Background Paper No. 19
Inefficiencies are inherent in any taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ation, because taxes distort the economic choices that people make. While the unavoidable inefficiencies imposed by taxation are a necessary cost of providing certain government services, it is obviously desirable to minimize the inefficiencies imposed by taxation.
The most efficient tax system minimizes this type of distortion. But excise taxes are conspicuously at odds with the goal of reducing tax distortions: they are the most distorting of all taxes per dollar raised. Instead of spreading the tax burden as neutrally as possible over a broad tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. es single out a few products for a high and discriminatory tax burden that motivates consumers to avoid that burden by shifting away from products that provide them with the greatest value per unit of production cost.
Corresponding to this consumption distortion are production distortions a s productive resources are shifted out o f higher-valued employments and into lower-valued employments.
Only in a very few situations where the consumption of a product is complementary to the use of some other good that cannot easily be priced directly can earmarked excise taxes be efficient. But even here the efficiency of the excise tax depends upon the revenues being unconditionally allocated to the complementary use to reduce the cost of rent seeking.
The greater the rent seeking over the allocation of the revenues from a potentially efficient excise tax, the less efficient the tax is and the lower the efficient rate f taxation (under reasonable assumptions bout the relevant elasticity of demand). Once we recognize the necessary requirements for efficient excise taxation, we cannot justify most examples of such taxation on any grounds other than political expediency. No government spending can be exclusively connected to the use of the product being taxed. And, because there is no clear justification for earmarking the revenues to particular government spending, most excise taxes generate revenues that inevitably go up for political auction. The resulting rent-seeking cost makes these taxes even more inefficient than they already are.Share