Sinc e 193 7 TAX FOUNDATION Federal Excise Taxes and the Distribution of Taxes Under Tax Reform BY J. SCOTT MOOD Y ECONOMIST TAX FOUNDATION JANUARY 1999 BACKGROUND PAPER 1N0.29 About the Tax Foundation In 1937, civic-minded businessmen envisioned an independent group of researchers who, by gathering data and publishing information on the public sector in an objective, unbiased fashion , could counsel government, industry and the citizenry on public finance . Six decades later, in a radically different public arena, the Tax Foundation continues to fulfil l the mission set out by its founders . Through newspapers, radio, television, and mass distributio n of its own publications, the Foundation supplies objective fiscal information and analysis to policymakers, business leaders, and the general public . The Tax Foundation's research record has made it an oft-quoted source in Washington an d state capitals, not as the voice of left or right, not as the voice of an industry or even of busines s in general, but as an advocate of a principled approach to tax policy, based on years of profes- sional research . Today, farsighted individuals, businesses, and charitable foundations still understand the nee d for sound information on fiscal policy.As a nonprofit, tax exempt 501(c)(3) organization, the Tax Foundation relies solely on their voluntary contributions for its support . Federal Excise Taxes and the Distribution of Taxes Under Tax Reform BY J . SCOTT MOODY ECONOMIST TAX FOUNDATION ANUARY 1999 BACKGROUND PAPER I NO .2 9 ©1999 Tax Foundatio n Price: $2 5 $60 annual subscription for six issues Tax Foundatio n 1250 H Street, NW Suite 750 Washington, DC 2000 5 202-783-2760 Te l 202-783-6868 Fa x www.taxfoundation .org tf@taxfoundation .org Table of Contents Introduction 1 A Look Back at Federal Excise Taxes 3 I. Who Bears the Burden of Federal Excise Taxes? 3 The Tax Foundation Excise Tax Incidence Model 3 II. An Overview of Federal Excise Taxes 6 The Most Regressive Excise Taxes 6 Moderately Regressive Excise Taxes 6 Slightly Regressive Excise Taxes 8 Conclusion 8 III. Tax Reform and Excise Taxes 9 Methodology 12 exempt under a consumption tax . As lev- Introduction els of wealth and levels of income tend t o be closely related, upper-income taxpayer s The most familiar aspect of tax fairness sim- also tend to own relatively large amounts ply relates to how the burden of a tax or a of wealth . Thus, replacing an income ta x tax system is spread among the taxpayers . with a consumption tax tends to reduce the In recent years, the distribution of the tax progressivity of the tax system, everything burden in the U .S. and the changes in that else held constant . distribution have played prominent roles i n From an economic perspective, the best guiding tax policy, including tax reform . tax rate structure has a single tax rate . A Naturally, major changes in the distribu - single tax rate minimizes the economi c tion of the tax burden are most likely whe n growth-robbing distortions imposed by the the nation seriously contemplates funda- tax system. Rightly or wrongly, social policy mental tax reform. In the current climate, considerations have historically dictated a the primary motivations for fundamental ta x progressive tax system . Progressivity can be reform are faster economic growth and sim - achieved in a consumption tax through vari - plification of the code. However, changes i n the tax burden's distribution are so impor- tant politically and socially that no eco- nomic or administrative improvements ca n "The elimination of these be considered without a thorough analysi s excises as part of tax of all possible distributional effects . As to economic growth, the scoffing of reform would advance critics does not deter many reasonable ana- the goals of tax reform lysts from believing that a more economi- cally neutral tax system will encourage a per- on virtually all fronts." manently higher level of economic output . In contrast to the controversy regarding additional economic growth, there is a ors exemptions, credits, and through a strong consensus that the current tax sys- graduated rate structure . However, each of tem is far too complicated, that this com- these devises increases the complexity o f plexity is harmful, and that great savings can the new system and diminishes the eco- be reaped in both administration and com- nomic gains tax reform would otherwis e pliance costs with the adoption of a muc h promise. simpler tax system . A partial solution to the progressivit y While economic growth and simplifica- problem for consumption taxes may b e tion arc key, the distribution of the tax sys - found by expanding the scope of tax reform . tem remains an important consideration. Traditionally, tax reform has involved replac - The current federal tax system, and the fed - ing the federal personal and corporate in - eral personal and corporate income taxe s come taxes . Some proposals would integrat e in particular, are highly progressive, mean - the federal payroll tax into the tax reform ing that an individual or corporation's tax proposal. Thus far, no major tax reform pro- burden tends to rise faster than income . posal has incorporated federal excise taxes . Most tax reform proposals would re - The federal government imposes a wid e place the federal income tax with som e array of excises that raised an estimated form of consumption tax . `lax rates aside , $55 .5 billion in 1998 . Discussed at greater the essential difference between an incom e length below, these taxes include the excise tax and a consumption tax is the taxatio n on gasoline and diesel fuel, the excise on of saving. Under an income tax, capital in - telephone services, and the excises on beer, come is taxed repeatedly, while saving is tax wine, distilled spirits and tobacco. The elimi- 1 nation of these excises as part of tax refor m sent only 1 percent of the tax collected, tha t would advance the goals of tax reform o n is still over $500 million annually that would virtually all fronts . be saved if the taxes were eliminated. Eliminating excise taxes is helpful to eco- Considering their effect on the distribu- nomic growth because it promotes neutral- tion of the tax burden, excise taxes also tend ity. Tax reform is intended to achieve a neu- to be regressive. A regressive tax is one i n tral tax system, and excise taxes are by thei r which the tax burden is proportionately very nature discriminatory and non-neutral . higher at lower levels of income than a t They lack policy rationale except in thos e higher levels of income .While there are ex- few cases where the tax is clearly linked to ceptions, such as the tax on luxury automo- an expenditure that benefits the payor of th e biles, most excise taxes impose a dispropor- tax and where the tax is no greater than th e tionate burden on lower-income taxpayers . value of those benefits, or where there is Thus, if tax reform were to involve the rev- some well-defined cost to society from an enue-neutral replacement of the personal individual's using a product. Even in such and corporate income taxes and some of cases, eliminating excise taxes would still b e the excise taxes with a consumption tax, the consistent with tax neutrality. net result could well be a tax distribution Eliminating excise taxes would help more acceptable to the Congress and th e simplify the tax code because each of these nation. excises imposes its own administration and compliance costs . Even if these costs repre- Figure 1 Excise Tax Receipts In Constant Dollars and As a Percentage of Total Tax Receipt s FY 1934-199 8 $80 50 % 40 % 10 % 0 11111111!IIII1111111111111111!11111111111111111111111111IIIli11 0 '34 '40 '45 '50 '55 '60 '65 '70 '75 '80 '85 '90 '95 '9 8 Fiscal Yea r Source : Tax Foundation . 2 A Look Back at Federal Excise Taxes I. Who Bears the Historically, excise taxes have been a major source of federal tax revenue . Figure Burden of Federal 1 shows total federal excise tax collections since 1934, in constant 1998 dollars, as well Excise Taxes? as their percentage share of total federa l revenue . In 1934, excise taxes made up 45.8 Tax incidence analysis seeks to discover percent ($14.9 billion) of total federal rev- who bears the real economic burden of a enues. By 1998, the share of federal revenue tax. In a market economy, the individual o r attributed to excise taxes had fallen dramati - business that directly pays a tax is not nec - cally to 3 .4 percent even though excise tax essarily the one that bears the burden of a collections had grown by more than 270 tax in the sense of experiencing a loss o f percent. Clearly, most of the decline in ex- purchasing power due to the tax . The real cise taxes' share is due to higher revenu e tax burden is often spread around as indi- collections from other sources such as in- viduals and businesses attempt to shift th e come and payroll taxes rather than a declin e burden onto others . in excise tax collections . An oft-repeated and irrefutable conclu- sion of tax incidence analysis is that busi- nesses do not pay taxes—people do . As such, taxes on business, direct or indirect , are shifted to individuals in any of four dif- ferent ways, either separately or in combi- nation . For example, an excise tax imposed on diesel fuel suppliers may be (1) shifted forward to consumers in the form of highe r prices on goods and services ; (2) shifted backward onto labor by reducing wages; (3) shifted backward onto other business sup - pliers; or (4) absorbed by the diesel fuel sup- pliers through lower profits.