Cascade Tax - Explained
What is a Cascade Tax?
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Table of ContentsWhat is a Cascade Tax?How Does a Cascade Tax Work?About Cascading Tax EffectAnalyzing the Cascade EffectThe United States Sales Tax System and the Sales Tax Cascading EffectAcademic Research on Cascade Tax
What is a Cascade Tax?
A cascade tax refers to a fee that the government levies on certain goods at every stage of production (from production to consumer consumption). It is a turnover tax where there is progressive taxation that is inclusive of all the charges of the earlier turnovers, in which the amount of end tax will be higher compared to the one indicated cascade tax rate.
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How Does a Cascade Tax Work?
Generally, the cascade tax system is capable of creating high tax revenues when you compare it to a one singe tax because the tax is charged on top of another tax. For instance, lets assume that a government charges a 2 percent cascade tax on all the goods and services that Company XYZ produces and distributes. The XYZ Company sells a piece of stone worth $1,000 for tax-exclusive price of $1,020 ($1,000 + 2% cascade tax) to the buyer. An artist then designs a sculpture from the piece of stone and plans to make a profit of $2,000 when he finally sells it to a sculpture dealer. It means that he will have to add the $2,000 figure on the amount he used to buy the stone to arrive at $3,020. He will then add the total to the cascade tax, which will bring the amount to $3,080 ($3,020 + 2% tax). After purchasing the sculpture from the artist, the art dealer wants to make $5,000 from the sculpture. So, when you add this to the $3,080 for a pre-tax and adds the 2% cascade tax, the total price will be $8,242. In total, the government would have collected a tax worth $242 ($20 + $60 + $162), which in this case, is an effective tax rate of 3.025% ($242/$8,000).
About Cascading Tax Effect
Cascading tax effect, also known as the tax on tax, is an effect that occurs when there is the taxation of a good on every stage of the production process. There is tax imposition on a product until that point when it reaches the consumer. In other words, there is progressive taxation on each succeeding transfer, inclusive of transfer preceding tax charges. When it comes to cascading tax, it is the final consumer who carries the tax burden. Remember that there are tax charges at every stage of production, which leads to multiple taxations. The result of all these is inflation of prices on a commodity that a consumer ends up paying in the process of purchasing the product. However, such taxes appear not right because they create an incentive that is artificial for vertical integration. For this reason, the value-added tax has replaced the cascade tax in countries such as:
- European Union countries
Countries that apply value-added tax have a single unified VAT system, where it functions across the country. What such countries do is to merge central taxes such as excise duty, service tax, and excise tax. Also charged is the state-level taxes such as entry tax, entertainment tax, luxury, and transfer tax. The collection tax under such categories is done as a single tax. So, any time the goods move from one production stage to the other, the vendor deducts the tax he or she has collected and forwards it to the governments taxing body. It does not matter how many times the product will change hands. What is essential is that the person who consumes the product will only pay a single full tax rate and not multiple taxes. It is also important to note that countries that use cascade tax struggle to remain competitive in the market, especially in the international ones. The reason is that this type of taxation forces them to inflate the prices of their products. When this happens, the availability of cheap labor becomes difficult, and this includes other factors of production. All these forces the market price to go above international rates.
Analyzing the Cascade Effect
Since a cascade effect is inevitable, it can sometimes be difficult to foresee a chain of events that affect the system. Where there is a possibility that a cascade effect will impact the system negatively, then it can be easy to analyze the impact with impact or consequence analysis. Those who do cascade effect analysis use visualized tree structures, also known as event trees.
The United States Sales Tax System and the Sales Tax Cascading Effect
Sales tax refers to the tax charged to the final product or services sale. Remember, sales tax is not like VAT, where the government charges a flat-rate fee to every invoice across the board. Its burden differs from one product to the other and from state to state. Sales tax happens to be a more transparent way of collecting tax revenue in the United States. The United States relies on three major elements when it comes to sales tax. They include:
- Nexus: This refers to states you are likely to pay tax charges in, which makes you have an association with it.
- Services or items in your list: This is where there is diverse taxation payable to various things.
- Charge exclusion: This is where you are excluded from paying certain tax charges, although it varies from one state to the other.
The state of California has a state-level sales tax rate of 7.25%, which, according to the United States sales tax system, it is the highest rate so far. However, it is essential to note that in the United States, they don't use the VAT taxation system. This means they have a cascading effect as a result of sales taxation. Since tax levying is done on top of the other, the government can collect more revenue.
Academic Research on Cascade Tax