Is an Excise Tax Progressive or Regressive?
An excise tax applies to specific goods, but its economic burden is not shared equally. Learn how this tax structure impacts different income levels.
Taxes are often categorized by their impact on individuals across the income spectrum to understand the fairness and economic consequences of taxation. A central question is how to classify excise taxes, which apply to specific goods and services. Determining whether these taxes disproportionately affect lower-income or higher-income individuals helps in evaluating their role in the broader fiscal system.
What is an Excise Tax?
An excise tax is a legislated tax on specific goods, services, or activities. Unlike a general sales tax, an excise tax targets a narrow list of items. These taxes are often levied at the point of manufacture or sale and are included in the final price a consumer pays, making them a form of indirect taxation. Because of this, consumers may not be aware they are paying the tax.
Common examples of goods subject to federal excise taxes include gasoline, tobacco, alcohol, airline tickets, and indoor tanning services. For instance, the federal government imposes a tax of $0.184 per gallon on gasoline and a tax of $1.01 per pack of 20 cigarettes. These taxes can be a fixed amount per unit, known as a specific tax, or a percentage of the price, referred to as an ad valorem tax. An example of an ad valorem tax is the 7.5% tax on domestic air transportation.
Understanding Tax Structures
Tax systems are defined by three primary structures: progressive, regressive, and proportional. A progressive tax is one where the tax rate increases as income increases, meaning higher-income individuals pay a larger percentage of their income in taxes. The federal income tax system is an example of a progressive structure.
A regressive tax is one where the tax burden falls more heavily on individuals with lower incomes. A proportional tax, often called a flat tax, is a system where the same tax rate is applied to everyone regardless of income.
To illustrate, in a progressive system, someone earning $30,000 might pay 10% in taxes, while someone earning $100,000 pays 25%. Under a proportional system, both individuals would pay the same rate, for instance, 15% of their income.
The Regressive Nature of Excise Taxes
Excise taxes are considered regressive. This is not because the tax rate itself changes, but because the tax is levied on a unit of a good, not on a person’s income or ability to pay. The fixed nature of the tax means it consumes a much larger portion of a low-income household’s budget compared to a high-income household’s budget.
Consider the federal excise tax on gasoline. A person earning $30,000 per year and a person earning $150,000 per year both purchase a 15-gallon tank of gasoline. They both pay the same federal excise tax of $2.76 ($0.184 per gallon multiplied by 15 gallons). For the individual earning $30,000, this $2.76 represents a significantly larger fraction of their income than for the individual earning $150,000.
This effect is magnified with goods like tobacco. If two individuals, one with a low income and one with a high income, both smoke a pack of cigarettes a day, they pay the same federal excise tax of $1.01 per pack. Over a year, this amounts to $368.65 for each person, a much heavier burden for the lower-income individual.
Rationale for Implementing Excise Taxes
Governments implement excise taxes for several policy reasons. One motivation is to discourage the consumption of goods considered harmful to individuals or society, often referred to as “sin taxes.” By increasing the price of products like tobacco and alcohol, the government aims to reduce their use and offset some of the societal costs associated with them, such as public health expenses.
Another rationale is to function as a user fee. In this capacity, the tax revenue is intended to fund services directly related to the taxed activity. The federal gasoline tax is an example, as revenue from this tax is deposited into the Highway Trust Fund to help finance the construction and maintenance of highways and public transit systems.
Similarly, taxes on airline tickets help fund the Federal Aviation Administration and airport infrastructure. This approach links the cost of a public service to the people who use it most.