Taxing the Poor

Studies | Taxes

No. 300
Friday, June 22, 2007
by the National Center for Policy Analysis Task Force on Taxing the Poor


Section IV: Other Excise Taxes and Fees

Introduction

The analysis of excise taxes thus far has been limited to so-called sin taxes on tobacco, alcohol and gambling, which are intended, in part, to discourage sinful behavior or behavior that may be considered inappropriate or harmful.  However, there are also excise taxes on certain necessities of everyday life.  Virtually anyone who owns a phone, drives a car or has purchased an airline ticket has been confronted with federal and state - and sometimes local - excise taxes.  Just as lower-income people pay a larger share of their income when they use tobacco or alcohol or gamble than do those with higher incomes, they also face a disproportionate burden from excise taxes on goods like gasoline or telephone service that are considered necessary in modern living.  This section focuses primarily on excise taxes levied on two necessities: motor fuels and telecommunications. 

Taxing Necessities

“More than 78 percent of all excise tax revenues are from taxes on necessities, such as gasoline and telephones.”

Excise tax revenues at the federal, state and local levels have grown dramatically over the past several decades.  This growth has not come primarily from sin taxes, but rather from excise taxes on a variety of necessities like telephones and gasoline, as well as a host of "trust fund" taxes for highways, airports and environmental concerns.  In fact, more than 78 percent of all excise tax revenues are from taxes on necessities. 

  • Federal excise tax collections totaled some $73.5 billion in fiscal year 2006, of which non-sin excise taxes made up about $57.7 billion. 1   [See Table IV-1 .]
  • State and local excise tax collections totaled about $99 billion in fiscal year 2005, with the vast majority coming from non-sin excise taxes.  [See Table IV-2 .]

“Federal excise taxes totaled some $73.5 billion in 2006.”

While economic theory does not offer a single, clear definition of a "necessary good," there are several markers of a good's importance to everyday life.  First, a necessity should be relatively insensitive to changes in price; that is, quantity demanded of the good should not change much if the price goes up.  For example, someone who must take a fixed quantity of a medication in order to live is unlikely to take less if the price rises. 

“In 2005, the states collected almost $99 billion in excise taxes.”

Second, the demand for a necessary good is also likely to be insensitive to income:  A rich person and a poor person who both need a specific dosage of a life-saving medication will likely buy the same amount.  By this standard, it is clear several heavily taxed goods, such as gasoline, are necessities.  This has important implications for the burden and efficiency of these taxes. 

Consider the percentage of income people at different income levels dedicate to necessities like utilities and services.  [See Table IV-3 .]

  • As expected, the highest earners spend much more on necessary household items than the lowest earners ($4,301 versus $1,720 per year).
  • But while the highest earners spend just 3.3 percent of household income on these necessities, the lowest earners spend almost six times as much (18.8 percent of income).

Thus, when items like phone service, public utilities and so forth are taxed, the taxes can be quite regressive.

Case Study: Excises on Motor Fuels

“Total federal and state gas taxes average about 40 cents per gallon.”

The federal government imposes a tax of 18.4 cents per gallon of gasoline.  Every state also taxes gasoline at rates ranging from 8 cents per gallon in Alaska to 31.2 cents in Pennsylvania.  The total federal and state gas tax is now about 40 cents per gallon on the average.  Federal and state governments also levy similar taxes on diesel fuel and gasohol (gasoline mixed with ethanol) products. 

The gasoline tax was originally intended to fund the construction and maintenance of public highways through the U.S. Highway Trust Fund. 2   The federal government is projected to collect about $39 billion into the highway fund in 2006; additionally, states took in about $34.6 billion in 2005.  The federal gas tax was increased twice in the 1990s, with the revenues going to myriad purposes:

  • Among the many provisions of the Omnibus Budget Reconciliation Act of 1990 was a measure that increased the tax rate on highway fuels by 5 cents per gallon, from 9 cents to 14 cents; half of the new revenue was dedicated to the Highway Trust Fund, but the other half went to general federal deficit reduction.
  • The Omnibus Budget Reconciliation Act of 1993 continued the trend by raising the excise tax on gasoline to the current level of 18.4 cents per gallon, with much of the increase entirely devoted to deficit reduction.

“The highest earners spend just 3.3 percent of income on necessities, while the lowest earners spend almost six times as much.”

Pros and Cons of Raising the Gas Tax .  A number of policymakers advocate radically higher gas taxes.  Their primary rationale is that this would capture some of the external costs imposed on society by the burning of gasoline.  Proponents reason that higher gas prices will induce people to purchase fuel-efficient cars, use public transportation or generally drive less.  In fact, higher gas taxes have been seen by some as a way to cure a whole host of society's ills, from global warming (by reducing CO 2 emissions) to terrorism (by reducing dependence on foreign oil). 

Can gasoline be priced high enough to cause consumers to make substantial reductions in their gasoline purchases?  A study by the Federal Trade Commission (FTC) found that a gasoline price increase of 10 percent would reduce quantity demanded by just 2 percent in the short run and by only 6 percent over the course of one year, demonstrating the relative inelasticity of demand. 3

Distributional Effects of Rising Motor Fuel Prices.   The question of how gasoline expenditures vary by income is somewhat complicated.  It is clear that higher-income groups spend somewhat more on gasoline than do lower-income groups, but as a percentage of income, lower earners spend more.  [See Table IV-4 .] 

  • Households with extremely low incomes (an average of about $9,000 per year) spend only about $730 a year on gas and motor oil, which amounts to only 8.0 percent of their income.
  • Households in the second-lowest income quintile (about $24,000 a year) spend about $1,157 on gas and motor oil, which amounts to more than 4.8 percent of annual income. 
  • By contrast, households in the highest quintile (about $132,000 per year) spend about $2,500 a year, or only 1.89 percent of income. 

“People making $24,000 a year spend more than twice as much of their income on gasoline as those who earn five times as much.”

Corroborating evidence is presented in a recent report by the Federal Reserve Bank of Chicago. 4   According to this analysis, households with incomes in the top quarter of all households devoted 3.3 percent of their expenditures to gasoline, while households in the bottom income quartile spent 3.8 percent on gasoline and those in the second-lowest quartile spent 4.1 percent.

“The working poor spend a higher proportion of their incomes on energy than any other group.”

The Fed report also reveals one other important pattern that is both disturbing and underreported:  The impact of the cost of gasoline on the working poor.  As Table IV-5 shows, the working poor spend a higher proportion of their income on gasoline than any other group identified in the study.  This is not surprising since the working poor have lower incomes but still need transportation to work and child care.  Thus, an increase in gasoline taxes would have a much more significant impact on the lives of these people than on the lives of, say, the upper-income elderly.

As the FTC report indicated, to induce more than a marginal change in behavior, gas prices would have to be so high that they would interfere with economic growth.  Further, higher gas prices would place a disproportionate burden on lower-income people both because of 1) the regressive nature of gas taxes and 2) the higher price of shipping goods to the market. Higher shipping costs would be passed through to consumers and take a larger bite out of lower earners' paychecks as a percentage of income than paychecks of higher earners. 

Case Study: Taxing Telecommunications

While new technologies create new opportunities for entrepreneurs, they also create tempting new targets for tax collectors.  There are several reasons to suspect that new businesses might be especially vulnerable to being taxed:

  • First, opposing coalitions of consumer and business interests will be less organized in new markets. 
  • Second, those involved in new, cutting-edge businesses may seek government support in some other areas - perhaps seeking subsidies for research or assurances of exclusive rights to certain markets; taxes might be a concession for these favors. 

The tendency to tax new businesses is most obvious in the current frenzy of federal and state governments to tax wireless communications. 

“Wireless communications have become a popular source of revenue for state and local governments.”

Taxing Telephone Service.   Traditional telephone service has long been subject to special taxes imposed at all levels of government.  The tax on telephone service was initially instituted in 1898 as a "luxury tax" - back when phones were considered luxury goods - to fund the Spanish-American War.  Over time the federal excise tax has ranged from 1 percent to 10 percent of a phone bill, and for the past two decades has been set at 3 percent.  The tax raised about $5.8 billion for the federal government in 2005. 5

But the marketplace is changing.  Wireless telephone service and use have exploded over the past couple of decades.  [See Figure IV-1.]  According to recent reports, cell phone revenue grew from $56 billion in 2000 to $102 billion by 2004; landline revenue fell from $228 billion to $197 billion over the same period. 6

Figure 4-1

“Wireless telephone use has exploded over the past couple of decades.”

As the market makes the transition from traditional landlines to cellular service, wireless communications have become a popular source of revenue at the state and local levels.  Cell phone taxes increased nine times faster than taxes on other goods between January 2003 and April 2004, according to a recent industry study. 7   Baltimore, for example, instituted a new $3.50 per month tax in late 2004. 8

Table IV-6 presents the myriad state and local tax rates on cell phone service:

  • State rates range from a low of about 4 percent in Nevada to a high of about 30 percent in Virginia. 
  • Overall, state and local telecom tax rates average about 14.17 percent of a phone bill. 
  • The federal government also charges taxes on cell phone service, which have been estimated as high as 6.05 percent. 9

“State tax rates on cell phone service range from 4 percent in Nevada to almost 30 percent in Virginia.”

Distributional Effects of Taxing Telecommunications.  Since these telecommunications taxes are new, there is little research as to their distributional impact.  However, there has been some analysis as to where the growth in the use of cellular phones has been greatest, with particular attention de-voted to the question of whether cell phones are replacing landlines. 

“Average state and local taxes on telecommunications are over 14 percent.”

Interestingly, there is increasing evidence that lower-income households are especially likely to rely entirely on cell phones.  A recent survey by the Pew Foundation shows the proportion of respondents that used a cell phone but did not have access to a landline to be disproportionately low-income (53 percent earned less than $30,000). 10   Thus - while the evidence is still preliminary - it seems lower-income earners bear a large share of the extraordinarily high telecommunications taxes.  

Conclusion

While there is some justification for higher motor fuel taxes on the grounds that they recoup some external cost, there is no similar justification for taxes on utilities like phone service.  The only argument in favor of such a tax is that it is difficult to evade, since it is collected by phone service providers.  That is one reason they have been so popular with state and local governments.  When rushing to raise taxes on phone services and other utilities, decision-makers should remember that these taxes are regressive and raising the rates will disproportionately harm their lower-income constituents. 

References: Table IV-1 , Table IV-2 , Table IV-3 , Table IV-4 , Table IV-5 , Table IV-6

Notes

1 The federal government also taxes alcohol fuels, aviation fuel, coal, compressed natural gas, gas guzzlers, kerosene and other special motor fuels as part of the excise tax regime.  

2 While federal and state gas taxes are supposedly intended to fund construction and maintenance of highways, state governments routinely divert highway trust fund revenues to programs unrelated to road construction and maintenance. 

3 "Gasoline Price Changes: The Dynamic of Supply, Demand, and Competition," Federal Trade Commission, June 2005.  Available at http://www.ftc.gov/reports/gasprices05/050705gaspricesrpt.pdf.

4 David B. Cashin and Leslie McGranahan, "Household Energy Expenditures, 1982-2005," Federal Reserve Bank of Chicago, Chicago Fed Letter , June 2006.

5 Internal Revenue Service.

6 Telecommunications Industry Association, as quoted by Dennis Cauchon, "City, State Cell Phone Taxes on the Rise," USA Today , May 8, 2005.

7 As reported in Scott Woolley, "How to Duck Cell Phone Taxes," Forbes , June 6, 2005.  Available at http://www.forbes.com/technology/2005/06/06/cz_sw_0606cellphone.html.

8 Ibid.

9 After five appeals courts all ruled that the federal excise tax on long-distance calls was illegal, the Treasury Department finally agreed in 2006 to quit collecting the tax and to refund about $15 billion to taxpayers (of course, the tax on local phone service still remains in effect).  Federal taxes still apply to local service, but no new estimates of the new effective tax rate have been made.  See Dennis Cauchon, "City, State Cell Phone Taxes on the Rise."  Also see "Telephone Tax Refund Questions and Answers," Internal Revenue Service. Available at http://www.irs.gov/newsroom/article/0,,id=161506,00.html.

10 Scott Keeter, "Cell-Only Voters Not Very Different; Fewer Registered, More First-Time Voters," Pew Research Center for the People and the Press, October 26, 2006.

NOTE: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any bill before Congress. 


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