Economy & Jobs

Consumption Tax vs. Income Tax: Why More States Are Opting to Collect Consumption Taxes Only

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States obviously need money to fund the various strongholds that keep society in good working order, such as public safety, education, infrastructure, and transportation. To do so, individual states charge an income tax, consumption taxes (such as sales and use tax), or a combination of both.

The average revenue collected by states from consumption tax vs. income tax is currently 30 percent and 41 percent, respectively. However, these percentages could change drastically as state collection trends begin to surface. In times of economic hardship, many states are looking to raise revenue solely through consumption-based taxes. States such as Georgia, Kansas, Louisiana, Missouri, and Nebraska are considering reducing or eliminating income taxes altogether, stating that the consumption of many products, such as alcohol, remains the same during economic downturns. This gives states more consistent revenue to work with despite economic volatility.

Background on State Revenue Collection

Property and corporate taxes aside, your state can collect revenue through one, or both, of the following:

  • Income tax: Raising funds by taxing your pay and your capital (any interest earned from savings or dividends/capital gains earned from stocks).
  • Consumption tax: Collecting taxes when you consume something (typically at the point of transaction). Your receipt shows the amount of consumption taxes collected

There are seven states that do not collect income taxes at all: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. Additionally, Tennessee and New Hampshire do not have income taxes, though they do tax on interest and dividends. There are also five states that collect no statewide sales tax: Alaska, Delaware, Montana, New Hampshire, and Oregon. (Note that Alaska and Montana localities institute their own sales tax.)

If you live in any other state than those specifically mentioned above, then you are charged both income and consumption taxes.

Your Changing State

The recent trend is moving towards a consumption tax alone, abandoning state income taxes. If your state is considering this method, there are some changes you can anticipate.

  • Increase in taxable items: By removing income taxes, your state will need to fill in the revenue gap. It’s likely that the sales tax rate, and/or the sales tax base (e.g. the items they collect taxes on), will increase.
  • Frugal shoppers rejoice: Some states may opt to not tax basic necessities, like food or medicine, in an attempt to decrease the tax burden on those struggling to get by. So if you are a frugal shopper who only buys the basics, you’ll pay less taxes than you used to.
  • April is no longer daunting: Come tax season, you won’t have any surprises with this pay-as-you-go system. All taxes owed are paid during your transactions.
  • More in your paycheck: Abolishing your state’s income tax is equivalent to receiving a small pay bump each paycheck.
  • Changes in buying behavior: Since you are taxed on consumption, you may think twice before making a purchase. With a healthier savings account, you may even give bartering a try through sites like Craigslist. When bartering, however, beware of possible tax consequences.

In the consumption tax vs. income tax debate, more states are opting to tax on sales. The potential financial gains for residents are exciting. Just remember that taxes based on spending put you in control — for better or worse — so make sure any new financial gains aren’t offset by impulsive purchases.

Amanda L. Grossman is the creator and owner of FrugalConfessions.com -- live a VIP life on an average paycheck -- where she shows hard-working people how to end anemic savings account syndrome and pay off debt years earlier than your creditors want you to without getting a second job or eating ramen noodle dinners. Amanda's area of expertise is in personal finance, and she has authored several personal finance articles for the Houston Chronicle, is a featured blogger at the Houston Chronicle, and has staff written for ReadyforZero.com Blog and RelayRides.com Blog (several of which have been syndicated to LifeHacker, Business Insider, and Yahoo Finance). She has a knack for taking seemingly complex, and irrelevant financial topics and making them accessible and meaningful to the average person. She, her husband, and their two cats (Lyla Bear and Danny Boy) live in a fixer-upper in Houston TX.