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Excise Tax

An 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.

What Activities Are Subject to Excise Taxes?

Excise taxes are imposed on manufacture, sale, or consumption of commodities, and upon licenses to pursue certain occupations. Federal dependence on excise taxes is down significantly since 1950, when almost 20 percent of federal tax collections were from excise taxes. Today, excise taxes only make up about 3 percent of federal collections as individual and corporate income tax revenues have grown dramatically.

History of Excise Taxes

The first excise tax levied in the U.S. was on the manufacture of whiskey in 1791. The tax was unpopular and only survived until 1802. In the early years of the Republic, excise taxes served as a revenue tool related to wars and economic downturns. During the Great Depression in 1934, excise tax revenues made up almost half of the federal government’s total revenue and three times more than the individual income tax. Today, there are federal excise taxes on motor fuel, tobacco, and alcohol, among other goods, services, and activities, in addition to a wide range of state excise taxes.

What Are the Reasons to Levy These Types of Taxes?

Excise taxes can be employed as Pigouvian taxes, or sin taxes, to price in externalities. An externality, in economics terms, is the side effect or consequence of an activity that is not reflected in the cost of said activity. For instance, excise taxes may be employed to reduce consumption of cigarettes or sugar-sweetened beverages, to curb pollution, or to reduce traffic congestion.

Excise taxes can also be employed as user fees. The role of excise taxes as a user fee is best understood with the example of the motor fuel tax, where gasoline purchases serve as a proxy for a driver’s contributions to traffic congestion and road wear-and-tear, in effect setting a price on the use of public roads.

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