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What are the Advantages and Disadvantages of a Tax on Earnings?

Tricia Christensen

Last Modified Date: February 21, 2024

A tax on earnings is a tax on income whether it be salary, inheritance, or profits from investments. This is often contrasted with a consumption tax, where taxes are imposed on those goods and services that are consumed. Some argue that consumption tax is more logical, since it is argued that people who earn more would reasonably spend more, making the tax structure more equitable. Others argue that there's no guarantee of this, however, and that a consumption tax would cause consumer prices to rise significantly.

The advantages of imposing a tax on earnings can include the following:

People are taxed based on total income, so people who make less theoretically pay less.
Not all people consume at the same rate, therefore tax on earnings is a more equitable way of assessing tax than with a consumption tax.
People with lower incomes would be the most affected by a straight tax on consumption, since even necessary items like cars would be significantly more expensive.
Income is an easier way to levy taxes and decide deductions. While people may deal with a few pay stubs they have to save, in consumption tax, people might have to save receipts for every purchase they made during a year in order to qualify for tax breaks.

This type of tax also has some disadvantages:

Tax collection is generally thought to more difficult than a consumption tax, which would be levied at the point of sale.
For the those in the middle class and lower classes, an earnings tax may be a financial hardship, regardless of the amount.
Some believe that income tax is a violation of a citizen's individual freedom. They argue that it violates the individual’s right to decide how to use the money he earns.
People paid “under the table” may be able to evade paying any income taxes.

A W-2 wage and tax statement states how much an employee was paid and how much in taxes was withheld.

Both methods of taxation are in use in the United States. Most states and many cities impose a consumption or sales taxes on certain items. Many also require people to pay state income tax, as does the federal government. This leads to the claim that US citizens are disproportionately taxed according to where they live, be it state to state, county to county, or rural versus urban areas. Those who claim that this is a disadvantage of the current system believe that it would be best to have one system in place that assesses taxation more equitably.

Theoretically, people who make less also pay less when earnings are taxed, rather than consumption.

An idea that has been garnering increasing support is called FairTax. This would be similar to consumption tax, and some feel it would not only benefit individuals but also corporations. In this plan, people would pay a 23% tax on purchases of most goods and services, often excluding food. When added to state sales taxes, this would, increase taxes on purchases to about 30% in most cases. Some proponents argue that this method would lower prices and make production less expensive. Others say that the middle class would bear the burden of the majority of taxes under FairTax.

The method of taxation is a complex one that requires extraordinary scrutiny. Any change to the method of taxation in the US would require Congressional approval and possibly constitutional amendments.

Tricia has a Literature degree from Sonoma State University and has been a frequent SmartCapitalMind contributor for many years. She is especially passionate about reading and writing, although her other interests include medicine, art, film, history, politics, ethics, and religion. Tricia lives in Northern California and is currently working on her first novel.

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Discussion Comments

icecream17

January 4, 2011

Cupcake15-I agree that a consumption tax like a national sales tax would be fair. I also like the idea of the flat tax which would make all Americans pay the same percentage of tax.

This would eliminate the tax on social security earnings as well as the federal tax table. There would be no need for income tax estimator because there would be no IRS and everyone would know exactly what they would owe in taxes.

I prefer a consumption tax vs., and income tax, but I doubt that congress will make any changes to the tax code anytime soon.

cupcake15

January 2, 2011

Income tax on earnings offers the federal government a more guaranteed tax base. Since most people work and have a job this would be the most consistent way for the government to receive tax revenue.

In addition, they can also tax income on overseas earnings. The federal government would be able to place an income tax on Social Security earnings as well.

The disadvantage is that not all people will file income taxes properly which creates a shortfall in tax revenue estimates.

A consumption tax is actually more equitable because all people would be paying taxes. Currently 50% of Americans pay no income taxes. A consumption tax would cause this 50% to contribute to the tax base and ease the burden on the top 10% who pay 96% of all income taxes.

The consumption tax would also allow tourists to contribute to the tax revenue which should add even more tax revenue for the government. The consumption tax is a good idea if they eliminate the federal income tax which seems unlikely.