Why Differentiating between Taxes and Fees Is Important

April 4, 2013

Everything the government does should be justified by law, including the levying and spending of taxes and fees. Nearly all states have adopted a meaningful definition of what a "tax" is. The legal precedents and decisions about whether a tax is necessary depends on the purpose of a tax, says Joseph Henchman, vice president of legal and state operations at the Tax Foundation.

  • Elected and appointed officials have raised taxes to deal with fiscal shortfalls but instead labeled them user fees, fines, surcharges, revenue enhancements and special assessments among others.
  • In many state constitutions, taxpayers are protected by procedural steps and limitations that apply to tax increases.
  • By labeling taxes as different mechanisms, policymakers are avoiding many of these legal protections that have been in place for years.

A "tax" is defined as a charge imposed with the primary purpose of raising revenue, with the resultant funds spent on general government services. A "fee" is a charge imposed for the primary purpose of recouping costs incurred in providing a service to the taxpayer. A "penalty" is a charge imposed for the primary purpose of punishing behavior.

  • Beyond the label, what really matter is how a charge operates and how the money is used, not just the label used to describe it.
  • If a charge is not imposed by the government, it cannot be a tax.
  • If a charge's primary purpose is to alter behavior it is a penalty, and if its primary purpose is to recoup costs it is a fee.
  • If the charge's primary purpose is to raise revenue (if the revenue is used for general purposes) it is a tax, and if it is used for dedicated purposes it is a user tax or a fee.

Every state and the District of Columbia defines a tax as a charge with the primary purpose of raising revenue with the exception of Oregon and North Carolina, which have not addressed such issues.

Determining the purpose of the charge should be figured by looking at three factors: which entity imposes the assessment, the parties upon whom the assessment is imposed and the use of the revenue.

Source: Joseph Henchman, "How Is the Money Used? Federal and State Cases Distinguishing Taxes and Fees," Tax Foundation, March 2013.

 

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