Advantages And Disadvantages Of Tax And Consumption Tax

Introduction

Weather to tax income or consumption is one of the most debatable topics amongst economist and policy makers. Both the types have their own share of advantage and disadvantage. This paper has taken the arguments of those favoring the consumption tax and tried to evaluate it by comparing it with existing tax system that is income based taxation. Consumption tax is directly associated with consumption which means increasing rate of consumption tax will discourage savings and decreasing rate will encourage savings. Increased rate of Consumption will contribute to government tax revenue. When level of consumption decreased than it will contribute to increase in level of savings and investment. Both the above mentioned cases will

Working contributes to monetary income while leisure consist of doing unpaid work that doing work for self consumption or getting unrecorded monetary benefit. In case of Income Tax, workers are de-motivated to use their time on work and increase their leisure time. This makes companies less efficient and makes employees to shift towards unaccounted work.

In consumption based tax employees need not to pay tax on their income. Rather they have to pay tax on their consumption. So this will motivate employees to work more and more and spend less on leisure time. Thus productivity of the company will increase. Thus consumption tax has a positive effect on incentive to work.

This holds true when the rate of Income tax rates are higher, but when the rates are nominal than there won’t be much difference in incentive to work weather its income or consumption tax. Another disadvantage of consumption tax can be that people may take goods unaccounted. Which means if a person takes unaccounted goods than he need not to pay tax on it and company also saves some amount of tax if they sell goods unaccounted as they also need not to pay tax on raw materials. Thus tax evasion can also be evident here and unaccounted work will increase which finally result into decreased incentive to work.

EFFECTS ON THE INCENTIVE TO

This can be explained by an example. A is a person with annual income of 5 lakhs and B is a person with annual income of 50 lakhs. Out of annual income A is able to save 50,000 annually while B is able to 20 lakh annually. If rate of tax is flat and non progressive at the rate 10% on consumption than A will pay 45000 as tax while B will pay 300000 as tax. In absolute number it seems that B is paying more tax as his consumption is more. But if we compare it with savings than A is paying tax almost equivalent to savings while B is paying tax which is 1/7th time of savings. Now this is where disparity comes in picture. If we go in more details it may be possible that A’s all expense was on necessity while B would have spend a proportion on