Frequently Asked Questions

What is a consumption tax?

A consumption tax is a tax that is imposed on goods, services, and other items sold, exchanged, or consumed. Unlike income taxes, which are imposed on earnings (including savings), consumption taxes are imposed on consuming. Consumption taxes can come in many forms. The most common forms are “indirect” taxes like a retail sales tax or a value added tax.

What is a goods and services tax or value added tax?

A goods and services tax (GST) or value added tax (VAT) is a type of consumption tax that is collected on the amount by which the value of an article has been increased, or the “value added,” at each stage of its production or distribution. Thus, from the perspective of a consumer, a GST or VAT is like a sales tax levied on a good or service. But, from the perspective of a business, it is a tax only on the value added to a product or service by that business.

How are value added consumption taxes levied and collected?

The most common method for implementing a value added tax is called the “credit-invoice” system or method. The Progressive Consumption Tax Act (PCTA) uses this system. Under a credit-invoice system, businesses collect consumption taxes imposed on the goods and services that they sell or distribute on a transaction-by-transaction basis. These businesses can also claim a credit for the consumption tax they previously paid on inputs—the business purchases they used to produce or distribute their own goods and services.  Total credits are netted against total consumption taxes collected and remitted.

A common alternative to the credit-invoice method is a “subtraction method” consumption tax. Typically, the subtraction system uses businesses’ accounting records to calculate value added, and imposes a consumption tax on that amount.


How many other countries have value added consumption taxes?

Approximately 150 countries worldwide have some form of a GST or VAT. Except for the United States, all countries that are members of the Organisation for Economic Cooperation and Development (OECD)—countries with advanced economies similar to that of the United States—have a consumption tax. Nearly all of the OECD countries use a “credit invoice” method value added tax. For countries seeking admittance to the European Union (EU), the adoption of a value added tax is a prerequisite for membership, due partly to the trade benefits that a GST or VAT provides.

Much has been made of the fact that the United States currently has the highest statutory corporate rate of all the OECD countries. However, this analysis does not take into account the fact these countries also impose a GST or VAT. Below is a table that compares current U.S. tax rates, OECD country averages, and rates imposed under the PCTA.

Country

Top marginal individual income tax rate, 2013

Top marginal corporate income tax rate, 2014

General consumption tax rate, 2014

 

 

 

 

United States (current)

39.6%

35%

0%

OECD average (unweighted)

36%

23%

19.2%

United States under PCTA

28%

17%

10%

   

 

Source: Latest data from OECD Tax Database, available at http://www.oecd.org/tax/tax-policy/tax-database.htm. The latest individual income tax data from the OECD Tax Database for all OECD countries is from 2015

What are the typical policy critiques of consumption taxes?

While technical critiques of different consumption taxes vary across systems, value added consumption taxes face two main policy critiques:

Regressivity. Consumption tax systems are often considered to be inherently regressive since low- to middle-income households spend a greater percentage of their income than high-income households do, and so a consumption tax hits them harder. The Progressive Consumption Tax Act counters this directly with significant income tax exemptions, called “family allowances,” and Progressive Consumption Tax (PCT) rebates based on income.

Open Spigot. Consumption taxes are often criticized for allowing governments to raise money too easily and without adequate transparency. For those who have this concern, enacting a consumption tax could mean enacting a new and easy-to-adjust lever to raise taxes irresponsibly. The Progressive Consumption Tax Act addresses this concern with a circuit breaker that returns overages from the PCT to taxpayers when revenues exceed predetermined levels.

How does a consumption tax affect savings?

Income taxes have a discouraging effect on savings because they are levied on all taxable income, including savings. Consumption taxes do not tax earnings, including savings. Instead, consumption taxes focus on spending. If an individual or household spends less, they pay less tax.

Consumption taxes are considered “temporally efficient.” This means that a consumption tax does not affect families’ choices between current and future consumption, since savings are not taxed. Taxing interest, dividends, and capital gains, as under income tax, results in less investment and savings.

How does a consumption tax affect economic growth?

According to both economic theory and recent research on OECD countries’ value added taxes, income taxes are associated with slower long-term economic growth than taxes on consumption.
Recent research on OECD countries’ value added taxes indicate that consumption taxes are associated with greater growth of Gross Domestic Product (GDP) per capita compared to income taxes. In a study that examined 35 years of data on 21 OECD countries, consumption taxes are found to be more growth-friendly than both personal income taxes and corporate income taxes. Corporate income taxes, especially, appear to have the most negative effect on GDP per capita. This evidence suggests that growth-oriented tax reform should move away from income tax revenues and towards consumption tax revenues, as the PCTA does.
In theory, because income taxes levy a tax against savings, taxpayers will choose to do less saving and more current consumption. This arguably results not only in less investment but also less economic growth and lower future living standards, since future consumption is reduced both by the extra current consumption caused by the tax on savings and by the foregone returns that greater savings would have produced.

According to both economic theory and recent research on OECD countries’ value added taxes, income taxes are associated with slower long-term economic growth than taxes on consumption.

Recent research on OECD countries’ value added taxes indicate that consumption taxes are associated with greater growth of Gross Domestic Product (GDP) per capita compared to income taxes. In a study that examined 35 years of data on 21 OECD countries, consumption taxes are found to be more growth-friendly than both personal income taxes and corporate income taxes. Corporate income taxes, especially, appear to have the most negative effect on GDP per capita. This evidence suggests that growth-oriented tax reform should move away from income tax revenues and towards consumption tax revenues, as the PCTA does.

In theory, because income taxes levy a tax against savings, taxpayers will choose to do less saving and more current consumption. This arguably results not only in less investment but also less economic growth and lower future living standards, since future consumption is reduced both by the extra current consumption caused by the tax on savings and by the foregone returns that greater savings would have produced.

Who supports consumption-based tax reform?

While preferences on consumption-based tax reform will vary from proposal to proposal, in general, consumption taxes have been historically favored by many policymakers, economists, and others—ranging from Alexander Hamilton (who wrote in Federalist No. 21 on the advantages of consumption taxes) to Bill Gates (who has spoken in favor of a progressive consumption tax).  In addition, since the original introduction of the PCTA in 2014, many policymakers, including in Congress, have become increasingly interested in moving to a border-adjustable consumption tax base.

Development of the Progressive Consumption Tax Act (PCTA)

Why introduce the PCTA now?

The PCTA was introduced in the 113th Congress to give legislators, policymakers, and all taxpayers an opportunity to see what this type of tax reform would look like. While consumption taxes are already imposed by all other OECD countries, the PCT would be new to the U.S. tax code.

After a period of considering comments from stakeholders and analyzing its revenue impacts, the Progressive Consumption Tax Act was reintroduced, with several refinements, in the 114th Congress. 

Further review and input from stakeholders is needed on the bill.  This input is more important than ever as Congress considers moving forward with tax reform—and may consider moving forward with consumption tax proposals.  If you have a suggestion on the Progressive Consumption Tax Act, or more questions, please email PCT@cardin.senate.gov

Have other consumption tax proposals been introduced or discussed in comprehensive tax reform debates?

No consumption tax proposals have been introduced in recent Congresses. However, consumption taxes have long been considered as an option in the comprehensive tax reform debate. National sales taxes have from time to time been considered in Congress since as far back as 1862; special panels, task forces, and Administration reports have included VAT-related recommendations for the past four decades.

Previously introduced consumption-based tax proposals include the “USA Tax” (providing an unlimited deduction for savings, and replacing the corporate income tax with an 11 percent value added tax), the “FairTax” (a national sales tax first proposed in Congress in 1999) and the “X Tax” (a two-part tax that taxes businesses through a subtraction method VAT and taxes individual wage income progressively). The President’s Advisory Panel on Tax Reform, formed in 2005 under former President George W. Bush, recommended a partial replacement VAT combined with reductions in the individual and corporate income tax rates. The Panel also considered and enumerated the benefits of a progressive consumption tax plan.

Has Congress passed any consumption tax proposals recently?

Other than the PCTA, no consumption tax legislation has been formally introduced in recent Congresses. 

However, consumption taxes have long been considered as an option in the comprehensive tax reform debate. National sales taxes have from time to time been considered in Congress since as far back as 1862; special panels, task forces, and Administration reports have included VAT-related recommendations for the past four decades.

Previously introduced consumption-based tax proposals include the “USA Tax” (providing an unlimited deduction for savings, and replacing the corporate income tax with an 11 percent value added tax), the “FairTax” (a national sales tax first proposed in Congress in 1999) and the “X Tax” (a two-part tax that taxes businesses through a subtraction method VAT and taxes individual wage income progressively). The President’s Advisory Panel on Tax Reform, formed in 2005 under former President George W. Bush, recommended a partial replacement VAT combined with reductions in the individual and corporate income tax rates. The Panel also considered and enumerated the benefits of a progressive consumption tax plan.

In addition, two 2016 proposals from Members of the House Ways and Means Committee are based on consumption tax principles.

In June 2016, House Ways and Means Republicans released a document entitled “A Better Way for Tax Reform.”  This plan, also called the “House GOP Blueprint,” is not formal legislation, but a white paper detailing the challenges presented by tax reform, the opportunities presented by tax reform, and the high-level structure of a plan for individual income tax simplification and a cash-flow based business tax.  While careful to point out that “[t]his Blueprint does not include a value-added tax,” the Blueprint does anticipate that eventual legislative text will include major aspects of a subtraction method VAT, including immediate expensing of certain purchases and border adjustability, and notes that these changes “reflect a consumption-based tax.”

In July 2016, Representative Jim Renacci (R-Ohio) released a white paper on a proposal called the “Simplify America’s Tax System” plan, or SATS.  Rep. Renacci’s plan reforms the individual income tax code and replaces the corporate income tax with a credit-invoice method value added tax. 

Is the PCTA based on of any other country’s consumption tax system?

The PCTA is generally based the modern goods and services taxes (GSTs) employed by Australia, New Zealand, and Canada. While all OECD countries have some kind of VAT, the Australia, New Zealand, and Canada GSTs are considered by commentators to be the most efficient to administer, and the Canadian system provides a model on how a federal VAT can interact with sub-jurisdictions (in Canada’s case, its provinces) that already impose a sales tax.

That being said, there are several aspects of the PCTA that are unique, such as the way the PCT revenues are used to maintain progressivity and lower income taxes, and how progressivity is maintained through the use of rebates as opposed to select exemptions or preferential rates in the current income tax code.

Why does the PCTA use the "credit invoice" method instead of a "subtraction" or "cash-flow" based method of collection? 

The design of the PCTA was carefully considered before it was first introduced in 2014.  A critical component of this decision was the collection method.  As noted above, the two most common design choices in this respect are the “credit invoice” method and the “subtraction” method.  The credit invoice method has been the preferred method of countries that impose consumption taxes and have economies similar to the U.S.  The PCTA uses the credit invoice method for many reasons; several major reasons are outlined below.

First, the credit invoice method makes the PCT transparent and more easily enforceable.  Under the PCT, there is required reporting of PCT liability on invoices that are generated by each business in a good or service’s supply chain.  All participants in a supply chain need to undertake this reporting in order for those participants to receive offsetting credits.  Hence, there is an incentive for businesses to report correctly to each other and to consumers in order to make sure they don’t overpay the government.  Under a subtraction method system, entities reports a single, aggregated tax liability, without itemization by transaction.  The tax is assumed to be passed onto consumers, but consumers don’t get to view a separate statement of the tax embedded in their purchases.

Second, the credit invoice method makes the PCT a more stable, reliable source of reasonable revenue because it is transaction-based and ultimately imposed on individual consumers, not businesses.  Therefore, it is typically considered less apt to draw political pressure for preferential tax treatment by businesses, industries, and sectors providing certain goods or services.  In addition, because the tax has to be stated on invoices (like state and local sales taxes) to consumers, the effect of any proposals to raise the PCT would be highly visible to taxpayers.

Third, using the credit-invoice method means the PCT is compliant with existing WTO rules.  While there are arguments that a subtraction method VAT is economically equivalent to a credit invoice method and thus should also be considered WTO compliant, no such scenario has ever been evaluated in the WTO.  A subtraction method VAT, or a variation of a subtraction method VAT, may result in litigation in the WTO and create considerable uncertainty for businesses subject to that tax system.

 

Finally, paying taxes on a transactional basis under the credit invoice method means the PCT can become more and more automated as technology improves.  As we move away from a cash economy, for instance, payment at the cash register (or Internet website) could be translated to immediate remittance of tax to the government, greatly lowering the tax gap.  The same can’t be said for subtraction method consumption taxes, which are not collected on a transaction-by-transaction basis.

What changes have been made to the PCTA since it was first introduced in 2014?

The updated PCTA contains several refinements to how financial products and services are taxed.  These refinements are based on the input we received thus far from stakeholders and conversations with practitioners familiar with modern goods and services taxation systems.  Further details on these changes can be found on our Financial Products and Services Fact Sheet and Additional Input document.

 

In addition, the updated PCTA contains an exemption for small businesses with annual receipts under $100,000.  This exemption level is based on levels in countries with developed economies similar to the U.S.  Further feedback from the small business community on establishing a specific exemption and its level is welcome.

What are the revenue impacts of the PCTA?

The full budgetary and distributional impact of the PCTA have not been evaluated by the Joint Committee on Taxation. While the rates in the PCTA have been based on a comparison of U.S. tax liabilities to OECD countries with value added taxes, and a similar plan estimated by the Tax Policy Center, depending on the feedback we receive and other changes to the PCTA, these rates and their structure may change.

However, since its release in 2014, the PCTA’s static and dynamic revenue effects have been analyzed by the Tax Foundation.  That analysis can be found here.  According to the Tax Foundation’s Taxes and Growth model, the PCTA would be pro-growth and progressive on both a static and dynamic basis; however, a 14.2 percent PCT rate, rather than a 10 percent rate, would be needed to achieve revenue neutrality on a static basis. 

 

What issues still need to be addressed?

As reintroduced in the 114th Congress, the updated Progressive Consumption Tax Act is meant to provide an opening for further discussion and a continued opportunity to review legislative language for this type of comprehensive tax reform. Overall, the Act shows how a PCT can make our tax code fair and more effective. However, there are open issues that the Act does not address in its current form.  More details on open issues can be found in our Additional Input document.

How can I submit a comment?

If you have a suggestion on the Progressive Consumption Tax Act, or more questions, please email PCT@cardin.senate.gov.   

 

Details on the Progressive Consumption Tax (PCT)

What is the PCT rate set in the PCTA?

As introduced, the PCTA sets the PCT rate at 10 percent.

It is important to keep in mind that the full budgetary and distributional impact of the PCTA has not been evaluated by the Joint Committee on Taxation. Since the U.S. is a low-tax country compared to other advanced-economy countries, the PCT will likely be set at a rate below the current OECD average of approximately 19 percent. A score by the Tax Policy Center of a similar plan by Professor Michael Graetz resulted in a revenue-neutral rate of 12.9 percent, and a report by the Tax Foundation shows that the PCTA is pro-growth and progressive on a static and dynamic basis, but that revenue neutrality on a static basis will require a PCT rate of approximately 14 percent. Depending on the Joint Committee on Taxation analysis, the feedback we receive, and any further changes to the PCTA, the rates and their structure under the current bill may change. 

What transactions are subject to the PCT?

The PCT is a very broad-based consumption tax. Thus, almost all goods, services, and other items, unless exempt or zero-rated under the Act, will be subject to the PCT.

Specifically, goods, services, and other items (called “supplies”) are taxable if: (1) the supply is made for consideration; (2) the supply is made in the course of carrying on a trade or business or other type of commercial activity; and (3) the supply is made in connection with the United States.

Other types of commercial activities subject to the PCT include the commercial activities of nonprofits and governments, which will also be required to comply with the provisions of the PCT.

What transactions are not subject to the PCT?

As introduced, there are three types of transactions under the PCT. Taxable transactions include almost all goods, services, and other items. However, there are two additional, narrow classes of supplies that are subject to special rules.

(1) PCT is not levied on “exempt” supplies. There are only four types of exempt supplies: the provision of financial supplies, residential housing, residential rent, and de minimis supplies. Financial products and services are subject to special considerations.  In addition, certain small businesses are exempt from the PCT regime.

(2) PCT is payable at a rate of 0 percent on “zero-rated” supplies. The only zero-rated supplies are exports or use of goods, services, and other items (such as rights) outside of the United States.

What is the difference between “exempt” and “zero-rated” transactions?

If a supply is exempt, no PCT is levied on that supply. However, no input tax credits related to that supply may be claimed by the business providing the exempt good or service.

If a supply is zero-rated, a business may still claim input tax credits for the business inputs used to make the zero-rated supply.

How is the PCT collected on transactions subject to the PCT?

The PCT is a credit invoice consumption tax. Under the credit invoice method, businesses collect PCT on taxable goods and services that they provide to either another business or consumer on a transaction-by-transaction basis. These business are then allowed to reduce the amount of PCT they are liable to remit by a credit equal to the amount of PCT they have previously paid to other businesses in purchasing inputs (such as intermediate goods, services, and equipment).

Are there any other special rules that apply to exempt financial products?

A very narrow class of financial products is exempt from the PCT. This narrow class is drawn from the experiences of existing consumption tax systems like those in Australia and New Zealand. Exempt financial products and services include the provision of a bank account, a debit or credit arrangement, a mortgage, a superannuation fund, an annuity, insurance, a financial guarantee, an indemnity, currency, securities, or derivatives. Any products or services related to but separate from the provision of these products—e.g., checks provided along with a bank account—must be separately stated and the PCT must be charged for those products or services.

The latest version of the PCTA contains several refinements related to financial products and services.  These changes are based on the experiences of practitioners from other countries with modern goods and services taxes, as well as suggestions from U.S. stakeholders.

In particular, the updated PCTA contains changes similar to the “reduced input tax credit” and “financial acquisitions threshold” regime in Australia’s GST system.  More details on this system and areas for further consideration can be found in our Financial Products and Services Fact Sheet and Additional Input Document.

Who pays the PCT?

The PCT is a consumption tax, and so is ultimately paid by the consumer. However, sellers are required to collect and remit the tax on goods and services they provide. Sellers include not only businesses, but also nonprofits and governments to the extent they engage in taxable transactions.

In certain cases, special collection rules provide that the purchaser, rather than the seller, remit the tax. These special rules apply to imports of goods generally, and imports of services and other items to businesses. The PCT for imported goods is intended to be collected at the border, much like a customs duty. Thus, the importer is liable for the tax. In addition, “reverse charge” rules apply to certain services and other items performed or done outside of the United States, but used within the United States in a trade or business. In these cases, the purchasing business must remit the tax.

How would a typical consumer see or pay the PCT?

To a typical consumer, the PCT would be paid just like a sales tax and would replace their income tax liability.  Low- and middle-income consumers would receive additional rebates to further offset the burden of the PCT.  For a purchase, a retailer would charge the consumer PCT at the register (or website).  PCT would be stated on the receipt the consumer receives.

Do private consumers need to keep track of PCT charged on their purchases?

No, in general, private consumers—end-users of goods and services—do not need to keep track of PCT charged on their purchases. Under the PCTA, PCT is typically collected and remitted by sellers. Private consumers also do not need to keep track of their PCT liability in order to claim the rebate, which is based on earned income or adjusted gross income.

Is there an exemption for small businesses?

Yes.  The updated version of the PCTA exempts small businesses with under $100,000 in annual receipts from collecting the tax.  Exempt businesses may nonetheless collect the PCT if they prefer.  This exemption level is based on levels in countries with developed economies similar to the U.S.  Further feedback from the small business community on establishing a specific exemption and its level is welcome.

How is the PCT progressive?

The PCTA has two measures that counteract the regressivity inherent in consumption taxes. The first is the large income tax exemption, called a “family allowance,” of $100,000 for joint filers, $50,000 for single filers, and $75,000 for head of household filers.

The second is a PCT rebate designed to counteract the new consumption tax burden and make up for the loss of the Earned Income Tax Credit (EITC), the Child Tax Credit (CTC), and the Additional Child Tax Credit (ACTC). Since the goal is to make the new tax system that includes the PCT as progressive as the current system, these programs aimed at low- and moderate-income families need to be replaced. Therefore, the PCT includes a rebate that replaces each of these components. Individuals and families that do not have an income tax liability would still be able to receive rebates.

More details on the calculation and administration of the rebate are contained in our Progressivity Fact Sheet.

Details on income tax reforms

What are the new income tax exemptions and rates?

The PCTA provides a significant individual income tax exemption, called a “family allowance,” of $100,000 for joint filers, $50,000 for single filers, and $75,000 for head of household filers. The personal exemption for 2017 is $4,050 and the standard deduction is $12,700 for joint filers, $6,350 for single filers, and $9,350 for head of household filers.

For those who still have an individual income tax liability, there will be three marginal brackets, set at 15, 25, and 28 percent, with the following thresholds:

Taxable Income

Marginal Rate

Over

But Not Over

 

Single

$0

$50,000

15%

$50,000

$250,000

25%

$250,000

 

28%

Married Filing Jointly

$0

$100,000

15%

$100,000

$500,000

25%

$500,000

 

28%

Head of Household

$0

$50,000

15%

$50,000

$250,000

25%

$250,000

 

28%

Under current law, there are seven marginal brackets, with a top marginal rate of 39.6 percent that in 2017 applies to taxable income over $418,400 for single filers, $470,700 for joint filers, and $444,500 for head of household filers.

In this version of the PCTA, the corporate income tax rate is lowered to 17 percent. The top statutory corporate tax rate in the U.S. is currently 35 percent.

How else does the individual income tax change?

The PCTA simplifies the individual income tax. Because an income tax liability is eliminated for most households, many individual income tax preferences are streamlined or removed.

Four major tax benefits are retained: (1) the charitable deduction; (2) the state and local tax deduction; (3) health and retirement benefits; and (4) the mortgage interest deduction.

Individual income tax deductions for alimony payments, investment interest, and gambling losses are also retained because alimony received, investment income, and gambling winnings are included in income under current law. Including these deductions is necessary to prevent the duplicative taxation of alimony payments and to properly measure the net income from gambling and investment.

The foreign tax credit is retained for income taxes paid to a foreign government on income earned outside the U.S. Finally, the individual alternative minimum tax (AMT) would be repealed.

How else does the corporate income tax change?

Aside from the tentative rate change mentioned above, the corporate AMT is repealed in its entirety.

What happens to credits like the EITC?

Because the significant family allowances provided by the PCTA eliminate an income tax liability for most households, the benefits currently provided through refundable income tax credits like the EITC are instead provided through the rebate. For more information on the rebate, please see our Progressivity Fact Sheet.

How does the PCTA interact with other tax reform proposals?

The PCTA makes many changes to the individual income tax. However, as introduced, the PCTA is not meant to foreclose consideration of other corporate income tax reform proposals. Instead, it is intended to add another important proposal to the tax reform debate.

However, comments on the PCTA that will receive the most consideration will be those on the reforms specifically proposed by the PCTA. We do not anticipate making large changes to, for example, corporate international taxation within the current PCTA framework itself.

Details on the Revenue “Circuit Breaker”

Why include a revenue “circuit breaker”?

A major criticism of consumption taxes is based on the concern that the government will become “addicted” to consumption tax revenue. For those who have this concern, enacting a consumption tax means enacting a new and easy-to-adjust lever to raise taxes irresponsibly and without much transparency.

One goal of PCT-based reform is to more reliably raise the revenues that we need to for real investments that benefit all taxpayers—such as investments in defense, health, education, and infrastructure programs. However, the PCT is not meant to be a means to quickly raise revenues while disregarding the effects of higher consumption taxes on U.S. families and employers. Thus, the PCT includes the revenue “circuit breaker” mechanism to address these concerns and to benefit taxpayers.

How does the revenue “circuit breaker” work?

The revenue “circuit breaker” puts cash back into taxpayers’ pockets if PCT revenue in a given year exceeds a certain threshold.

Specifically, under this version of the PCTA, if PCT revenues as a percentage of GDP exceed 10 percent over the calendar year, then any excess revenue will be returned to all individual income tax filers, including those taxpayers who have filed for a PCT rebate. As introduced in the 114th Congress, the Progressive Consumption Tax Act returns a flat rebate to single and head of household filers, doubles that rebate for joint filers, and includes additional rebate money for filers with dependents.

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