It is worthwhile to briefly consider tax types that are not currently important in the U.S. because these mechanisms are used in other countries or are central in various proposals to reform the U.S. tax system. We summarize five tax types here:
- National sales tax. This would function similar to a state sales tax – as an addition to the retail price of certain products. A national sales tax would clearly be simpler and cheaper to administer than the current federal income tax. It would also encourage savings because, under most proposals, income that is not spent on taxable goods and services is not taxed. There are, however, two significant disadvantages to a national sales tax. First, it would create an incentive for black market exchanges to evade the tax. Second, it can be highly regressive – similar to the regressivity of state sales taxes. A national sales tax could be made less regressive, or even progressive, by providing rebates for low-income households. Eligible households could complete a form at the end of the year to determine their rebate amount.
- National consumption tax. This is slightly different from a national sales tax. A household would pay the tax at the end of the year based on the value of its annual consumption of goods and services. Rather than having a household keep track of everything purchased, consumption can be calculated as total income less money not spent on goods and services (i.e., invested or saved). Again, a consumption tax would promote savings by exempting it from taxation. A consumption tax could also be designed to be progressive by taxing different levels of consumption at different marginal rates.
- Value added tax. Most developed countries levy some form of value added tax (VAT). A VAT is levied at each stage in the production process of a product, collected from manufacturers according to the value added at each stage. Thus, the tax is not added to the retail price but incorporated into the price of the product, similar to the way excise taxes become embedded into the price of products. Compared to a national sales tax, a VAT reduces the likelihood of black markets.
- Wealth taxes. While the U.S. tax system includes local property taxes and, at least for a while, estate taxes, there is no tax on holdings of other assets such as corporate stocks, bonds, and personal property. Several European countries, including Sweden, Spain, and Switzerland, have instituted an annual wealth tax. A wealth tax could be very progressive by setting high rates and becoming effective only at significant wealth levels.
- Environmental taxes. These are levied on goods and services in proportion to their environmental impact. One example is a carbon tax, which taxes products based on the emissions of carbon attributable to their production or consumption. The rationale of environmental taxation is that it encourages the use and development of goods and services with reduced environmental impacts. Like other taxes on goods and services, environmental taxes can be regressive – suggesting that environmental taxes need to be combined with other progressive taxes or rebates for low-income households. Among developed countries, the U.S. collects the smallest share of tax revenues from environmental taxes.
- Global Development And Environment Institute, Tufts University