Excise Tax Definition | BoyceWire
Excise Tax Definition

Excise Tax Definition

Excise Tax Definition

WRITTEN BY PAUL BOYCE | Updated 27 January 2021

What is an Excise Tax

An excise tax is a tax that is levied on specific products, usually in order to create a socially optimal outcome. For example, cigarettes, alcohol, and fuel are all types of goods that have an excise tax. The aim is to reduce consumption and reduce the health impacts on the individual or society as a whole.

The excise tax is paid for by the producer, who may, in turn, pass those costs onto the customer, but must bear the burden. Often, the excise tax will lead to a combination of higher prices for the consumer and lower revenues for the producer.

Key Points
  1. An excise tax is also known as a ‘sin tax’ which is levied on goods that are deemed unhealthy or bad for the environment.
  2. The excise tax is levied on each unit and is paid for by the producer.

Excise Tax vs Sales Tax

The excise tax may seem similar to a sales tax, but it is different in four key ways:

  1. It is a unit tax, so it is based on a specific amount per unit. For instance, the US imposes an excise on beer that ranges between $0.11 to $0.58 per gallon. By contrast, a sales tax is an ad valorem tax that is based on the final value of the product and is calculated as a percent of this.
  2. Excise taxes are very narrow in focus and are limited to a small number of products. This compares to a sales tax which is very generic and broad in its focus.
  3. The general aim of excise taxes is to reduce the consumption of goods that can cause individual harm as well as negative externalities. For instance, alcohol can not only cause harm to the individual but also others if they decide to drive.
  4. Sales taxes are levied by the state government, whilst excise taxes are imposed on a federal level.

Excise Tax Examples

Some examples of excise taxes include:

  • Wine and made-wine
  • Beer
  • Airlines
  • Highways
  • Tobacco products
  • Biofuels

How the Excise Tax Works

The Excise tax is a tax on the producer, so they have to pay for each unit they produce. We can look at is as a type of fine for producing bad products such as alcohol and tobacco.

The excise tax is paid for by the producer, but often these costs are passed onto the consumer to bear the tax burden. If we take an example of a large tub of ice cream. The ice cream sells for $5 and creates a demand of 500 units. Let’s say the government wants to introduce an excise tax on it. This shifts the supply curve to the left as shown below.

In turn, the producer raises the price of the ice cream to the equilibrium point of $7, with quantity falling to 400. As the excise tax is $4, this means everything in grey is government revenue. So, in this case, it is $4 x 400, which equals $1,600. Everything below this is producer revenue. So $3 x 400, which would equal $1,200.

Now, the government is making $1,600 in revenue, but who is paying for it? Well, in this case, it is split evenly between the producer and the consumer. The consumer pays the excess difference between the initial price and the new price. In this case, the price of the ice cream has increased by $2. The total quantity sold is 400, so the price paid by the consumer is $2 x 400, which equals $800.

The other half of the cost is subsequently borne by the producer, which would amount to $800.

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