Excise Taxes on Individual Commodities or Services

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Background

Excise taxes are selective sales taxes on individual commodities, services, or transactions such as motor fuel, cigarettes, or home sales. Excise taxes on motor fuel, alcoholic beverages, and tobacco yielded 8 percent of state and local governments’ own revenue (excluding federal aid) in 2013 and 3 percent of federal revenue in fiscal year 2015. Localities also impose excise taxes. In 2016, referendums in several of them approved “soda” tax.

Excise taxes serve a useful social purpose by discouraging the consumption of commodities that are potentially harmful to health or the environment such as tobacco or gasoline. For this reason they are sometimes referred to as “sin taxes.” The public tends to object less to these taxes than to others, in part because of the nature of the taxed commodities and because people pay tax only if they choose to purchase the affected goods or services. These factors often make excise taxes a politically convenient tool for raising revenues.

For example, cigarette taxes help finance expanded health insurance coverage for children. To this end the Children’s Health Insurance Program Reauthorization Act of 2009 increased the federal cigarette tax from 39 cents to just over $1 per pack. The money helps offset the social costs imposed by tobacco, estimated at about $89 billion in public and private health care expenditures. The tax increase not only raises additional revenue, but may also significantly reduce the number of smokers. In recent years lawmakers have proposed increasing alcohol taxes, as excess alcohol consumption may also contribute to rising health care costs.

In response to budget problems in the aftermath of the Great Recession, many states have substantially raised their tobacco taxes and, to a lesser degree, alcohol taxes. In 2009, two-thirds of all states considered legislation to increase tobacco taxes. In 16 states the bills became law. Additional increases were enacted in 2010. In many instances such increases were proposed for general revenue raising, without connection to funding health-specific programs.

Taxes on alcohol, tobacco, and gasoline do not automatically keep pace with inflation because they are based on units sold. Thus revenues do not increase proportionately with price. This issue can be addressed either by changing the tax structure from “per unit” to “ad valorem” (per dollar) or by indexing per-unit taxes for inflation.

Gasoline tax is one of the taxes unchanged for many years. It is the major source of funding for investment in transportation infrastructure. In recent years these revenues were insufficient to replenish the fund due, in part, to the tax level remaining unchanged for decades. As a result Congress had to pass special measures to allow for continued funding of the transportation projects. So far, lawmakers have been unable to agree on a new, long-term solution to this problem.

Excise taxes typically are regressive, i.e., they take a higher percentage of income from low-income people. The regressive nature of tobacco and alcohol taxes can be mitigated if the revenue is used to finance programs such as health care for those with low incomes. In addition, excise taxes may violate the principle of neutrality if they tax individual commodities in excess of the social costs that are not captured by market prices.

Government lotteries may be considered a form of an excise tax on gambling. As such, lotteries are subject to the general considerations that apply to excise taxes in terms of their revenues, efficiency, burden distribution, revenue use, and other factors. Governments sponsoring the lotteries receive revenues from sales in a way similar to the revenues from excise tax on, say, alcoholic drinks. Typically lotteries are a regressive way to raise revenue.

Excise Taxes on Individual Commodities or Services: Policy

Excise taxes

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Excise taxes on individual commodities, such as tobacco or alcohol, should at least keep pace with inflation. Levying them on an ad valorem basis (i.e., on the value of the purchase) rather than a per unit basis would automatically adjust them for inflation.

Preferably, the revenue from increases in excise taxes on commodities should be used to help fund important social programs targeting the populations negatively affected by the taxed commodity, such as health programs preventing the use or offsetting the effects of tobacco or unhealthy diet.