A consumption tax is drawn when people start spending money. There are several types of a consumption tax such as a sales tax or value-added tax, which are mainly indirect. While an income tax is applied to everything we earn including interest and capital gains, a consumption tax is tied to everything we spend. It is quite clear to taxpayers who automatically pay it every time they purchase goods or services.
In the US, consumption taxes raised a controversy among the economists. The European model of taxation looks appealing to the US officials mainly because sales tax and value-added tax would greatly benefit to state and local governments. Every dollar consumers spend purchasing goods and services will be taxed so that the governments will earn from the increasing consumer’s society. On the other hand, consumption taxes will damage small businesses, which are not able to pass sufficient cost increases. While big businesses have certain mechanisms to defend themselves from the effect of governmental policies, small businesses cannot allow themselves any additional spending. Other sectors such as charity and healthcare are not enthusiastic about the tax reform either. Numerous deductions will disappear so that people will have to pay their taxes consumption taxes in full.
Taking into account the fact that consumption taxes are not applied to savings, it creates a disproportion between taxpayers. Policy makers anticipate that consumption taxes hit low and middle-income taxpayers in the first place. Less prosperous people spend most of their income on consumption while well-off individuals prefer to save their money and not to tax them. On the other hand, a consumption tax is a good incentive to save money.