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RETHINKING EXCISE TAXES

By David Brunori, Senior Director at RSM US LLP

According to the U.S. Census Bureau, in 2022 states collected about $193 billion in various excise taxes which accounted for about 13 percent of total state tax revenue. But unlike traditional sales taxes, excises are consumption taxes that are imposed on particular products, like tobacco, alcohol, and increasingly marijuana.


States raise the most excise tax revenue from fuel taxes – nearly $55 billion in 2022. But they are substantially different from the rest. Although fuel taxes are technically defined as excise taxes, they function more like user fees and that’s an important distinction. People drive, wear down the roads, buy gas, pay tax, and the government maintains the roads. So, though transportation funding is a critical issue in the United States, this discussion will not address the gas tax.


From a sound tax policy perspective, there is only one reason to impose excise taxes – to pay for the costs to the public of using a product – so-called externalities.


Cigarettes provide a perfect example. People who smoke are likely to get sick. There are significant health care costs associated with smoking (through Medicare, Medicaid, and generally higher insurance costs).  Those costs are not taken into account when cigarettes are purchased. Thus, an excise tax on cigarettes is justified to pay for the public expenses.


With that in mind, it makes sense for the excise tax revenue on a particular product to approximate the amount of externalities connected to that product. But that kind of sense isn’t often in the minds of policy makers and as a result there is generally little correlation between excise tax revenue and actual public costs.


No surprise there, as there are many other motives behind imposing excise taxes. Excise taxes are politically attractive methods for raising substantial revenue. That’s true, in part because they are almost always imposed on a minority of the population.  It is easier to tax smokers, for example, than impose a higher income or sales tax on everyone. In fact, many of the arguments in favor of legalizing marijuana in recent years have centered on the hopes that huge revenues will be raised.


Defenders of cigarette tax revenue point out that in many cases, these revenues are earmarked for education. But while that may be an estimable goal, it begs the question: “Aren’t schools important enough to pay with broad-based taxes?” A basic principle of tax systems is that they should built on a broad base with low rates. 


Another reason excise taxes are often imposed is to discourage a particular product’s use. They are called sin taxes for a reason. But again, such potential benefits notwithstanding, it confuses the avowed purpose of tax systems with other public policy initiatives.


Many excise taxes are championed by people in an effort to use tax policy instead of legislation in order to influence the way people behave. Over the years, there have been proposals to tax fatty foods, smoking, soda, “adult” books, guns and ammunition, and violent video games. Whatever your view on these – or any – products, they should not be subject to a special tax without an identifiable externality. Imposing one’s moral judgments on society through the tax code is perhaps the most pernicious use of excise taxes.


Of course, we often see other political motivations for imposing excise taxes. Politicians often turn to taxes when they believe they must “do something” in response to real or perceived societal problems. And sometimes they don’t seem to even have the desired real-world impacts at all. There are many other examples of using tax laws to address social issues. State and local governments have proposed and enacted soda taxes to reduce obesity. But there are many causes of obesity beyond consumption of soda. Such taxes are largely ineffective.


The overuse of excise taxes has many unintended consequences. In states that legalized marijuana, high taxes have resulted in consumers continuing to purchase cannabis illegally to avoid the tax. Cities that imposed taxes on firearms have seen gun stores close and move to neighboring jurisdictions. High cigarette taxes have led to significant smuggling and black-market sales.


There is a better approach. Policy makers should identify externalities clearly attributable to a particular product. Then, excise tax rates should be tied as closely as possible to pay for those costs.  Unfortunately, this is often not the case. It seems likely that taxes on marijuana and vaping/e-cigarettes will exceed externalities. On the other hand, it’s possible that taxes on alcohol don’t bring in enough to pay for the associated societal costs.


In all events, states should refrain from using excise tax revenue for general fund spending and avoid earmarking excise tax revenue for specific public spending, like education, that is unrelated to the use of any product. An approach to excise taxes that’s in line with basic tax principles may frustrate some as they lead to increases in other taxes. They will please others who purchase products that will no longer be subjected to excise taxes.


In either case, the proper use of this popular stream of revenues will lead to a fairer, more just, tax system. And that matters a lot – at least to some of us.


The contents of this Guest Column are those of the author, and not necessarily Barrett and Greene, Inc.


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