their decision to enter or exit an industry. The Canadian experience of moving to a VAT illustrates the benefits of reducing the cost of capital for business investment. journal entries to issue stock It also offers important lessons for the administration of a new consumption tax system. Canada illustrates how cooperation between national and subnational governments can reduce administrative costs while warning that carving up the tax base through exemptions and rebates claws back some benefits of moving to a broad-based consumption tax. For example, the policy of full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs.

So the question is on balance, is the extra incentive to save enough to offset the extra disincentive, the penalty on working? In any event it’s not likely to be a very large effect, it’s not going to turbo charge the economy.

Economic, Revenue, and Distributional Effects of a Value-Added Tax and Rebate

For taxpayers with child dependents, after-tax income on a long-run conventional basis would increase by 4.2 percent for the bottom 20 percent of families with children. The simplified lump sum credits are especially impactful for taxpayers with children, increasing income by more than the overall average for the bottom 60 percent of taxpayers. Replacing the corporate and non-corporate income taxes with a cash flow tax that allows full expensing of all capital investment significantly reduces the cost of capital and thus incentivizes new domestic investment.

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When factoring in the positive economic feedback from increased investment and work, federal revenue would decrease by about $130 billion. Using the same examples as above, a single parent with $5,000 in income and one child dependent would qualify for nearly $2,100 of tax credits under current law. The same family would qualify for $3,000 under the proposed reform. A family of joint filers earning $35,000 with two child dependents would qualify for about $7,000 to $9,000 of tax credits currently, which would fall to $6,000 under the proposed reform. Alternatively, fringe benefits could be taxed at the source, meaning firms would not deduct the cost of fringe benefits and households would not pay tax on fringe benefits, and could be subject to payroll taxes. In a world with a 20 percent income tax, Taxpayer A would owe $20 and be able to immediately consume the remaining $80 compared to $100 in a world with no taxes.

Taxes can be structured in many different ways with varying economic, administrative, and compliance costs. In the interest of supporting rising living standards and economic growth to advance well-being for families, we will outline two options to reform the current U.S. income tax by transforming it into a consumption tax. The transformation imposes tax when goods and service are consumed rather than when income is earned. The other groups that would be concerned is anyone who gets a tax break under the current system. Most of these consumption taxes, like a retail sales tax or value added tax or the flat tax, or whatever, talk about cleaning out the tax system, all the special exemptions and deductions and credits and stuff like that. So the charitable sector doesn’t like these things because the charitable contribution disappears.