February 12, 2024

Growing Florida's Revenue Sources: Best Practices on Levying Excise Taxes

Throughout the country, state and local governments levy excise taxes. As defined by the Internal Revenue Service, an excise tax “is imposed on the sale of specific goods or services, or on certain uses.” Typically, states levy excise taxes on tobacco, alcohol, and motor fuel. These taxes are different from broad-based consumption taxes (e.g., general sales tax) because they are selective in nature. The use of excise taxes can be justified by a variety of rationales:

  • Implementing an ability-to-pay approach to taxation (e.g., a so-called “luxury tax”). The Omnibus Budget Reconciliation Act of 1990 imposed a 10 percent excise tax on luxury items like expensive cars, boats, yachts, aircraft, jewelry, and furs. (The 10 percent luxury excise tax was repealed in 1993 and phased out by 2003.) Moreover, there are certain states that impose higher transfer taxes on luxurious properties, also known as a "mansion tax," whenever a house is purchased or sold.
  • Discouraging consumption of goods or services that are considered harmful or undesirable. Excise taxes intended for this purpose are known as "sumptuary excises." Examples include taxes on alcoholic beverages, tobacco products, and gambling. Undesirable goods or services that are addictive often have inelastic demand, meaning that consumer demand does not change much even if prices go up.
  • Addressing "negative externalities." This rationale is linked to sumptuary excises, highlighting the societal impact instead of the individual impact of goods or services that are harmful or undesirable. A negative externality occurs when a transaction has a detrimental effect on a third party uninvolved in the transaction. An example of this is the harm caused by secondhand smoke to individuals who did not purchase cigarettes themselves. In effect, revenue from excise taxes can go toward mitigation efforts.
  • Implementing a benefits-received approach to taxation. Take gasoline taxes, for instance, which play a vital role in funding highway travel and establishing a direct connection between the taxes individuals pay and the benefits they receive from roadways. The link is made even more powerful by specifically allocating or “earmarking” the revenue generated from an excise tax to support the provision of government services associated with the activity.

The rationales provided are not mutually exclusive, leaving it in the hands of policymakers in Florida to create excise taxes that effectively meet the demands of the state and local communities. It is important to remember that excise taxes have, by necessity, a narrow base. Implementing or increasing an excise tax poses less risk to the overall economy, especially regarding its limited effect on specific industries or consumers. However, according to the Institute on Taxation and Economic Policy, excise taxes are regressive. Floridians earning less than $40,000 a year spend a larger portion of their income on excise taxes than wealthier residents.

Also, policymakers ought to acknowledge the tension between raising revenue and behavioral adjustments. Most excise taxes aim to raise the price of a product or service, primarily to decrease consumption. However, they also serve the important purpose of generating revenue, while minimizing the likelihood of facing significant opposition. The goals of eliminating an activity and generating revenue through an excise tax are incompatible. If policymakers successfully devise a tax that eliminates an activity such as smoking, drinking, or gambling, the activity will also cease to generate any revenue. The Urban-Brookings Tax Policy Center explains that while states may initially see a boost in revenue, these gains are usually short-lived and can potentially pose major fiscal challenges in the long run. This is particularly true when revenue growth decreases or when higher tax rates are required to maintain a desired level of revenue.

While designing and implementing an excise tax is not easy, policymakers should consider the following best practices (for a discussion, see Tax Foundation):

1. Broadening the tax base is important for neutrality and efficiency in raising revenue at a low rate.

Excise taxes are typically based on harmful or cost-inducing factors. For example, the amount of tobacco plant intended for smoking or alcohol content.

2. Substitute goods that do not result in negative externalities should not be included in the tax base.

If an excise tax is levied on sugar-sweetened beverages, non-sugar beverages should not be taxed. Including substitute goods in the tax base can discourage desirable substitutions from more harmful goods to less harmful ones.

3. An efficient tax rate is not the same as a revenue-maximizing rate.

An excise tax is generally used to recover the social costs that come with selling a particular good or service. Appropriately leveled tax rates can be indexed to inflation to retain the real value of tax level. Excise taxes should not be used for general revenue, as this could result in excessive taxation for general spending.

4. Revenue from excise taxes should be allocated to cover societal costs related to consumption.

Excise taxes are usually meant to discourage certain behaviors and deal with negative effects on society. Revenue from excise taxes should be linked to the specific activity that generates them, such as health care expenses related to smoking or gambling, and transportation costs caused by driving. Adequately establishing a connection between an excise tax and revenue allocation ought to increase a taxpayers’ understanding of the tax.

5. Quantity is associated with negative externalities or costs while a product’s price often has no association.

An excise tax based on the quantity of goods or services sold (like alcohol content or packs of cigarettes) is often better than a tax based on the value of the goods or services.

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