Consumption tax: Definition and common types

Governments can use different types of taxes to collect revenue. And the two most common are income taxes and consumption taxes. While income taxes are levied on the money you earn—either by applying an income tax to wages and salaries or a capital gains tax to earnings from investments—consumption taxes are levied on the things you buy.

Consumption taxes aren’t new or novel. Local and state sales taxes are consumption taxes that you might regularly pay if you live in a state that has sales tax. But there are also other types of consumption taxes, including some types of taxes that don’t exist in the U.S. or that you might pay without realizing it.

Read on to learn about the types of consumption taxes and how they work.

Key takeaways

• Consumption taxes apply when you purchase products or services rather than when you earn income. 
• Common consumption taxes include sales tax, use tax and excise tax. Outside the U.S., value-added taxes (VATs) are also common.
• Governments often only add consumption taxes to certain types of expenses. You may be able to find exemptions or get refunds.

Consumption taxes are taxes that you have to pay based on what you buy. The taxes might be added to your purchase amount—which is the case with sales tax—or they may be included in the sticker price you see.

Consumption tax vs. income tax

Governments can collect tax revenue by levying consumption and income taxes. And one of the main differences between the two comes down to timing: Income taxes apply when you earn money, and consumption taxes apply when you spend money.

With either type of tax, there may also be different tax rates or exemptions depending on the type of income or purchase.

Although all consumption taxes apply to the purchase of goods or services, each type of consumption tax works a little differently. In general, you’ll pay the tax when you make your purchase, and the merchant will be responsible for collecting and forwarding the taxes to the proper government agencies. However, you sometimes have to determine your tax rate and make the payment on your own.

Common types of consumption taxes include sales tax, use tax, excise tax and value-added tax.

Sales tax

Sales taxes are a flat-rate tax—a set percentage of the purchase amount—that many people in the U.S. are already familiar with and pay.

Local and state governments often impose sales taxes on certain purchases, and you’ll pay the combined amount on every eligible purchase when you buy something in that area. If you’re shopping online, the merchant might collect sales tax if it has a physical presence in your state.

Use tax

Use taxes are generally state taxes that apply to the purchase, use or storage of products and services that are subject to sales tax but that you didn’t pay sales tax on.

For example, if you buy an item online and the merchant doesn’t collect sales tax, you may be required to report the purchase and forward the correct amount of use tax to your state. Similarly, use taxes may apply if you made a purchase while visiting a different state and paid a lower sales tax or no sales tax.

Excise tax

“An excise tax,” as the Congressional Budget Office (CBO) explains, “is generally levied on a smaller set of goods and services and is usually assessed on each unit purchased rather than on the value of the purchase.”

Excise taxes are commonly levied on air travel, gasoline, alcohol and tobacco products.

Value-added tax (VAT)

While the U.S. doesn’t have a value-added tax (VAT), over 160 other countries do. So what is a VAT, anyway?

“A VAT is a type of consumption tax levied on the incremental increase in the value of a good or service that occurs at each stage of the supply chain until the final point of sale,” says the CBO.

VATs can be set up in different ways, but you can think of a VAT as similar to a nationwide sales tax that applies to certain purchases. Rates can vary significantly, with some countries charging less than 5% and others over 25%.

You might have to pay the VAT on qualifying purchases if you’re traveling to a country that has this tax. But tell the seller you’re traveling back to the U.S. and hold onto your receipts, as you might be able to get the VAT you paid refunded—either from the merchant, at a refund booth at the airport, or by sending the required documents to the seller or proper government agency.

Whether there are consumption tax exemptions depends on the type of consumption tax and who levies the tax. But there often are exemptions.

For example, some states don’t have any sales taxes. And others exempt certain purchases—typically necessities like food and clothing—from sales tax.

Similarly, you might not have to pay use taxes on purchases that are exempt from sales tax. And countries that have a VAT might have lower rates or exemptions for necessities or purchases they want to encourage, such as food, transportation and books.

Consumption taxes are a way for governments to tax money that you spend.

In the U.S., the federal government primarily generates revenue with an income tax. But it also applies consumption taxes—in the form of excise taxes—to certain purchases. Many states also have an income tax and levy sales, use and excise taxes too.

Although the taxes can add up, there are often exemptions for necessary purchases