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Different ways exist to tax consumption

WASHINGTON—The current federal tax system taxes income. It also taxes labor as a percentage of wages or salaries. And it taxes capital, including interest earned, dividends and capital gains.

Federal Reserve Board Chairman Alan Greenspan endorsed the idea Thursday of taxing consumption. Here's what that means:

There are several ways to tax consumption. Some advocate a national sales tax on goods and services. They argue that is fair because it treats all transactions the same across the board and the more you consume, the more tax you pay. But critics say relatively poor people have no choice but to consume all their income, while rich people can channel income into nontaxed savings and investments, which critics say isn't fair.

Another form of consumption tax is a Value-Added Tax (VAT), such as those used widely in Europe. A VAT would tax production and distribution. A tax would be levied at each stage of production, from raw material extraction to manufacture to sale to business outlets. It's a tax paid by business, not consumers, but business would pass it along to consumers in the final price of a product.

Critics of the current income tax say it penalizes savings, which is bad because savings finance the investment that produces economic expansion.

VAT critics say governments are tempted to ratchet VATs up because they're less visible to the public. Some European nations have VATs as high as 25 percent in addition to income taxes.

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(c) 2005, Knight Ridder/Tribune Information Services.

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