Consumption Taxes Challenge Retailers

Historically, the U.S. has relied far less on consumption taxes than its peers, with just 15 percent of tax receipts coming from consumption taxes, compared with an average of 33.6 percent in other developed countries, according to research from The Wall Street Journal. But in the last few years, the tax-consumption idea has gained traction with lawmakers considering an overhaul of the current income-based tax system.

In March, the National Retail Federation (NRF) wrote to Congress, urging policymakers to reject any form of consumption tax as they review tax reform proposals. A consumption tax is a tax on money spent, in contrast to a tax on earnings or capital income. Common examples include Value Added Tax (VAT) and Goods and Services Tax (GST). The idea behind consumption tax is that a higher tax on goods and services could motivate consumers to save more, assuming taxes on interest, dividends and capital gains are eliminated.

A variety of consumption tax proposals have been put forward to Congress over the years, generally aimed at replacing the income tax. The proposal garnering the most attention in the United States is the Fair Tax Act of 2015, which would impose a flat national sales tax on the consumption of taxable property or services in lieu of the current income and corporate income taxes, employment and self-employment taxes, and estate and gift taxes.  The plan calls for a 23 percent tax-inclusive rate, which translates to about 30 percent in actual sales tax.

What are the potential implications of transitioning to a consumption-based tax system?

Keep it simple, stupid. If there is one thing both sides of the aisle tend to agree on, it’s that our tax code should be simplified. Proponents of the consumption tax argue that having a uniformly administered national sales tax would simplify tax filing requirements.

Say goodbye to the IRS. Because retailers, and not individual taxpayers, could be responsible for collecting and remitting tax, some analysts suggest that the IRS could be abolished, freeing up federal dollars for other uses.

Encouraging investments. Part of the aim of a consumption tax system is to help boost savings and investments. With the capital gains tax eliminated, individuals can pocket investment income without paying additional taxes, and withdraw funds without incurring tax penalties.

But the Fair Tax Act isn’t without its critics. Where economists and legislatures disagree is the short and long-term impact on consumer spending, a key driver of GDP and the heartbeat of the retail economy.

Mo’ Money, Less Problems. Elimination of income and employment taxes would undoubtedly increase household incomes. Advocates of the Fair Tax Act and other consumption tax approaches theorize that more disposable income would lead to increased consumer spending, boosting the overall economy. However, the rate of increase could be disproportionate and the effect short-term. Generally, consumers spend a lower percentage of their income as it increases.

The paradox of thrift. A national sales tax would incentivize people to invest, save or pay down debt rather than purchase goods. But if everyone spends less and saves more, overall demand will drop, thus hurting, and not helping, economic growth.

Beware of sticker shock. Consumers are programmed to buy on sale. We want the best value for the lowest price. A sudden 30 percent hike in prices, regardless of the rationale, could scare off shoppers and would require a change in mindset. Retailers may also have to adjust pricing to account for the increased sales tax and the eliminated cost of payroll taxes and income taxes.

The great unknown. Uncertainty and unpredictability could cause consumers to cut back on discretionary spending while they wait to see how everything works out. It’s also worth noting that while many other countries levy consumption taxes, the Fair Tax Act is a unique approach and remains untested.

As the debate over the consumption tax continues, it’s important for retailers to understand the discussions surrounding consumption tax and how they may need to prepare should such taxes go into effect.