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Chapter 11 Taxes on Sales and Consumption Chapter outline 1.Why Tax Sales? 2.Sales Taxes, Value-added Taxes, Excise Taxes 3.Efficiency Issues in Sales.

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Presentation on theme: "Chapter 11 Taxes on Sales and Consumption Chapter outline 1.Why Tax Sales? 2.Sales Taxes, Value-added Taxes, Excise Taxes 3.Efficiency Issues in Sales."— Presentation transcript:

1 Chapter 11 Taxes on Sales and Consumption Chapter outline 1.Why Tax Sales? 2.Sales Taxes, Value-added Taxes, Excise Taxes 3.Efficiency Issues in Sales Taxation 4.Equity Issues in Sales Taxation 5.The State Retail Sales Tax in the United States

2 6.Local Sales Tax in the U.S. 7.Excise Taxes 8.Value-added Taxes

3 Taxes on sales are primarily a state and local revenue source in the United States. State retail sales and excise taxes accounted for 27% of all state revenue, 38% of own- source revenue, and 50% of state tax revenue. Sales taxes are also used by more than 7,000 local governments.

4 1.Why Tax Sales? There are three reasons why tax sales. ① Transactions offer a convenient tax handle. ② Consumption spending is a measure of ability to pay taxes. ③ They provide a way of exporting some taxes to visitors who use local and state public services. The short-run elasticity of the retail sales tax base is estimated at 1.039 (1.377 if food is excluded), but the long-run elasticities are estimated at only 0.66 and 0.701. Thus states that rely heavily on sales taxes need to complement them with other revenue sources that have higher long-run income elasticities.

5 2.Sales Taxes, Value-added Taxes, and Excise Taxes The type of sales taxes in widespread current use around the globe are retail sales taxes, selective sales or excise taxes, and value-added taxes. Sales taxes can be grouped by whether they are single-stage or multistage, broad based or narrowly focused, or levied on the buyer or seller.

6 3.Efficiency Issues in Sales Taxation A primary objection to sales taxation is that the sales tax tends to erode its own base over time, particularly if the base of the tax is anything less than total consumption or the tax rates are very different in adjacent jurisdictions. Another way to avoid the tax is to shift purchases from taxed to exempt items. ① Shifting Between Markets The broader the coverage of the tax in terms of both geographic extent and variety of purchases subject to the tax, the less base erosion there will be.


8 ② Avoiding Cascading Another efficiency issue in sales or consumption taxes is ensuring that taxes do not accumulate so that some items are taxed only once and others two or more times, resulting in different tax burdens on different purchases and an unintended distortion of consumer choice. With the support and encouragement of the World Bank, and the example of the European Community’s success with the value-added tax, most of the nations that had been using cascade taxes have replaced them with VATs or some other, less distorting form of sales tax.

9 However, cascading can occur in a single- stage tax if some business purchases at the taxable stage are incorporated into products or services also subject to the tax.

10 4.Equity Issues in Sales Taxation The primary objection to sales taxes is that they tend to be regressive, except for certain excise taxes on luxury goods. ① Broaden the Base Broaden the base, primarily by including some services, to keep the rate low and include more of the consumption spending of higher income households. However, broad coverage of services has been difficult to achieve in most states because of political pressure.

11 ② Narrow the Base Narrow the base by eliminating consumption that represents a large fraction of income for lower income households, especially food and clothing. The food exemption is appealing, but difficult to administer because of the challenge of defining food. 85% of the population is not poor, yet their food purchases are also exempt. ③ Fine-tune the Tax Fine-tune the retail, wholesale, or value-added sales tax with excise taxes or differential rates on certain items that are consumed more heavily by upper income classes.

12 ④ Protect the Poor Rebate some of the sales tax through means-tested income tax relief. In some cases the rebate is only to reimburse for sales taxes on food. This approach has the advantage of giving relief only to low-income households, thus sacrificing less revenue than the tax expenditure approach of exempting food for all state residents.

13 5.The State Retail Sales Tax in the United States ① History and Evolution State retail sales taxes came into being in the 1930s, with a second wave enacted after World War Ⅱ.The average tax rate increased during the 1980s and 1990s. Why did states turn to sales taxes rather than to other revenue source? By 1933 the federal government was making fairly heavy use of the individual income tax, while local governments relied heavily on the property tax. With only three major kinds of broad-based taxes, some form of sales tax seemed the most obvious choice.

14 ② Efficiency Issues Efficiency issues specific to this tax include the taxation of business inputs and the incomplete coverage of consumption, both of which distort locational choice and allocation of consumer spending among various goods and services. ③ Equity Issues Regressivity is the primary equity issue for most kinds of broad-based sales or consumption taxes, but the retail sales tax has some specific equity challenges because of the way it is administered in the United States. It is likely that failure to tax a large share of mail-order and Internet sales makes the sales tax more regressive.

15 6.Local Sales Tax in the U.S. Local sales taxes are more recent in origin and at lower rates, typically 0.5% to 2%.

16 7.Excise Taxes Many excise taxes are specific. ① Rate and Base Excise tax rates tend to be higher than typical retail sales tax rates and thus cause more deadweight loss.

17 ② Revenue, Equity, and Sumptuary Goals Excise taxes service multiple purposes. One is revenue. A second purpose is to tax items consumed more heavily by upper income groups, in order to offset the regressivity of a general sales tax at the wholesale or retail level. A third goal is to discourage consumption of goods or services as a way of reducing negative externalities. Governments can regard excise taxes on activities that are socially undesirable as a win-win situation.

18 8.Value-added Taxes Because income taxes are used in a much more limited fashion in most other countries, the VAT is not only the predominant form of sales tax but also a major source of central government revenue as well. ① Basic Features This tax is levied on the difference between the value of inputs and the value of outputs or sales, so it is effectively a tax on wages and profits. The most common way of assessing the tax is to levy a tax on sales with a credit for any value-added tax already paid on inputs.

19 ② Efficiency and Equity Issues Like all sales taxes, it is regressive. Typical rates for a VAT are quite high, in the 15% to 20% rate. The high rates increase the deadweight loss or excess burden. It is also criticized in terms of its high collection and compliance costs.

20 True-false questions If false, change the statement to make it true. 1.Base erosion from a sales tax is smaller with more elastic supply and/or demand. 2.A sales tax will be less regressive if the base includes services. 3.A value-added tax tends to have higher compliance and collection costs than other kinds of taxes.

21 4.The excess burden, relative to taxes collected, tends to be higher for a general sales tax than for a specific excise tax. 5.Multistage taxes other than the VAT tend to distort production and consumption decisions because different products will bear different relative tax burdens depending on the number of taxable stages through which they pass.

22 Answers: 1. F (less elastic) 2. T 3. T 4. F (The opposite is true.) 5. T

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