The Treatment of Financial Services Under a Broad-Based Consumption Tax
Posted: 7 Mar 2001
This paper examines the appropriate taxation of financial services under a broad-based consumption tax. It is assured that the underlying objective of the consumption tax is to maintain undistorted prices between current and future consumption (i.e., to impose no distortion on savings decisions), and, in a model with uncertainty, between consumption in different states of the world. It is argued that, in order to achieve such neutrality, proportional financial service charges, like interest rate spreads and insurance premium loadings, should be untaxed. On the other hand, identifiable fixed fees should be taxed. This is because, under the assumption that the size of the spread used to finance financial services is fixed, the price of such services automatically increases with the introduction of the consumption tax. Levying the tax on them explicitly would then increase their relative price, and impose an unwanted distortion.
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