Sales tax is a type of consumption tax applied by state and local governments at the point of sale (when you buy goods or certain services). It’s generally calculated as a percentage of the purchase price and added at checkout. The seller collects this tax from the buyer and then submits it to the appropriate tax authority. Sales Tax are often separately stated on an invoice.
What Is Excise Tax? Definition, Types & Examples
Governmental finance strategies are vast, intricate matrices founded upon numerous types of indirect taxes. One lesser-known tax type is the excise tax. Although many people may be unfamiliar with the term, they are likely well-acquainted with its effect on their purchasing power.
What is an excise tax?
Excise tax, also known as a duty or sin tax, is a type of indirect tax levied on certain goods or services – typically those deemed as harmful or linked to health issues. Its primary objective is twofold: firstly, to serve as a mechanism for raising government revenue, and secondly, to discourage the consumption of certain goods or services.
While sales taxes levied on goods are generally a flat percentage of the sale price across different categories, excise taxes are specific. This means they are often charged per unit or quantity (e.g., per gallon of gas, per pack of cigarettes), rather than as a percentage of the cost.
How Excise Taxes Work
Excise taxes are typically collected at the manufacturer or importer level, rather than at the point of sale to the end consumer. This makes them a form of indirect taxation, where the tax burden is often embedded in the price of the product or service. For example, when you purchase gasoline, the excise tax has already been paid by the supplier and passed down the chain — you don’t see it itemized, but you’re still paying it.
Depending on the product and jurisdiction, excise taxes can be calculated in two ways: specific excise taxes are charged per unit (e.g., cents per gallon of fuel), while ad valorem excise taxes are based on a percentage of the product’s value. Businesses responsible for excise taxes typically report and remit them to the IRS using Form 720 on a quarterly basis. At the state level, processes and rates vary, adding complexity for businesses operating across jurisdictions.
Examples of Excise Tax
Excise taxes are imposed on goods or services such as:
- Tobacco
- Alcohol
- Gasoline
- Airline tickets
- Gambling
The items chosen to carry excise taxes often have negative societal, environmental or health consequences that governments seek to curb.
Take smoking, for example – excise taxes increase the cost of tobacco, dissuading more people from starting or continuing the habit. Additionally, the revenue generated from these ‘sin taxes’ often funds public health initiatives, indirectly compensating for the societal costs these products may cause.
The role of excise tax in governments' indirect taxation strategy
Indirect taxes such as excise taxes hold a secure place in governmental tax strategies for several reasons. Firstly, they are a steady income stream that is relatively stable and predictable due to the inelastic demand for many of the goods and services they tax.
Secondly, and perhaps most importantly, it can be an effective tool for achieving social policy objectives. Through strategic implementation of excise taxes, governments can guide public behavior, push for healthier lifestyles, boost environmental sustainability and even improve traffic congestion.
Complexity in calculating excise taxes
Given that they are typically applied to very specific goods or services, excise taxes often display great variance in terms of their rates and applicability. Determining the correct excise tax rate can be a complex task heavily influenced by the category of the product or service; the intended policy goals; and the jurisdiction in which the product or service is purchased.
The computation gets further complicated when considering that excise taxes can be ad valorem or specific:
Ad Valroem Taxes: Ad valorem taxes are assessed as a fixed percentage of the product's value.
Specific Taxes: Specific taxes are charged per unit of the product.
Choosing which manner to impose the tax can have significant impacts on both consumers and producers. For example, a high ad valorem tax might be most effective for expensive luxury goods, discouraging excessive consumption. However, a fixed per-unit tax might be preferred for harmful substances like alcohol or tobacco, where the goal is to decrease consumption across all price points.
Moreover, the location of purchase can drastically influence the excise tax. States, countries and even local jurisdictions have different rates for the same goods.
The impact and challenges of excise taxes in public policy and society
Excise taxes, while not as frequently discussed as other forms of consumption taxes, play a crucial role in public finance and social engineering. They are a potent tool for governments to control consumption patterns, encourage desirable behaviors and drive revenue for public initiatives.
However, the complexity in calculating the correct amount of excise tax shouldn't be understated. It's a delicate balancing act. Set it too high, and the tax may disproportionately harm lower-income consumers, creating socioeconomic inequalities. Set it too low, and the tax fails in its objective to curb consumption and generate ample revenues.
As is true for all forms of taxation, finding the right equilibrium is the ultimate challenge. Yet, with careful implementation and thoughtful regulation, excise taxes can serve as a powerful lever in the “policy tool kit” that governments use to shape society for the better. Despite its complexities in calculation and implementation, their potential in aiding important public policy objectives can't be overlooked.
Digging deeper into the mechanism of taxation further underlines the interconnected nature of economics and society. It sheds light on how an often-undervalued tool such as excise tax can have an outsized impact. A little bit of indirect taxation here and there indeed goes a long way toward shaping the world around us.
Disclaimer
Please remember that the Vertex blog provides information for educational purposes, not specific tax or legal advice. Always consult a qualified tax or legal advisor before taking any action based on this information. The views and opinions expressed in the Vertex blog are those of the authors and do not necessarily reflect the official policy, position, or opinion of Vertex Inc.
FAQ's
Excise tax refers to a levy applied to goods produced domestically, distinguishing it from customs duties, which are imposed on imported goods. It is administered by governmental authorities and serves as a targeted fiscal instrument within national borders. Excise Tax is often applied earlier in the supply chain, paid by the manufacturer, importer, or distributor. Cost is rolled into the product’s price on an invoice, paid indirectly and without a separate line item on the receipt.
For more information, check out our blog: “Identifying Important Kinds of Taxes: Direct and Indirect Taxes”.
Excise tax is a targeted levy applied to specific goods, services, or activities—unlike sales tax, which broadly covers consumer purchases. It’s typically a fixed amount rather than a percentage, and it’s assessed earlier in the supply chain, often per unit. This tax is usually paid by manufacturers, producers, or service providers and is often embedded in the final price of the product.
The federal excise tax is imposed by the U.S. government on specific goods and services—think fuel, tobacco, alcohol, air travel, and certain chemicals. Unlike general sales tax, it’s typically collected from manufacturers or importers of record rather than consumers. These entities report the tax to the IRS, often using Form 720, and the cost is usually built into the product’s price before it reaches the buyer.
Surcharges are extra fees added by companies or service providers — basically, they decide to charge you more for something, often used to stay profitable with rising input costs (eg. off-setting fluctuations in commodities or stated as service fees – think accepting credit card fees). Surcharges are often separately stated on an invoice.
In short, excise taxes are public levies with legal backing, while surcharges are private fees driven by business needs.
Surcharges are private fees driven by business needs and taxes are set by the government and are required by law. The money from surcharges goes to the business, while tax money goes to public funds. A surcharge may be considered a tax if describe a government-mandated fee passed on to customers - taxes that governments impose and require businesses to collect from customers, e.g., USF Surcharge, Emergency service surcharge (E-911).
- Excise tax is imposed by a government body targeted at specific goods or services—like fuel, alcohol, or tobacco- usually a fixed amount per unit and is charged earlier in the supply chain, often paid by manufacturers or importers and built into the product’s price.
- Surcharge is an extra fee added by businesses or service providers, not by the government. It’s typically used to cover operational costs or special circumstances (like fuel or service fees) and goes directly to the company, not public funds.
- Custom duties are taxes imposed on goods brought into a country. They’re set by the government to regulate trade, protect domestic industries, or generate revenue. These are paid at the border by importers and vary depending on the product type and origin.
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