Most of us are familiar with sales taxes: the small percentages state and local governments tack on to the retail price of goods and services. But there are often other, less apparent taxes baked into the totals you see at checkout—including excise taxes, which apply to specific items, from medical services to alcoholic beverages. Whether you know it or not, you—and your customers—are paying them. Here’s more on excise taxes and how they fit into the tax code.
What is an excise tax?
An excise tax is a tax a government levies on specific goods and services, often with the goal of discouraging their consumption or to make up for their associated social costs. Unlike traditional sales taxes—which apply to broad swaths of commerce—excise taxes target items such as fuel, tobacco, and firearms. Excise tax revenue usually makes up a relatively small portion of a government’s total revenue.
Excise taxes are typically indirect taxes, meaning customers don’t direct payments to the government imposing the tax (i.e., paying federal income tax to the Internal Revenue Service). Excise taxes are instead levied earlier in the process—on the manufacturer, for example—and the costs are eventually passed down to the customer at the point of sale (POS).
Most excise taxes come from federal and state governments, though local governments also sometimes impose them. Here’s how they vary across different levels of government:
- Federal excise taxes. Federal governments levy federal excise taxes. These federal taxes often take the form of tariffs on imported goods, like steel or timber.
What are types of excise taxes?
Excise taxes are either fixed or proportional: specific or ad valorem taxes, respectively:
- Specific taxes. A specific tax is a fixed dollar amount. It’s the same for every purchase of a particular taxable item. Think of fixed fees added to a gallon of car gas, an airline ticket, or a month of mobile network service.
- Ad valorem taxes. Ad valorem taxes are assessed as a purchase price percentage (or proportion). In many countries, the most common type of ad valorem tax is a value-added tax (VAT). This is a tax pre-baked into the cost of a consumer good or service, and it is assessed as a percentage of the item’s value. A VAT differs from a US-style sales tax because the VAT is included in the item’s price tag. The consumer doesn’t pay additional tax at the point of sale.
What is the purpose of an excise tax?
Governments craft tax policies to generate revenue and inspire citizens to take specific actions. Excise taxes fulfill both these goals. They can:
- Fund government initiatives. Like other taxes, an excise tax funds government spending programs.
- Discourage certain behavior. An excise tax, sometimes called a sin tax or a Pigouvian tax, can dissuade or discourage harmful, unhealthy, or socially detrimental behavior. Cigarette taxes and alcohol taxes can be considered Pigouvian taxes.
- Generate income without discouraging consumption. Sales taxes generate revenue, but they also can discourage spending since they’re added to a customer’s bill at checkout. An excise tax may not have the same effect because it’s incorporated into a product or service’s overall cost and doesn’t appear as a last-minute add-on. An excise tax’s lack of visibility makes it less likely to discourage consumption because customers are often unaware they’re paying it.
What goods and services are taxed under the excise tax?
Governments use their discretion in setting excise taxes. Taxed goods and services vary depending on the country, state, county, or locality. Items subject to excise taxes include:
- Imported goods
- Motor fuel
- Airline tickets
- Phone service
- Hotel rooms
- Parking garage tickets
- Health insurance plans
- Medical devices
- Restaurant services
What is the difference between excise tax and sales tax?
Excise taxes and sales are different taxes. Both are applied to the cost of consumer goods and services. However, they vary slightly in function:
- Sales tax is direct. Sales tax is added to the retail price of a product or service. It’s paid directly by the consumer and appears as a line item on their bill of sale. While the consumer pays the sales tax, the merchant is responsible for remitting it to the appropriate government agencies.
- Excise tax is indirect. Excise taxes are fees, duties, and tariffs added to the cost of a good or service before it reaches the consumer. For instance, imported steel is taxed when it crosses a border. Manufacturers and retailers then absorb the tariff in the retail price, which the consumer pays indirectly.