Excise Taxes and Sound Tax Policy
Background Paper No. 18
Excise taxes have been a staple of the Federal tax structure since the beginning days of the Republic. The growing tax reform debate offers a useful occasion to reconsider the use of excise taxes at the Federal level and possibly to consider including excise tax reform as part of a general overhaul of the Federal tax system. The first section of this paper presents the role and history of excise taxes in the U.S. tax system. The economic efficiency of excises is examined in the second section. The next section discusses the use of excises as means of capturing social costs. The fourth section provides a brief look at the administration, compliance costs, and implementation of excise taxation. The last section focuses on excise taxation and tax fairness, specifically, the relationships between excise taxes and regressivity, lifetime vs. annual income incidence, and the effects of excise taxes on low-income and rural taxpayers.
Historically, the primary reason for introducing excise taxes has been the need for revenue to finance government activities. As the Federal government instituted additional tax sources, such as the payroll tax and the income tax, the role of the excise shifted as a tax policy tool. Increasingly, excise taxes were treated as user fees, dedicated to fund specific services or programs provided by the Federal government. More recently, excise taxes have been employed as policy tools intended to capture costs thought to be borne by society at large but created through individual actions.
When excises are levied simply as revenue sources, or to offset perceived societal costs without an accurate assessment of those costs, then the tax can have highly distortionary effects on economic activity, thereby lowering the value o f national output and society’s welfare. Whether an excise has been well-targeted or not, however, by conventional measures of income most excise taxes fall disproportionately on lower-income taxpayers. To the extent a goal of tax policy is to levy a tax on a proportional basis, or even disproportionately on upper-income taxpayers, most excise taxes fail to achieve this objective.