How do excise taxes work

Significant concerns regarding privacy must be addressed and balanced against a desire for a targeted, equitable, and efficient tax. Over the last few years, several new categories of excise taxation have emerged—some, like sports betting and marijuana, due to legislative changes, and others, like ride-sharing and vapor, due to technological developments. Finally, proposed or implemented taxes on plastics and sugar are indicative of changes in public opinion.

Most of these categories are still developing, so tax law and policy should remain agile enough to track the maturation of new markets. The following section introduces and analyzes these developing excise tax categories. Establishing legal access to recreational marijuana [56] is a still relatively new trend 15 states have done so , [57] but reports of growing marijuana sales and expanding popular support make it likely that more states, and maybe even the federal government, will consider allowing licensed sales of, and taxing, marijuana.

In , several additional states may look at excise taxes on recreational marijuana. Lawmakers in 15 states have expressed interest in revenue from recreational marijuana or passed legislation to establish a legal market.

While meaningful revenue may be available eventually , lawmakers should remain cautious as revenue will not materialize for a number of years and could be volatile. See Table 5 in the Appendix for revenue potential by state calculated based on actual revenue collections in states with legal recreational marijuana markets operating for three or more years. That being said, there are examples of legal markets working. Facilitating affordable accessible marijuana seems to have worked in Colorado, Oregon, and Washington, where legal sales have successfully outcompeted the illicit market—at least to a certain degree.

At the same time, these states have raised the revenue required to cover the cost of the system. The marijuana market still has potential to grow as more states enter the fray. S data. A profitable new industry to tax is understandably enticing to many lawmakers, but an excise tax on recreational marijuana should be based on the following principles:.

Taxes that capture general consumption, profit generation, and property value exist outside the excise tax space. Lawmakers should rely on these broad-based taxes rather than develop gross receipts tax es or ad valorem taxes to this new tax economic activity. In order to tax marijuana efficiently, the tax should be levied at a rate that corresponds to the externalities associated with the product.

This is difficult as the actual externalities are hard to estimate for any product, and no study on the subject exists for marijuana. For instance, the external cost of marijuana use is smaller if consumption of marijuana is substituted for alcohol, painkillers, or tobacco consumption and vice versa.

Nonetheless, these principles can be helpful to tax writers. For this and perhaps other reasons, most states have implemented price-based ad valorem taxes on recreational marijuana levied at the retail level. Levying the tax on retail sales allows for simplicity because there is a taxable event with a transaction, allowing for simple valuation.

However, if an ad valorem tax is applied at the wholesale level, it is difficult for vertically integrated businesses to calculate the taxable value, as there is no transaction. To offset that, Colorado and Nevada levy their ad valorem tax based on a fixed rate adjusted at different intervals and weight. Although structured as an ad valorem tax, applying a fixed price essentially converts these taxes to a weight-based tax. Although ad valorem taxation is simple, it is neither neutral nor equitable.

Furthermore, such a design harms consumer choice and product quality as it incentivizes manufacturers and retailers to reduce prices to limit tax liability. It also incentivizes downtrading, which is when consumers shift from premium products to cheaper alternatives.

Downtrading effects do not reduce harm and have no relation to any externality the tax is seeking to capture. In addition, like any tax in an immature market, ad valorem systems run the risk of being too high in the beginning, when supply is low, and too high after a few years, when prices might drop significantly. When supply is low, the tax rate may add significant cost to an already scarce expensive product.

As the market develops, prices may fall, which would subsequently reduce tax revenue. This effect is not yet widely noticed as states have been expanding the market, with growth in sales masking this effect. Rather than levying the tax on price, lawmakers should use a specific tax base: weight and potency THC-based. By including the weight component, the levy would also respect the different harm profiles of smoking a little versus a lot of marijuana.

A specific, separate category should be created for edibles and concentrates as they are easier to test. Neither weight nor potency are perfect, but both are substantially better proxies than price for internalizing the externalities.

Note: Testing for THC in plant material may still need time. Thus, a tax could be established purely on weight for now. Using THC as a tax base assumes that THC content is the best proxy for potency and therefore the best measure of externalities related to marijuana consumption.

This, however, is an area that should be studied further. Even with a THC focus, there may be a need to levy one rate on edibles and another of concentrates to account for different and more potent absorption mechanisms. For instance, New York State has recently proposed a tax system where edibles are taxed four times higher than concentrate.

Furthermore, one of the great challenges with tax design for marijuana is the amount of product types available on the market, from pre-rolled joints to sparkling water, and the yet unknown products to come. Any tax system should either be nimble enough or be updated frequently enough to capture new products as they enter the market.

State taxes should be levied at the wholesale level to avoid tax pyramiding. If interstate commerce becomes legal, marijuana risks double taxation if the origin state taxes cultivation and the destination state taxes sales. To avoid this problem, states should not levy taxes on products that are not consumed in the state. Avoiding tax pyramiding would guarantee that the excise tax is a tax on consumption rather than on cultivation or production.

Excise tax revenue should be appropriated to relevant spending priorities related to the consumption of marijuana. Examples include public safety, cessation programs, marijuana research, and youth drug use education. National Collegiate Athletic Association overturned the federal ban on sports betting, 23 states and the District of Columbia have legalized betting several more are in the process , and most have also introduced excise taxes on the revenues.

Most states that have legalized sports betting have allowed operators to offer both in-person and online betting. There are a few states that only allow in-person or only allow betting on tribal lands. The market share of online betting has grown quickly since the beginning of the coronavirus pandemic in With many professional sporting events taking place without spectators, online betting has become more popular than ever.

Since many states still mandate social distancing, brick and mortar casinos and physical sportsbooks are not able to compete with online sports betting. Out of the 23 states that allow wagering, this is an issue for seven, because they do not allow online betting. Those states, along with states that have not legalized, are more likely to have residents utilizing illegal bookies.

If states choose to legalize, they should give the new industry the best possible chance to succeed and the new consumers a variety of options. Allowing online betting and several operators to service consumers is the best way to support the new industry and consumers. Sports betting taxes are almost always levied as a percentage of the value of the adjusted revenue revenue minus winnings , which is effectively an ad valorem tax on each bet.

Sports betting is one of the few products where an ad valorem tax is appropriate. The best proxy for any harm caused by betting is certainly the amount of money spent on betting.

Tax rates vary significantly among states, where some levy single digit taxes and others impose taxes worth fully half of industry revenue. It is important to remember when setting tax rates on wagering that sports betting facilities will be competing with illicit markets in a way that is analogous to how legal marijuana competes with illegal product.

Setting gambling tax rates too high could keep bettors in untaxed markets. Just like states want to raise revenue from sports betting, so do professional sports leagues. The rise of in-game betting intensifies the importance of the integrity of in-game data, at least theoretically.

Many policymakers have questioned the justifications for these integrity fees and only three states Illinois, Michigan, and Tennessee have adopted them. Despite the pandemic, was a good year for the sports betting industry. In the long run, sports betting represents a real opportunity for new revenue for states—especially if they develop an appropriate regulatory and tax framework, one which allows the industry to grow.

However, it is very unlikely that revenue from sports betting will have any meaningful impact on budget shortfalls. Too often, lawmakers appropriate the funds to tangential spending programs, as in Colorado, where tax revenue from sports betting is used for water projects. The nicotine market in America has changed dramatically over the last decade.

Since vaping entered the market in the mids, it has grown into a well-established product category and viable alternative to smokers.

So far, 28 states and the District of Columbia impose an excise tax on vaping products. In addition, the federal government is likely to impose a tax on vaping products in the near future. From a pure public health standpoint, the rationale for taxing all nicotine products, and not just traditional tobacco products, is not very strong.

It is generally believed beneficial for society every time a smoker becomes a vaper. While more research relating to the potential harm-reduction qualities of vapor products is needed, for now, the consensus is that vapor products are less harmful than traditional combustible tobacco products.

Public Health England, an agency of the English Ministry for Health, concludes that vapor products are 95 percent less harmful than cigarettes. Before discussing the trade-offs in nicotine tax policy design, it is important to introduce the concept of harm reduction. This is the notion that it is more practical to reduce harm associated with use of certain goods rather than attempting to eliminate it completely through bans or punitive levels of taxation.

This concept is relevant because vapor products are less harmful than combustible tobacco products. The main reason for the low success rate in smoking cessation is the addictive nature of nicotine. To put it simply: it is very difficult to quit. Consequently, vapor products could be a key tool in the fight against tobacco-related morbidity and mortality. Protecting access to harm-reducing vapor products is connected to excise tax design as nicotine-containing products are substitute goods.

There is some correlation, and perhaps causality, between recent growth in the vapor market and the pace at which the cigarette market is declining. While vaping has been growing in many states, the decline in smoking has accelerated—especially among teens and young adults. Rather than protecting public health, high-rate excise taxes on vapor products risk harming public health by pushing vapers back to smoking combustible products.

If the policy goal of taxing cigarettes is to encourage cessation, vapor taxation must be considered a part of that policy design. Lawmakers can make sure that the least harmful products are cheaper than the most harmful products by adhering to excise tax principles and levying a tax rate based on the negative externalities and associated costs.

That strategy is utilized in a couple of states, which have introduced provisions in their tax code cutting tax rates in half if the FDA classifies a product with a modified risk tobacco product MPTP order.

These provisions should be encouraged. As a revenue tool rather than a public health tool, the vapor products tax might be tempting. Some of the decline in revenue from traditional tobacco can be made up by taxing other nicotine consumers more. However, assuming the rationale for taxing tobacco involved considerations beyond mere revenue and it should , the harm-reduction potential of vapor products may advise against this, and this rationale still leaves questions around the justification for targeting a single product and group of consumers for revenue.

To the extent that legislators do choose to tax nicotine products, they should design a principled excise regime. For a new category like vapor product, the first step is clear definitions.

Currently the states define vapor products in different ways, which affects how the tax is imposed. Examples of failed definitions can be found in the Tax Base section.

In terms of base, a specific excise tax based on volume e. It is not as simple as it may seem given that vapor products are not all similar.

Closed systems typically have higher nicotine content than open systems. Another option for establishing the base is to tax the potency of the product, but a strength-based nicotine tax has a significant flaw. Such an excise system for vapor products results in high nicotine-liquids becoming relatively more expensive compared to low nicotine-liquids. The logical outcome would be that consumers switch to low-nicotine liquids and customizable devices.

Of course, vapor products are not the only disruptive product on the nicotine market. Nicotine pouches, small non-tobacco-containing pouches that consumers place in their mouth; heated tobacco products, tobacco products without combustion; and snus, pasteurized oral tobacco, have all grown market share over the last few years.

Taxation of these products should follow the same principles as the taxation of vapor products. If they are proven to reduce risk associated with nicotine consumption, they should be taxed at lower rates. Below is a quick guide to appropriate tax base choices. One argument that proponents of high taxes on vapor products often articulate is the need to keep vapor products out of the hands of young people.

While this is a laudable goal, regulation is a far better tool than taxation. For instance, raising the smoking and vaping age to 21—meaning that no high schoolers have access to the product legally—appears to have yielded immediate results. According to results from the National Youth Tobacco Survey, almost two million fewer middle and high schoolers used vapor products in than in While taking the issue of youth nicotine addiction seriously, policymakers would do well to consider the potential of these products in combating smoking of combustible tobacco products before supporting punitive taxes or even bans.

Obesity is a major driver of preventable disease and health-care costs in the United States, and prevention is a worthy goal. Excise taxes on sugar-sweetened beverages SSB has been proposed as one way to help tackle the issues surrounding obesity, but it is doubtful whether such a tax is appropriate to the task.

Sugar-sweetened beverage taxes are generally implemented to curb consumption and as a tool to raise revenue for prioritized spending programs. Regardless of whether such an excise tax is designed as a revenue tool or as a health initiative, it carries inherent flaws. First, the tax base is exceedingly narrow and is thus likely to result in volatile revenue. Second, it is highly regressive, resulting in low-income Americans paying a disproportionate share of their disposable income in excise taxes on SSBs.

So far, no state has implemented an SSB tax, but 10 localities have. Nine out of these 10 levy the tax on liquid by volume. These localities exempt percent fruit juice, unsweetened milk products, dietary aids, and infant formula from the base.

However, both Philadelphia and the District of Columbia include diet beverages in their tax base. Philadelphia implemented a tax of 1. While the stated goal of the tax was to raise money for education programs, the revenue in the first year was about 15 percent lower than projected. Revenue has since picked up and some reports have even found that the tax has, in fact, lowered SSB consumption.

Other reports point to insignificant changes. While SSB taxes may decrease consumption, there are some indications that the taxes are not effective in decreasing caloric intake. National Health and Nutrition Examination Survey data suggests that when individuals reduce soda consumption due to soda tax increases, they fully offset the calories they would have consumed from soda with calories consumed elsewhere, rendering soda taxes ineffective in terms of caloric reduction.

At a rate of 1. Finally, a study concluded that the impact of soft drink taxes on body mass index BMI is minimal and not statistically significant. In terms of internalizing externalities, the issue is that an SSB tax is simply too narrow. By taxing liquid, the tax on high sugar beverages and low sugar beverages of equal volume are the same, which means the tax fails to target the actual sugar content.

This removes any incentive on the manufacturer or consumer to switch out a high sugar product with a low sugar alternative. This flaw could be addressed by taxing sugar directly rather than liquid by volume. However, even if the tax base were adjusted, the base would still only consist of sugary beverages.

Hence, the taxes do not account for sugar intake from other sources, and many other sources of sugar contain significantly more sugar by weight than SSBs. Only taxing sugar in beverages would be equivalent to taxing alcohol in beer but not in wine or only taxing tobacco when smoked in cigars. If sugar is the harm-causing agent and a clear externality can be identified, all sugar should carry the tax regardless of consumption method.

The experiment with SSB taxes has not substantiated claims that such a tax could have a positive benefit on public health. In addition, the inherent design flaws in such a narrow tax also makes it unsuitable to raise revenue in a stable and equitable manner.

State and local governments have long used car rental excise taxes to raise revenue, including for projects with no connection to the taxed activity, like stadium construction and amateur sports funding. Forty-four states levy rental car excise taxes. Most states also permit county and municipal governments to add a rental car tax, which may range from a flat-dollar surcharge to an ad valorem percentage of the price of the car rental. Excise taxes on car rentals are examples of tax policy that aim to export the tax base onto nonresidents.

This has negative effects for residents as well when they pay higher prices for rental car services. States also experience lower economic growth when travelers adjust their behavior to avoid the tax. Evidence shows that travelers reduce their demand for car rentals when taxes rise and they cross state lines in search of a better deal.

Any negative externality associated with car rentals is likely covered by existing taxes on motor fuel, and it is hard to justify additional taxes simply because the vehicle is rented rather than owned.

The sharing economy has given people the opportunity to rent out their own cars through peer-to-peer car-sharing arrangements. This has led to discussions about whether to levy car rental excise taxes on car sharing. However, instead of extending poor tax policy onto new business models, policymakers should reevaluate the tax regime imposed on car rental services. Given that ride-hailing services are substitutes for traditional taxi services, some localities have extended taxes on taxi fares to online ride-hailing services.

Road wear-and-tear, congestion, and other externalities associated with driving are covered by motor fuel taxes; a vehicle being used in ride hailing or for taxi services does not increase these costs. In fact, ride hailing decreases congestion compared to people using their own vehicles. Notably, taxes on cab fares and ride-hailing services are not even always dedicated to infrastructure. In Chicago, the tax pays for public transportation costs, and in Philadelphia, the tax contributes to education spending.

Officials in some cities have argued that ride-hailing services take customers away from public transit and add to congestion. Even if that were the case, only the cost associated with services utilized by cabs and ride-hailing services should be reflected in the tax base and rate.

If a tax is levied, the best base is likely to be a low, flat, per trip charge for pickups at airports or other transit hubs where the unique cost is associated with use of restricted ride-hailing areas. In cases where a state or locality does not levy a tax on regular cab fares, singling out ride-hailing services for taxation is inappropriate. Lawmakers should avoid the temptation of applying special taxes on new and emerging industries simply to raise revenue.

One of the newest trends in excise taxation is taxes on single-use plastics. Examples of these are plastic bags, plastic bottles, and food containers. Some U. The most serious domestic initiative to establish a more comprehensive tax on single-use plastics is in California.

The California Plastic Waste Reduction Regulations Initiative may be on the ballot in and would establish a tax or fee of up to 1 cent per item of packaging.

Revenue from this tax is estimated to amount to a few billion dollars and would be allocated to administer and implement programs intended to reduce waste, increase recycling, and restore habitats. Excise taxes that target all or some types of single-use plastics are likely to become more common in the future.

While this kind of tax may be justified as a means to internalize the externalities associated with single-use plastics, like pollution, one should remember that negative externalities are associated with most common consumption and that tax policy does not happen in a vacuum. A plastics tax, even a quantity-based one at a low rate, would significantly increase tax burdens on businesses and consumers. This is especially relevant in California—a state that already has one of the least business-friendly tax systems and highest tax burdens on residents nationwide.

The excise tax on firearms was established under the National Firearms Act in , though archery items were not added as taxable items until Pistols and revolvers are taxed at 10 percent of value; ammunition and other firearms are taxed at 11 percent of value; and archery items are taxed at 11 percent except shafts, which are taxed at 39 cents per shaft.

The allocation of the receipts is regulated by the Pittman-Robertson Act. The excise tax on fishing gear was established by the Dingell—Johnson Act in Traditional IRA. Income Tax.

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I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. Personal Finance Taxes. What Is an Excise Tax? Key Takeaways Excise taxes are taxes required on specific goods or services like fuel, tobacco, and alcohol.

Excise taxes are primarily taxes that must be paid by businesses, usually increasing prices for consumers indirectly. Excise taxes can be ad valorem paid by percentage or specific cost charged by unit. Some excise taxes can be required directly from the consumer like property taxes and excise tax penalties on certain retirement account activities.

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This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace. For example, the tax on an airline ticket generally is paid by the purchaser and collected by the airline. If the due date for filing a return falls on a Saturday, Sunday or legal holiday, the due date is the next business day.

The IRS does accept paper excise tax returns. However, electronic filing is strongly encouraged, when possible. To make this process easier for taxpayers, the contact information for all approved e-file transmitters of excise forms is listed on IRS.

Businesses can submit forms online 24 hours a day. When businesses e-file, they get confirmation that the IRS received their form. Also, e-filing reduces processing time and errors.