Excise taxes are an example of what have been traditionally called indirect taxes: taxes that are imposed on a transaction rather than directly on a person or corporation. Excise taxes are narrow-based taxes, as compared with broad-based taxes on consumption such as a general sales tax, a value-added tax, or an expenditure tax. Excise taxes can be collected at various stages, including the point of production, the wholesale level, or the retail level. They are also known as selective sales taxes or differential commodity taxes.
Excise taxes are levied on either a unit or ad valorem basis. For unit (also known as specific) excises, the tax is denominated in terms of money per physical unit produced or sold. Examples include the federal government taxes of 18.4 cents per gallon of gasoline, $13.50 per gallon of distilled spirits, and $3.10 per domestic flight segment for passenger airline travel. Ad valorem excises are based on a percentage of the value of the product or service sold. The 7.5 percent federal tax on the cost of domestic airline passenger tickets and the 3 percent tax on the cost of telephone services are examples of ad valorem taxes.
Broader-based taxes, such as the income and general sales taxes, are difficult to administer when most of the economic activity takes place outside a structured market setting. Excise taxes are sometimes used as a means of implementing an ability-to-pay approach to taxation. So-called luxury taxes are an example of this approach.1 The United States currently levies an excise tax on expensive passenger vehicles. This tax is set at 10 percent of the value in excess of a floor amount of $30,000. The tax on high-value automobiles has also been explained as a means of making foreign imports (which comprise a large percentage of such vehicles) more expensive than domestic Automobiles. By taxing items consumed disproportionately by higher-income individuals, excise taxes can achieve an element of progressivity. There are questions, however, concerning horizontal equity because not all people at the same income level have similar expenditure patterns for luxury items. Excises are also levied on goods or services that are considered harmful or undesirable, in an Attempt to discourage consumption. Taxes based on this rationale are labeled sumptuary excises. Examples include taxes on alcoholic beverages, tobacco products, and wagering. Because many of the goods and services taxed by sumptuary excises have relatively inelastic demands, these taxes May have only a limited impact on curtailing consumption. This presents an added benefit, however, for the government in that it provides a relatively stable source of tax revenue. Sumptuary Taxes are often popular politically because many citizens do not engage in the taxed activities, whereas purchasers of the taxed items do so voluntarily. Such taxes may have negative consequences from the standpoint of vertical equity because sumptuary excises are often highly regressive. Excises may also be imposed as a technique for dealing with negative externalities. This is related in some ways to the sumptuary excises. Taxes on “gas guzzling” automobiles and gasoline can be explained as a kind of Pigouvian (corrective) tax to reduce the divergence of the private and social costs relating to pollution or congestion. Such taxes are usually an imperfect technique for internalizing externalities, because an efficient Pigouvian tax should be related to the marginal damage caused by an activity, which is not necessarily proportional to the level of consumption.
Finally, excise taxes may be employed as a means of implementing a benefits-received approach to taxation. Gasoline taxes are an example. Gasoline usage is closely related to highway travel, thereby providing a link between taxes paid and benefits received from roadways. This link is further strengthened by earmarking where the revenues collected from an excise tax are designated for use in providing government services related to the activity. Examples include the earmarking of motor fuel taxes for highways and taxes on airline tickets for air traffic control and facilities expansion.