Taxing the Poor
Friday, June 22, 2007
by the National Center for Policy Analysis Task Force on Taxing the Poor
Table of Contents
"The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least amount of hissing."
-- Jean-Baptiste Colbert
Governments have many ways to finance their activities. Unfortunately, the desire to adopt a tax policy that will meet the least resistance leads many lawmakers at the federal, state and even local level to pursue policies that have a disproportionately negative impact on lower-wage earners. For example, selective consumption taxes, or excise taxes, have been used to raise government revenue in America since before the Colonies became the United States. In recent years, excise taxes have become popular instruments in state leaders' fiscal toolboxes. However, the research presented in this report demonstrates that such taxes are regressive because they tend to take a higher percentage of the income of lower-income households - in some cases significantly higher.
This report examines excise taxes in several interesting ways. The first three sections deal with "sin taxes," or taxes on tobacco products, alcohol (including beer, wine and spirits) and gambling. The fourth section examines excise taxes on necessities. Taxes on these activities have a long history, are economically significant and are often controversial. Thus, this report is guided by an extensive body of literature examining the impact of excise taxes.
What Are Excise Taxes?
Excise taxes are fees levied on specific products like cigarettes, beer and gasoline. Unlike broad-based taxes, such as general sales or income taxes, excises are often paid by a narrow subset of the population, for example, smokers, consumers of alcohol and so forth. These taxes are often hidden from consumers because they are embedded in a product's retail price.
“Excise taxes are regressive — meaning the tax burden falls disproportionately on lower earners.”
Some excise taxes are referred to as "sin taxes," because they purportedly discourage undesirable behaviors such as smoking, drinking and gambling. Others are levied on necessities like gasoline, air travel and utilities. Excise taxes are attractive to lawmakers because they are easy to identify, easy to collect and, in the case of taxes on sinful products, it is easy to summon the political will to pass them. By hiking sin taxes, policymakers have been able to raise revenues without encountering the voter backlash that would come with an overt hike in broad-based tax rates. Further, because close substitutes for addictive or indispensable products are difficult to find, demand for the product will likely not change much in response to higher taxes.
Excise taxes are a significant source of public revenue, especially at the state and local level:
- The federal government collected $79 billion in excise tax revenues in 2004 (the last year for which comprehensive data are available). 1
- In 2004, state and local governments collected more than $17.6 billion in tobacco and alcohol taxes alone.
- In 2005, state governments collected almost $100 billion in excise taxes, and collected an additional $42.7 billion in state liquor license fees and other licenses and fees. 2
Policymakers repeatedly attempt to raise more revenue with excise taxes - particularly at the state level, and particularly from sin taxes. For example:
- In recent years, 42 states have increased cigarette taxes. 3
- In the 2006 elections alone, voters approved ballot measures to increase tobacco taxes in Arizona and South Dakota (and to require smoke-free workplaces and public places in Arizona, Nevada and Ohio). 4
- The last two deficit reduction measures at the federal level - in 1989 and 1993 - included a large dose of excise tax hikes on tobacco, alcohol and gasoline. [See the sidebar "Excise Taxes throughout American History."]
Who Pays Taxes, the Rich or the Poor?
“Low earners spend a higher percentage of their incomes on excise-taxed goods than higher-income people.”
There is little doubt that excise taxes are regressive. Because they are simply narrowly-focused consumption taxes, they drain a larger share of the incomes of lower earners than of higher earners. Consider two families, one earning $10,000 a year and the other earning $100,000. If both spend $100 a year on cigarette taxes, the amount constitutes 1 percent of the lower earner's salary, but only 0.1 percent for the higher earner. Consider: 5
- People in the lowest-earning quintile (average income $9,168) spend 31.1 percent of their incomes on alcohol, tobacco, utilities and gasoline, on average.
- By contrast, the highest earners spend just 6 percent of their income on the same items.
- Since excise taxes on these items are paid as a percent of the purchase price, the taxes paid are also regressive.
Further, looking just at smokers and gamblers, those with lower incomes actually spend more in real dollars than higher-income people, on the average, making the regressivity problem even worse.
This report focuses primarily on the effect of excise taxes on people with different incomes. However, some scholars suggest that examining excise taxes alone is misleading because the tax system as a whole is progressive. Consider: 6
- The top 0.1 percent of taxpayers earn 9.1 percent of the income, but pay 17.4 percent of all federal taxes.
- The top 1 percent of taxpayers earn 19 percent of the income but pay 36.9 percent of the taxes.
- The top 5 percent earn 33.4 percent but pay 57.1 percent, while the bottom 50 percent earn 13.4 percent but only pay 3.3 percent of federal taxes.
The story is much the same at the state level. The system looks even more progressive when one considers government transfers to lower earners through the Earned Income Tax Credit, Food Stamps, Medicaid and other welfare programs.
Other researchers go one step further and suggest the targeted spending of excise tax revenues on smoking cessation programs, education, alcohol abuse prevention and roads make the taxes much less regressive - and maybe even progressive. The reason: Lower earners receive large portions of their income in the form of government transfers, and these transfers are implicitly or explicitly tied to the taxes collected. In other words, if people pay higher excise taxes and revenues increase, so do transfers. However, new excise tax revenue seldom finds its way to its promised objectives, and there is no guarantee that the revenue does not simply replace funding that was going to be spent anyway.
“Policymakers increasingly rely on excise taxes, rather than broader-based taxes, for new revenue.”
Take, for example, alcohol taxes. Recently proposed alcohol tax increases are supposed to have gone toward alcohol awareness and abuse prevention programs, but much of the money was actually slated for other projects, such as offsetting income tax reductions, pay raises for teachers and education. 7 If the new money generated by higher taxes on alcohol funds non-alcohol-prevention-related general budget items, then state legislatures are punishing alcohol consumers. Thus, they are burdening lower-income people and adding cash to state coffers.
These perspectives are valid and deserve further study. However, federal and state decision-makers increasingly rely on excise taxes for new revenue, rather than broader-based taxes like a general sales tax or income tax. Thus, an examination of excise taxes - and their effects on lower-income populations - is both interesting and important.
Why Excise Taxes? Why Not?
Advocates of higher excise taxes pursue them for two purposes. First, like any tax, excises are intended to raise revenues for government programs. Second, they are intended to recoup the cost of "externalities," or in the case of sin taxes, to encourage people to commit less sin.
“Many excise taxes are intended to discourage ‘sin.'”
An externality is a cost not paid by the person who enjoys the benefit. Smokers create externalities by exhaling second-hand smoke. Cars that belch exhaust create externalities by polluting the air. Taxes are one way of forcing someone who creates externalities to bear the costs. But how high should the excise tax be? The problem comes in identifying the "correct" tax rate. For example, the research in this report indicates that smokers already pay their own way, yet tobacco taxes continue to rise each year. And high taxes on alcohol will likely harm moderate drinkers who cause no externalities. While some of these externalities arguments are considered in this report, the primary focus is on the burden of these excise taxes on the poor.
Appeals to Efficiency . Most proponents of excise taxes acknowledge their regressive nature, but justify them on the basis of efficiency. All taxes distort the relative prices of goods and impede the flow of goods and services to their best use. A tax on gasoline, for example, may increase the cost of transportation to the point where someone is prevented from seeking a better but more distant job. A tax on cigarettes may increase the cost of smoking to a smoker who cannot quit the habit. In the terminology of economics, an efficient tax is one that induces minimal distortion. A significant amount of published research on excise taxes explores the question of efficiency, often concluding that these taxes are efficient. One of the reasons they are efficient is that such taxes are difficult to evade, since they are collected by service providers or at the point of sale. Further, because there are few substitutes for sinful products or necessities, demand for the good doesn't change much in response to an increase in price. That is one reason they have been so popular with state and local governments. Of course, heavily taxing a good might result in a black market, diverting funds from both the government and the industry.
Paternalism . An additional consideration in this report is the role of the government in protecting people from their own choices. Despite America's tradition of independence and freedom, there is also a strong strain of moral paternalism in American life. Certain religious and cultural traditions have long-standing objections to alcohol and gambling. More recently, some states claim the right to regulate unhealthy choices, in particular the use of tobacco. Questions of paternalism may be inextricably linked to an analysis of the burden of the tax. While many of these paternalistic arguments seem arrogant and condescending, they should be addressed.
Nowhere is this more apparent than in the case of sin taxes. Not only is there a patchwork quilt of charges and fees on tobacco, alcohol and gambling products, but states also regulate every aspect of their sale. The clearest example is gambling: States regulate where people can gamble, the games available and how much people can spend. In addition, regulations in some states impose an even larger implicit tax on alcohol than stated in this paper. For example, some states require certain types of alcohol to be purchased from state-sponsored or state-operated stores, which imposes a large cost in convenience as well as price. And it is easy for politicians to gin up support for sin taxes, since they can trumpet an altruistic intent to stamp out smoking, drinking and so forth.
“States increasingly rely on sin taxes for revenue.”
But sin taxes present a bit of a conundrum for the state. Some policymakers advocate higher sin taxes to discourage harmful behaviors, but there is no doubt states have become increasingly reliant on sin taxes as a base of revenue. Thus, states are in the awkward position of trying to wean people off "bad behavior" while also depending on said behavior to fund state programs. Cynics might conclude that state leaders pay lip service to reducing bad behavior but, in reality, see excise taxes as a politically expedient way to raise more money in a Byzantine tax system.
By any measure, excise taxes place a heavier burden on lower-income families; as a result, they are regressive. Policymakers who consider raising excise taxes at the federal, state or local level - regardless of the good they think they are doing - should consider the disproportionate burden their lower-income constituents will bear.
1 Tax Foundation, "Federal Excise Tax Collections, 1940-2006," Fact Sheet, April 28, 2006. Available at http://www.taxfoun
2 U.S. Census Bureau, "State Government Tax Collections: 2005," May 22, 2006. Available at http://www.census.gov/govs/statetax/0500usstax.html.
3 Statement by William V. Corr, Executive Director of the Campaign for Tobacco-Free Kids, "Voters Across America Rebuff Big Tobacco, Approve Ballot Measures to Reduce Smoking, Save Lives," Campaign for Tobacco-Free Kids, Press Release, November 8, 2006. Available at http://www.tobaccofreekids.org/Script/DisplayPressRelease.php3?Display=954.
5 "Consumer Expenditure Survey, 2004," U.S. Department of Labor, Bureau of Labor Statistics.
6 Thomas Piketty and Emmanuel Saez, "How Progressive Is the U.S. Federal Tax System? A Historical and International Perspective," National Bureau of Economic Research, Working Paper No. 12404, July 2006.
7 Alcohol Policies Project, Center for Science in the Public Interest.