Taxes What Is a Consumption Tax? By Joshua Wiesenfeld Joshua Wiesenfeld Joshua Wiesenfeld is a financial investigator, certified public accountant (CPA), and certified fraud examiner (CFE) with almost a decade of experience. He writes about taxes and investing and has been published in the Journal of Accountancy and Fraud Magazine. Joshua has a master's of public administration in forensic accounting from John Jay College. learn about our editorial policies Updated on January 6, 2023 Reviewed by David Kindness Fact checked by Lars Peterson In This Article View All In This Article How Consumption Taxes Work Example of Consumption Taxes Types of Consumption Taxes Benefits of Consumption Taxes Criticisms of Consumption Taxes Frequently Asked Questions (FAQs) Photo: Dougal Waters / Getty Images Definition Consumption taxes are taxes levied on purchases of goods and services. Key Takeaways Consumption taxes are taxes on the purchase of goods and services designed to tax individuals when they spend money rather than when they earn it.Examples of consumption taxes include excise taxes, VAT taxes, sales taxes, and taxes on imported goods.Consumption taxes may be fairer and simpler than income tax since it is easy to conceal income.Consumption taxes may also encourage saving since it discourages spending.Some studies indicate that consumption taxes do not encourage saving and adversely affect low-income households. How Consumption Taxes Work A consumption tax is a tax levied on goods and services consumed or purchased. Essentially, consumption taxes tax you when you spend money rather than when you earn money, as in the case of income taxes. Consumption taxes were first introduced in the U.S. in the 1800s and have since been an integral part of the tax system. Globally, though, consumption taxes have a stronger presence and are a very popular form of revenue generation for governments. The United States is unusual in that there is no federal consumption tax on goods and services; it is up to state and local entities to set it up. Nevertheless, consumption taxes do play a role in raising government funds in the U.S. In the U.S., consumption taxes usually are designed as sales taxes, excise taxes, and taxes on imported goods. Note An excise tax is a common form of consumption tax levied on items not considered healthy or wholesome. Example of Consumption Taxes In the U.S., a special tax—specifically an excise tax—is levied on tobacco products. Because of the government-imposed tax, a pack of cigarettes at the local convenience store costs more than it would without that tax. These tax rates depend on the state you live in, and there are often local excise taxes, too. In New York, for example, the state excise tax rate is $4.35 for a pack of 20 cigarettes, and the New York City local excise tax is $1.50 for the same amount. That means you’ll pay $5.85 in taxes on top of the retail price, bringing the retail price to about $10 for a pack of cigarettes. Other examples of consumption taxes include VAT taxes, sales taxes, and taxes on imported goods. Note Revenue from consumption taxes makes up less than 20% of total tax revenue in the U.S. In comparison, as of 2020, consumption taxes make up 32.1% of tax revenue in OECD countries. Types of Consumption Taxes Consumption taxes come in several forms, including excise taxes, sales taxes, VAT taxes, and taxes on imported goods. Let’s dive into how they all work. Excise Taxes Excise taxes—also known as “sin taxes”—are taxes levied on specific categories of goods or services. Excise taxes can be imposed on the producer, retailer, or consumer and are often used to discourage behaviors considered detrimental. The tax rates vary depending on the state. Examples of excise taxes include taxes on alcohol, tobacco, coal, and gambling. Sales Taxes Sales taxes are taxes levied on the retail sale of goods or services. Unlike excise taxes, sales taxes are not designed to target vices. In the U.S., retail sales taxes are a significant revenue source for state governments, and many allow local counties, cities, and municipalities to add their own separate taxes to the state rate, too. Some governments exempt necessities such as groceries from sales taxes. Note Some states, but not many, have little to no sales tax. As of 2022, there are just five states with no sales tax at all: Alaska, Delaware, Montana, New Hampshire, and Oregon. VAT Taxes The value-added tax, or the VAT tax, is a very common consumption tax in European countries. The VAT is very similar to the sales tax in that the tax is ultimately levied at the retail level. The tax, however, is determined by calculating the value added at every stage of production of the product. Taxes on Imported Goods Tariffs are taxes levied by one country on goods or services imported from another country. Tariffs are usually paid on raw materials at the producer level or for finished goods at the distributor level. Tariffs differ from import duties, which are consumption taxes paid by retail consumers for imported finished goods. Benefits of Consumption Taxes The U.S. government generates most of its revenue via income taxes, payroll taxes, and corporate income taxes. In other words, most revenue is generated on money earned. This model poses several problems. First, income is very difficult to measure, especially when complex financial calculations such as capital gains and depreciation are taken into account. Consumption taxes, on the other hand, are relatively easy to quantify: Any time an individual spends money, a portion of the expenditure is remitted to the government. The consumption tax can also encourage saving. Under the current income-based model, individuals and households are subject to a tax whether or not they are careful to set aside funds for the future. The consumption tax model reverses this paradigm, as money is only taxed when spent, which can encourage people to spend less and save more. A consumption tax may also be fairer than an income tax. Since income is difficult to measure, it is also easier to hide income and avoid potential taxes therein. Consumption is more difficult to conceal, and since the wealthy generally spend more on goods and services, they are liable to pay more taxes. Criticisms of Consumption Taxes The consumption tax can present several drawbacks, too. For example, many people with very low incomes pay no income tax under the current system because of the current threshold. If a consumption tax were to be implemented, low-income people would suddenly have to pay taxes on every purchase. Since low- and middle-income households spend more of their income than wealthy households, the consumption tax can prove regressive. Research further suggests that even with a switch to a consumption model, savings would not increase significantly. Frequently Asked Questions (FAQs) Which is an example of a consumption tax? The sales tax is a popular example of a consumption tax. Many states and local governments levy a sales tax, which represents a percentage of the purchase amount for various goods and services. What does consumption tax mean? Consumption taxes are taxes that you pay when you purchase goods and services. A consumption tax is designed to tax you when you spend money versus an income tax, which taxes a portion of your wages. Consumption taxes can be targeted to specific products, such as excise taxes, which tax alcohol, tobacco, and gambling. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. New York State Department of Taxation and Finance. "Cigarette and Tobacco Products Tax." Tax Foundation. "Sources of Government Revenue in the OECD." The Tax Foundation. "State and Local Sales Tax Rates, 2022."