Congressional Research Service Report: 'Federal Excise Taxes – Background & General Analysis'
WASHINGTON,
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SUMMARY
In the tax policy context, excise taxes are selective taxes on specific consumption or behavior (in contrast with sales taxes, which tend to apply to all consumption, with some exceptions). Today, federal excise taxes apply to a variety of goods and economic activities, such as alcohol, tobacco, firearms and ammunition, gasoline, airline passenger tickets, and indoor tanning services.
There are four common types of excise taxes:
1. Sumptuary (or "sin") taxes: Historically imposed for moral reasons, but are currently levied, in part, to discourage a specific activity that is thought to have negative spillover effects (or externalities) on the consumer and society.
2. Regulatory taxes: Imposed to offset external costs associated with regulating public safety or to discourage consumption of a specific commodity that is thought to have negative externalities on society.
3. Benefit-based taxes (or user charges): Imposed to charge users of a particular public good (e.g., a highway or national park) for financing and maintenance of that public good.
4. Luxury taxes: Often imposed to raise revenue, particularly from higher-income households.
Excise taxes have generally played a diminishing role in financing the federal government since the middle of the 20th century.
Excise taxes tend to be regressive, meaning that households with lower incomes generally pay a larger share of their income in excise taxes than households with higher incomes. Because excise taxes generally increase the price of the taxed commodity, they also tend to lower consumer demand.
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Contents
Introduction ... 1
History of Federal Excise Taxes ... 2
Revenue ... 5
Historical Trends ... 5
Revenue by Major Types of Excise Taxes ... 7
Dedicated Excise Tax Revenue ... 8
Interactions with State and Local Excise Taxes ... 9
Administration ... 10
Setting the Tax Rate ... 10
Choosing the Stage of Production to Levy the Tax ... 11
Transition Issues ... 12
Reporting ... 13
Equity ... 13
Efficiency ... 15
General Behavioral Effects ... 15
Luxury Taxes ... 16
Sumptuary Taxes ... 16
Benefit-Based Taxes ... 17
Regulatory and Environmental Taxes ... 18
Figures
Figure 1. Federal Excise Tax Collections, FY1940 to FY2020 ... 5
Figure 2. Federal Excise Tax Receipts as a Share of Gross Domestic Product (GDP), FY1940 to FY2020 ... 6
Figure 3. Federal Excise Taxes as a Share of Federal Revenues, FY1940 to FY2020 ... 7
Figure 4. Federal Excise Tax Revenue by Major Type, FY2020 ... 8
Figure 5. Share of Federal Excise Tax Revenue Dedicated to Trust Funds, FY1940 to FY2020 ... 9
Figure 6. Average Federal Excise Tax Rate by
Appendixes
Appendix. Select CRS Resources on Excise Taxes ... 19
Contacts
Author Information ... 20
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Introduction
In the tax policy context, excise taxes are selective taxes on specific consumption or behavior (in contrast with sales taxes, which tend to apply to all consumption, with some exceptions). Today, federal excise taxes apply to a variety of goods and economic activities, such as alcohol, tobacco, firearms and ammunition, gasoline, airline passenger tickets, and indoor tanning services.
There are four common types of excise taxes:/1
1. Sumptuary (or "sin") taxes: Traditionally imposed for moral reasons, but are currently rationalized, in part, to discourage a specific activity that is thought to have negative spillover effects (or externalities) on consumers and society./2
2. Regulatory taxes: Imposed to offset external costs associated with regulating public safety or to discourage consumption of a specific commodity that is thought to have negative externalities on society.
3. Benefit-based taxes (or user charges): Imposed to charge users of a particular public good (e.g., a highway or national park) for financing and maintenance of that public good.
4. Luxury taxes: Often imposed to raise revenue, particularly from higher-income households./3
The role of excise taxes has changed over time. Excise taxes narrowly imposed on the consumption of certain products, such as alcohol and tobacco, formed the basis for a significant portion of federal tax revenue until the modern income tax was enacted in the early 20th century. Although excise taxes have played a diminishing role as a federal revenue source over time, there is persistent interest in using excise taxes to raise revenue or discourage behavior that is believed by some to have negative effects on society (e.g., a tax on carbon emissions). There is also interest in reducing current excise tax rates as a means to encourage short-term growth in particular industries.
This report provides an introduction to and general economic and policy analysis of excise taxes. It first provides a brief history of
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1 This list is not exhaustive. For example, rationing taxes have been temporarily levied in order to reduce the consumption of critical supplies during wartime (e.g., rubber) and import duties are basically excise taxes levied on imports. Additionally, this list and, more broadly, this report discuss excise taxes in the economic and policy contexts.
Legal analysis of the meaning of the term excise taxes and of the different types of excise taxes is beyond the scope of this report.
2 Economists also refer to taxes applied to an activity generating negative externalities as a "Pigovian tax." This type of tax is named after economist
3 Excise taxes were previously imposed on luxury vehicles, furs, yachts, and other luxury goods. However, most of these provisions have either expired or been repealed over the years.
4 For a comprehensive list of federal excise taxes and their tax rates (as of 2015), see
Subsequent to that publication, some of the Affordable Care Act taxes were eliminated in 2019: the medical device tax, the tax on certain high-value insurance policies (popularly known as the "
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History of Federal Excise Taxes
Federal excise taxes have had a dynamic role within the
New excise taxes or changes to existing tax rates have often been used for the control of social costs and as user charges in recent years.
Excise taxes played a key fiscal role in the early history of
The burden of the tax was controversial along both geographical (westerners on the frontier tended to both consume more whiskey and use it as a medium of financial exchange) and ideological (Federalists versus Anti-Federalists) divisions. This opposition peaked in the Whiskey Rebellion of 1794 in southwestern
Federal excise taxes expanded after the suppression of the Whiskey Rebellion in 1794.
In 1797, a direct tax was imposed on the ownership of houses, land, and slaves as tariff revenue declined during a period when European powers were at war. The taxes' unpopularity contributed to
All internal excise taxes were repealed in 1802, as the fiscal demand arising from the war in
Federal excise taxes played a significant role in public finances throughout the 1800s. Excise taxes were temporarily reintroduced during the War of 1812, but were repealed from 1817 until the Civil War./10
Following the onset of the Civil War,
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5 For an earlier history of federal excise taxes, see
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11 The Revenue Act of 1861 also temporarily imposed the first income tax, which was implemented in 1862. The income tax was repealed in 1872.
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Most of these excise taxes were repealed after the end of the Civil War, with taxes on distilled spirits and tobacco remaining in effect. In the decades after the Civil War, excise taxes accounted for between one-third and one-half of all federal revenue./12
Excise taxes were the single largest source of internal revenue during this era./13
During the Spanish-American War (1898), excise tax revenue was a larger source of federal tax collections than customs duties on foreign imports, as revenue from tariffs often declined during wartime. Emergency excise taxes were levied on a variety of items, such as pianos, playing cards, yachts, and billiard tables, to fund military spending. After the war ended, most of these emergency excise taxes were repealed.
Excise taxes were utilized to fund wartime spending during the early 20th century. Temporary excise tax provisions were imposed in the Revenue Act of 1918, passed during World War I, to help fund wartime spending, including the first excise tax on firearms, shells, and cartridges. As a result, excise tax collections quadrupled from 1914 to 1919./14
Excise tax revenues declined significantly after the beginning of Prohibition (falling to less than half of pre-Prohibition revenue levels by 1930) but rebounded above pre-Prohibition levels after the consumption of alcohol was made legal again after 1933./15
Existing excise tax rates were increased again virtually across the board around the time of World War II, and new taxes on luxury goods (such as furs) were introduced./16
Additionally,
Excise taxes underwent a time of dynamic reform during the latter half of the 20th century. The Revenue Act of 1951 increased many excise tax rates in existence at the time (such as alcohol and tobacco) and increased the tax base for some user charges. However, the Excise Tax Reduction Act of 1954 (P.L. 83-324) and the Excise Tax Reduction Act of 1965 (P.L. 89-44) reduced the number of provisions and their respective tax rates. In particular, the Excise Tax Reduction Act of 1965 eliminated most federal excise taxes with the goal being to "help sustain economic expansion."/18
Certain excise taxes were also expanded, in part, to reflect a desire for a wider federal role in domestic affairs./19
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12 By comparison, trade tariffs produced from one-half to two-thirds of all revenue in the decades after the Civil War, whereas proceeds from federal land sales accounted primarily for the remainder of revenue collections. See Lance E.
Davis and
13 During parts of this time period, only customs duties outnumbered excise tax collections as the primary source of federal revenue.
14
15 See Table 3 in
16 See Revenue Act of 1940 (P.L. 76-656), Revenue Act of 1941 (P.L. 77-250), Revenue Act of 1942 (P.L. 77-753), and Revenue Act of 1943 (P.L. 78-235); and
17 See
18
19 See
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For example, the modern highway system's development shows this linkage between excise taxes and the expansion of federally provided public goods. The Highway Revenue Act of 1956 (Title II of P.L. 84-627) increased the federal gasoline tax (in effect since 1932) and directed its collections from the
Specific excise taxes linked to trust funds related to air travel, mining, waterway travel, oil spills, and other hazardous chemicals (among others) were created in the 1970s and 1980s. A rising budget deficit helped to bring about the excise tax increases in the Omnibus Budget Reconciliation Act of 1990 (OBRA90; P.L. 101-508). OBRA90 increased tax rates on distilled spirits (last increased in 1985), beer and wine (last increased in 1951), tobacco (last increased in 1982), and gasoline (last increased in 1982).
In recent decades, excise taxes have played a diminishing role in the mix of federal revenue sources even as new provisions have been introduced. As discussed in the "Revenue" section, excise tax collections have nominally increased in recent years, but have not changed as much in inflation-adjusted (real) values. Excise taxes have also fallen as a share of overall federal revenue.
The excise tax rate on gasoline, the largest federal excise tax by revenue, has remained unchanged and unadjusted for inflation since 1997. The excise tax on tobacco was last increased with the Children's Health Insurance Program Reauthorization Act of 2009 (P.L. 111-3), but revenue from the tobacco tax has declined over time in part due to decreased demand for tobacco products.
Alcohol taxes were reduced, by allowing a reduced rate on lower quantities of production and the provision of credits, temporarily in the 2017 tax law (P.L. 115-97, commonly referred to as the "Tax Cuts and Jobs Act") and permanently in the Consolidated Appropriations Act, 2021 (P.L. 116-260).
Several new excise taxes were created by the Affordable Care Act (P.L. 111-148 and P.L. 111-152, as amended), enacted in 2010, such as taxes on indoor tanning bed services, medical devices, and certain high-value insurance plans. The taxes on medical devices and certain high-value insurance plans, as well as a health insurance industry fee, were later fully repealed in the Further Consolidated Appropriations Act, 2020 (P.L. 116-94).
The future role of federal excise taxes in federal policy is still unclear. Excise taxes in the form of user charges could continue to play a role in financing public goods and services. Excise taxes could be one tool to raise revenue, particularly in the absence of a general consumption tax at the federal level./21
Some long-standing excise tax proposals to correct a perceived social issue have also resurfaced in policy discussions. Some of these proposals could be targeted toward specific products or activities (e.g., a sugar-sweetened beverages tax), whereas others could affect a broad range of economic activity and potentially raise a significant amount of revenue (e.g., a carbon tax)./22
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20 For more information on financing public highways, see CRS Report RL30304, The Federal Excise Tax on
21 Congressional interest in enacting consumption taxes has been low. For example, a type of national consumption tax--a value-added-tax--has been explicitly rejected by
22 The
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Revenue
Since the end of World War II, excise taxes have comprised a diminishing portion of federal revenues. At the same time, federal excise tax revenue has fallen as a share of GDP. However, excise taxes have remained important public policy tools as they have increasingly been used as a source of dedicated revenue to directly fund certain federal government programs.
Historical Trends
Excise taxes have had a diminishing role in federal public finance over time. Several forms of data analysis, presented in this section, illustrate this point.
Excise taxes are generally imposed on either a per-unit basis, which means the tax rate is applied per individual unit produced, purchased, or sold, or an ad valorem basis, which means the tax rate is applied as a percentage of the product's value. One concern with per-unit excise taxes is that they are often set in statute at specific levels, so the inflation-adjusted value, or real value, often falls over time./23
This trend usually continues absent legislative action to increase the statutory rates to reflect the effects of inflation./24
As Figure 1 shows, federal excise tax collections have generally increased each year in nominal (unadjusted) terms. However, when considering inflation, federal excise tax revenues have been much more volatile, increasing over time but not necessarily each year.
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[See link at end of text for Figure 1. Federal Excise Tax Collections, FY1940 to FY2020]
Source: Figure created by CRS using data from
Notes: Data labels shown on both lines for FY1940 and FY2020. The Constant (FY2020) Dollars line additionally shows a data label for FY2015.
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23 Because these calculations control for changes in the price level, economists generally compare dollar-denominated amounts over time in real terms, not nominal.
24 For particular federal trust funds that are financed through excise taxes, the decline in the value of excise tax revenue may be a concern. If the growth in spending exceeds revenue, then the trust fund could be depleted over time.
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Although nominal excise tax collections have increased from
The highest amount of inflation-adjusted revenue raised by federal excise taxes since 1940 was in FY2015, when those taxes raised
Federal excise tax receipts as a share of gross domestic product (GDP) are lower today than they were in the past. As shown in Figure 2, annual excise tax receipts averaged between 2.0% and 2.5% of GDP during the Great Depression, before hitting a peak of 3.1% in FY1946. After the end of World War II, federal excise tax receipts declined as a share of GDP--particularly after the mid-1960s. After a brief spike in the early 1980s, largely due to the enactment of the oil industry windfall profits tax, excise tax revenue as a share of GDP trended back below 1.0% by the end of the 1980s. In FY2020, federal excise tax receipts were 0.4% of GDP.
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[See link at end of text for Figure 2. Federal Excise Tax Receipts as a Share of Gross Domestic Product (GDP), FY1940 to FY2020]
Source: Figure created by CRS using data from
Notes: Data labels are shown for FY1940, FY1946, and FY2020.
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25 Crude Oil Windfall Profit Tax Act of 1980 (P.L. 96-223).
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Federal excise taxes have also declined as a share of all federal tax receipts. As shown in Figure 3, federal excise taxes comprised 30.2% of all federal tax receipts in FY1940. By the early 1950s, the share of federal tax receipts from excise taxes began a slow decline below 15% to its current share of 2.5% in FY2020.
The declining share of federal tax receipts collected from excise taxes corresponded with an increase in the role of other sources of tax receipts, notably the individual income and payroll taxes. In FY1940, individual income taxes amounted to 13.6% of all federal tax receipts and applied primarily to a narrow tax base./26
During World War II, the individual tax code supplanted excise taxes as being the primary source of federal revenue, as income taxes accounted for 45.0% of all tax receipts in FY1944 (compared with 10.9% from excise taxes)./27
Receipts from payroll taxes,/28 which fund various social insurance programs, have also increased over time and are now a significant portion of federal receipts. In FY2020, individual income taxes comprised 47.0% and payroll taxes 38.3% of federal tax receipts, compared with 2.5% from federal excise taxes./29
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[See link at end of text for Figure 3. Federal Excise Taxes as a Share of Federal Revenues, FY1940 to FY2020]
Source: Figure created by CRS using data from
Notes: Data labels are shown for FY1940 and FY2020.
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27 The rise in income tax receipts during World War II was largely due to the enactment of the "Victory Tax" under the Revenue Act of 1942 (P.L. 77-753). The Victory Tax was a flat 5% tax (lowered to 3% in 1943) on net income over
28 The largest payroll taxes, by revenue, are the
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Revenue by Major Types of Excise Taxes
Federal excise taxes cover a broad range of economic activity, as shown by Figure 4. The largest set of taxes relates to surface transportation, accounting for 45% of total excise tax revenue in FY2020. These excise taxes are dedicated for the
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[See link at end of text for Figure 4. Federal Excise Tax Revenue by Major Type, FY2020]
Source: Figure created by CRS using data from
Notes: Excludes categories with negative receipts (meaning refunds exceed receipts).
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Dedicated Excise Tax Revenue
One of the most important changes in federal excise tax policy over the past several decades has been the increasing dedication of specific excise tax revenues to various trust funds and programs. The first dedicated federal excise tax revenues were collected in FY1957. The Federal-Aid Highway Act of 1956 (P.L. 84-627) increased the already-existing federal gasoline tax and dedicated revenues from the tax to the newly created
In contrast, excise taxes for general revenue have largely stagnated. In recent years, the medical devices excise tax and the health insurance industry fee were both permanently repealed. Recent cuts to the alcohol excise tax were made permanent. Another general fund excise tax--the tax on local telephone, typewriter, and local-service only prepaid phone cards--has been shrinking as its taxable base has largely vanished.
The portion of federal excise tax revenue dedicated for trust funds rapidly increased from the late 1950s to about 2000, as shown by Figure 5. Since then, the exact share has varied slightly but has consistently been above 60%. In FY2020, 66% of federal excise tax revenue was dedicated for trust funds.
The trust funds that receive revenue from excise taxes support a variety of federal programs. The largest, by far, is the
The next largest is the Airport and
For more on these trust funds and others funded by federal excise taxes, see the resources listed in the Appendix.
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[See link at end of text for Figure 5. Share of Federal Excise Tax Revenue Dedicated to Trust Funds, FY1940 to FY2020]
Source: Figure created by CRS using data from
Notes: Data labels are shown for FY1940, FY1956, FY2007, and FY2020.
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Interactions with State and Local Excise Taxes
Every state and many localities levy excise taxes. Some of the most popular goods to tax are the same as with the federal government: every state and
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Changes in the consumption of a taxed good depend, in part, on the interaction of federal, state, and local excise taxes levied on that good. Economists would predict that the relative changes in quantities of a good consumed given a federal tax change would differ based on state and local taxes on that good. Likewise, federal revenues may change, even if the federal tax rate does not change, if states and localities change how they tax certain goods.
Unlike the federal government, several states automatically adjust their gas taxes for inflation each year./34
This potentially provides more consistent revenue across years. Many states, like the federal government, set their alcohol and tobacco tax rates in statute. Some states that do not regularly increase these rates--especially for tobacco, with generally falling consumption--have been experiencing falling collections from these taxes./35
Administration
All forms of excise tax use some sort of physical control or measurement by tax authorities to determine tax liability and ensure compliance with the law.36 This section of the report describes the different ways that excise taxes are structured, and the advantages and disadvantages of each model.
Setting the Tax Rate
For excise taxes intended to compensate for the social costs of certain activities, economic theory suggests that the excise tax rate should be set at a level that offsets the negative costs of that consumption to society./37
In general, an excise tax rate can be applied in one of two ways:
* Per unit, where the tax rate is applied per individual unit produced, purchased, or sold. For example, different per-unit rates are levied on tobacco products based on the product type: 1,000 units of cigarettes or one pound of pipe tobacco.
* Ad valorem, where the tax rate is applied as a percentage of the value of the product, based on the manufacturer's wholesale or retail price. For example, the excise tax on firearms and ammunition is set at 10% of the sale price for pistols and revolvers and 11% for other firearms as well as shells and cartridges./38
Economists generally prefer per-unit excise taxes when marginal consumption of the targeted commodity is deleterious. For example, cigarette taxes are levied per unit sold because the alleged spillover effects of smoking (e.g., second-hand smoking) occur with every cigarette smoked. The excise tax on gasoline is levied per gallon of gasoline sold because the amount of gasoline consumed was (in the past) a rough approximation of how much wear and tear a driver would impose on federally managed highways.
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36 Sijbren Cnossen, Excise Systems: A Global Study of the Selective Taxation of Goods and Services (
37 If taxes are used this way to reflect the full cost of a particular type of economic activity to society, then excise taxes can lead to a more efficient allocation of resources. This concept is discussed in more detail in the "Efficiency" section of this report.
38 For more information on excise taxes on firearms and ammunition see CRS Report R45123, Guns, Excise Taxes, Wildlife Restoration, and the National Firearms Act, by
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Per-unit taxes can invite issues with both horizontal and vertical equity, as explained below in the section on "Equity." Also, because per-unit taxes are often set at static rates in statute, these rates often fall in inflation-adjusted (or real) terms./39
For example, the statutory federal excise tax rate on distilled spirits in 1951 was set to
The statutory tax rate was increased from
If the 1951 tax rate was indexed for inflation, it would be
In contrast, ad valorem tax rates largely avoid a real decline in value because they are applied based on the price of a commodity or activity rather than the quantity consumed or produced. Ad valorem rates can also be more progressive (meaning people with higher incomes pay a higher share of their income in taxes than people with lower incomes) than per-unit rates in certain circumstances. For example, if people with higher incomes are more likely to buy expensive distilled spirits, then an ad valorem tax would cause them to pay more tax relative to cheaper spirits than a per-unit tax would. However, ad valorem rates may be regressive (meaning people with lower incomes pay a higher share of their income in taxes than people with higher incomes) if the consumers of the commodity are not limited to those at the upper end of the income distribution.
Choosing the Stage of Production to Levy the Tax
An excise tax can be levied at different stages along a commodity's production and distribution chain:/43
* Production level: Tax is collected on sales by producers to wholesalers, retailers, or other producers. Transactions prior to the sale by the last producer are often partially exempted or taxed at reduced rates.
* Manufacturing level: Tax is collected on sales by manufacturers to wholesalers or retailers, including the occasional direct sale to consumers.
* Wholesale level: Tax is collected on sales by the last wholesaler or manufacturer to retailers, including the occasional direct sale to consumers.
* Retail level: Tax is collected on sales by retailers to final consumers, including wholesalers or manufacturers selling occasionally to consumers.
* Turnover taxes: Tax is collected on sales at all or nearly all stages; also known as "cascade taxes" on account of their cumulative effects.
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39 The decline in the real value of per-unit taxes is due, in part, to increasing real prices of the taxed commodity or activity over time.
40 A proof gallon is a combination of alcohol content and volume. A proof gallon is the volume in gallons, multiplied by the percentage of alcohol, multiplied by two, and divided by 100.
41
42 CRS calculations based on
43 Sijbren Cnossen, Excise Systems: A Global Study of the Selective Taxation of Goods and Services (
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Generally, an excise tax levied at earlier stages in the production process has lower administrative costs and fewer opportunities for tax evasion. In most situations, consumers vastly outnumber producers. Therefore, implementing an excise tax at the level of the consumer retail outlet often results in a duplication of bureaucratic processes compared with a tax on manufacturers. For example, about 249 billion cigarettes were purchased across
However, ad valorem taxes imposed at the manufacturer's level could provide an incentive for value-added options to be ordered further down the supply chain in an attempt to minimize the tax burden. The manufacturer tax on firearms, for instance, is levied on the assembly of a complete rifle, but any add-ons or modification kits are not taxed./45
Taxes imposed at the manufacturing level could lead to an effective tax rate that is higher than the statutory tax rate. This outcome occurs because some manufactured goods have a long inventory life, and a considerable time period may elapse between when the tax is paid (when the good leaves the manufacturer's premises) and the date that the good is sold. In effect, the manufacturer incurs an interest cost to borrow the money to pay the tax./46
An advantage of imposing a tax at the retail level is that it can more easily exclude certain consumers from an excise tax's revenue base, if desired. For example, farmers can receive an excise tax credit for certain fuel purchased for farm use, as this activity generally has a minimal effect on the quality of interstate highways./47
On the other hand, exemptions could diminish the tax's effect on its original goal. An exemption, in the form of a refund, can be implemented through a manufacturer's tax, although this might require additional administrative resources. In the case of federal motor fuel taxes, this is done by the consumer filing Form 4136 ("Credit for Federal Tax Paid on Fuels") to claim a credit against annual income taxes./48
Transition Issues
Special rules are sometimes used to accompany the imposition of a new excise tax or increases in any existing tax rates to prevent tax avoidance. If an excise tax is announced effective as of a specific date in the future, then individuals might stockpile the taxed commodity. One policy to prevent this behavior is a floor stocks tax, or an excise tax on all existing inventory as of a particular date. The floor stocks tax is usually imposed on the date a new tax takes effect or the date after a tax-rate increase takes effect; all new inventory subject to tax that is acquired after the new tax becomes effective is then subject to the new tax.
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44
45 For more information, see CRS Report R42992, Guns, Excise Taxes, and Wildlife Restoration, by
46 Alternatively, the manufacturer could have invested the money used to pay the tax and earned a market rate of return during the period between when it paid the tax and when the good is sold along the next step of the production chain.
47 For more information, see "Chapter 14--Fuel Excise Tax Credits and Refunds" in
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Reporting
Tax liability for most federal excise taxes is reported on
Most of the excise taxpayers using Form 720 must deposit the tax owed before filing the form with the
Equity
Economists generally assess tax equity using two measures: vertical equity and horizontal equity. Vertical equity holds that households with a greater ability to pay the tax (i.e., with a higher income) should pay a greater share of their household income in taxes than households with a lesser ability to pay the tax. A tax system is progressive if higher-income households pay a greater share of their income in tax than lower-income households, whereas the converse is true in a regressive tax system. Horizontal equity indicates that households with similar abilities to pay should actually pay similar amounts in tax. For example, all households earning a particular amount of income would pay the same amount in taxes, regardless of the income's form, in a tax system with perfect horizontal equity.
Note that the excise tax rate on a particular good does not reflect its effects on equity. Even if all consumers are subject to the same tax rate of
Figure 6 shows the distribution of excise taxes paid in 2018, by average tax rates, as calculated by the
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50 See https://www.ttb.gov/forms on the
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[See link at end of text for Figure 6. Average Federal Excise Tax Rate by
Source: Figure created by CRS using data from
Notes: Income groups are created by ranking households by income before taxes and transfers after adjusting for household size. Income includes labor, business, capital, retirement, and other sources of income, as well as the employer portion of payroll taxes. It also includes social insurance benefits, such as
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With regard to vertical equity, excise taxes tend to be regressive. The lowest income quintile of taxpayers paid, on average, 2.0% of their income on excise taxes in 2018, whereas the highest quintile of taxpayers paid 0.4% of their income in excise taxes.
The distribution burden of individual excise taxes varies considerably. For example, tobacco taxes are considered to be more regressive because smoking is most common among people with lower income./51
The federal excise tax on air passenger tickets is less regressive because people with higher incomes are more likely to fly./52
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52 Airlines for America, "Air Travel More Accessible in 2017, According to Latest Air Travelers in America Report," 2018, at https://www.airlines.org/news/air-travel-more-accessible-in-2017-according-to-latest-air-travelers-in-americareport/.
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A luxury tax may be less regressive than other forms of excise taxes, but it could be difficult to isolate the burden of such a tax to upper-income households. Middle-income consumers might purchase goods classified as luxuries, such as jewelry or watches. The definition of "luxury" also changes over time. For example, a federal excise tax on telephone calls was first introduced in 1892 as a luxury tax to help finance the Spanish-American War. After several instances of repeal and reauthorization throughout the early 20th century, the tax remained part of the permanent tax code from 1947 until 2006./53 Although one could make the argument in 1892 that telephone calls were luxury services, this was certainly not the case by the latter half of the 20th century.
With regard to horizontal equity, excise taxes have different effects on households with the same level of income. Households that consume the taxed good pay a larger share of taxes out of their current income than households that do not consume the taxed good. Excise taxes can also create horizontal inequities across consumers of a taxed product if unequal tax rates are applied to various forms of that product (e.g., beer vs. wine vs. distilled spirits).
Efficiency
Some excise taxes are intended to affect consumer choices. As such, they reduce economic efficiency by distorting what economists characterize as economically optimal consumer behavior. This distortion could be justified, in economic terms, if there is some sort of market failure whereby the consumer's price does not capture the effect of spillover effects to society that result from consumption of the good or service. Individual consumption of certain goods and services might have negative spillover effects, or externalities, on society. For excise taxes that are intended to compensate for the social costs of certain types of consumption (such as the airplane passenger "
General Behavioral Effects
All types of excise tax have some similar economic effects in a competitive industry./54 In the short run, an excise tax increases the price of the taxed product (by some fraction of the tax amount), and the tax burden is shared by producers and consumers. Next, the quantity of the product demanded is reduced. Lastly, the price received by producers for the product is also reduced (i.e., producers receive less for the product post-tax compared with pretax).
The exact effect depends on the responsiveness, or elasticities, of demand and supply for the product (i.e., the percentage change in quantity demanded or supplied, respectively, divided by the percentage change in price). The increase in retail price resulting from the tax will be greater as the elasticity of supply increases and the elasticity of demand falls. The effect on quantity will be greater as both the elasticity of demand and the elasticity of supply increase.
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53 The federal tax on telephone calls was imposed temporarily from 1892 to 1902 to raise revenue to help finance the Spanish-American War. The telephone tax was temporarily imposed again from 1917 to 1924 to help finance
54
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In regard to sharing the price burden, the more inelastic the demand is, the larger the share of the tax generally borne by consumers. The more inelastic the supply is, the larger the share generally borne by producers. In cases on either extreme, consumers could bear the full burden if demand is completely inelastic, whereas producers could bear the full price burden if supply is completely inelastic. Put differently, an excise tax on a product with a relatively inelastic demand will have less of an effect on consumption./55
Luxury Taxes
Luxury taxes are usually levied to increase progressivity in the tax system or to increase revenue, not on the basis of improving economic efficiency.
A common case study cited in the analysis of luxury taxes discusses the luxury boat industry during the early 1990s. Opponents of the luxury tax argued that the yacht industry experienced drastic reductions in sales following the enactment of a 10% ad valorem luxury tax in the Omnibus Budget Reconciliation Act of 1990 (OBRA90). According to this logic, the imposition of the excise tax was largely to blame for the decline in sales and rise in unemployment in the industry. However, economic analysis indicates that yacht sales were beginning to decline from their peak in 1988 (before the tax), and that sales of yachts were more sensitive to changes in personal disposable income and corporate profits after tax rather than price changes due to the tax./56
In any case, the tax was repealed in the Omnibus Budget Reconciliation Act of 1993 (P.L. 103-66).
Sumptuary Taxes
Sumptuary, or sin, tax increases are often based on market failures, relating to externalized costs of individual behavior associated with public health, public safety, and additional financial burdens placed on publically financed health services./57
In short, studies measuring the respective size of the externalities for alcohol and tobacco involve complicated technical calculations of lifetime external costs and savings associated with alcohol and tobacco consumption that are often subject to controversy and methodological scrutiny. An advanced review of this literature is beyond the scope of this report. Still, studies suggest that the current per-unit tax rates on cigarettes exceed the magnitude of the estimated net externalities, whereas the opposite could be true for alcohol taxes./58
* * *
55 The magnitude of the elasticity is sometimes reported and the negative sign omitted because consumer demand is often negatively correlated with prices. The important factor is if the elasticity is less than or greater than 1. Consumer goods with an elasticity greater than 1 are considered price elastic; less than 1, price inelastic. The elasticity of demand is not necessarily constant along all price points. Economic theory indicates that consumer demand is relatively more inelastic in the short run and with larger changes in price than with smaller changes in price. In the long run, however, elasticity of demand for a product is relatively elastic as consumers adjust their behavior to changes in prices.
56 This analysis is contained in out-of-print CRS Report 92-149, The Effect of the Luxury Excise Tax on the Sale of Luxury Boats, by
57 With regard to correcting for negative externalities, regulation can also serve as an alternative (or complementary) policy to taxation.
58 For the most comprehensive summary of this analysis, see archived CRS Report 94-214, Cigarette Taxes to Fund Health Care Reform: An Economic Analysis, particularly pp. 3-6. The analysis in this CRS report is largely based on the findings of a study commissioned by the
* * *
Behavioral responses to sumptuary taxes vary by consumption good. Demand for beer is not particularly responsive to changes in price (e.g., demand is inelastic). Meta-analyses tend to find the demand for beer is more inelastic (i.e., less responsive) to changes in price than demand for either wine or distilled spirits. However, studies diverge on the question of whether demand for wine is more or less elastic than distilled spirits./59
In comparison, CBO estimates the price elasticity of demand for cigarettes to be between 0.3 and 0.7, and that the average elasticity of the number of smokers is 0.3. In other words, a 1% increase in the price of cigarettes results in between a 0.3% and a 0.7% decrease in demand and roughly a 0.3% decrease in the number of smokers./60
Compared with a sumptuary tax on a product that is relatively elastic, a tax on a product that is relatively inelastic often results in a higher tax burden on lower-income households (due to the regressive nature of the tax) with a smaller degree of change in consumption.
Benefit-Based Taxes
If properly structured, benefit-based taxes may enhance economic efficiency by reducing the difference between private and social costs. Economic inefficiency often arises because private markets tend to overproduce economic activities that lead to negative social externalities and under produce economic activities that lead to positive externalities, absent government intervention. Economic theory suggests that government intervention can better incorporate social costs into the prices perceived by any one individual. However, it is often difficult to derive the "correct" tax rate that precisely accounts for the marginal social effects of an economic activity.61 Benefit-based taxes can affect consumer demand for public goods if the link between the tax and the use of the public good is clearly apparent. A lack of a direct link between the tax and the use of the public good could lead to declining revenues available for upkeep and maintenance of the public good. For example, one could argue that the purchase of gasoline does not necessarily lead to wear and tear on federal highways; some of this fuel could be used by drivers who only commute along local roads. Thus, many benefit-based taxes are levied on rough proxies that affect forms of consumption unrelated to the ultimate policy goal.
An alternative policy could include more direct forms of benefit-based taxation, but there could be a trade-off between the targeting precision of a tax and its administrative costs. For example, although a retail tax on gasoline sales might be an imperfect proxy for highway usage, it is less complicated than administering an excise tax based on the weight and mileage of every motor vehicle using a federal highway. The costs of the latter form of tax administration might exceed the benefits.
* * *
59 For two examples of studies that indicate that distilled spirits are more elastic than wine, see
60
61 For more discussion of these issues, see
* * *
Regulatory and Environmental Taxes
Much like benefit-based taxes, regulatory and environmental taxes are typically imposed on economic activities that generate externalities./62
Whereas benefit-based taxes are concerned with an underproduction of some positive externality (e.g., a public good), regulatory and environmental taxes are usually concerned with the overproduction of some negative externality (e.g., pollution). These negative externalities could include losses from damage to plants and animals and to their habitats, rapid deterioration to physical infrastructure, and various harmful effects on human health and mortality. Economic theory indicates that a tax on the marginal production of these negative externalities could be used as a disincentive for harmful production processes and as a means of compensating society for the cleanup and mitigation of those externalities.
In the choice between a tax on pollution (or the regulation of some other activity with negative spillover effects on society) and a total ban on its production, economists generally prefer a tax./63
From an economic perspective, a society's optimum level of pollution is usually not zero; instead, economists look to minimize total costs. For waste disposal, these costs could include residual waste or by-product recycling, input switching to safer materials, production modification, or other technology adoption. Marginal waste disposal pollution costs generally increase with increased waste disposal activities as greater investment in more advanced (and more costly) cleanup technologies and mitigation strategies becomes necessary. Put differently, there may be a point where the cost of eliminating a particular unit of pollution may exceed the benefit. The tax increases the private cost of pollution to reduce the difference between private and social costs.
To achieve optimum economic efficiency, the excise tax rate should be set at a level so that the marginal, private cost of pollution is equal to the marginal, social benefits of production.
Economic theory suggests that the tax should be imposed directly upon the activity which gives rise to the negative externality./64
The statutory incidence (or burden) of the tax may differ from the economic incidence, because the latter is affected by elasticities. Thus, consumers may bear some or all of the tax through higher prices./65
* * *
62 For more background on environmental taxes, see
63 In theory, negative environmental and regulatory externalities could be mitigated with policies other than a tax, such as production quotas or tradable permits. Each policy option has its own advantages and disadvantages, particularly with regard to setting the price of the tax or permit or the level of the quota. For a more in-depth comparison of these policies, see
64 For more information, see
65 A more elastic demand (supply) indicates that consumers (producers) are more responsive to changes in price. Consumers absorb a larger share of the tax when producer supply is more elastic than consumer demand.
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View figures and report at https://crsreports.congress.gov/product/pdf/R/R46938
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