CRS Report on Excise Taxation of Luxury Goods

                       CRS REPORT FOR CONGRESS

SUMMARY

[1] The United States has long and varied experience with excise taxation. Luxury excise taxes are used when a primary objective is to make the tax progressive (having the share of income taken by taxes be larger for higher income groups). In such cases the tax base is of necessity restricted to luxury goods. Luxury goods are loosely defined as goods for which demand is income elastic, which means the share of one's income expended on the good increases more than proportionately with income. In such cases, the resulting distribution of excise tax payments is termed "progressive."

[2] This review of the use of excise taxes on luxury goods to raise revenue and generate progressively distributed tax payments yields the following conclusions:

     o the primary economic effect of excise taxes is to interfere

[4] The federal government's choice of a tax base usually depends to some extent upon which of several policy goals is a primary objective: revenue generation; alteration of the private sector's consumption and production decisions in order to achieve some social objective; or distribution of the tax payments by income class in accordance with some predetermined standard of equity.

[5] For example, in the United States in the twentieth century, income has been the tax base of choice when revenue generation is the primary goal. One reason for this choice is that an income tax can be easily manipulated to achieve a desired income class distribution by adjusting the tax rate structure. Taxes on consumption sales, in contrast, have not been nearly as productive as a source of federal revenue. General sales taxes have been the province of the state and local sector, leaving the federal government to impose excise taxes on selected goods with a resultant smaller tax base and revenue potential.

[6] Circumstances at times narrow federal policy options, so that the tax instrument best suited to achieve a particular objective is not politically feasible. Such a situation existed in 1990. The simplest way to raise federal revenues would have been through increases in income tax rates, but supporters remained committed by and large to continuing the low tax rates as enacted in the Tax Reform Act of 1986 (TRA86) (P.L. 99-514). While rates were modified under the Omnibus Budget Reconciliation Act of 1990 (OBRA90) (P.L. 101-508), the low marginal income tax rate structure (15%, 28%, and 31%) enacted was not adequate to achieve the two goals of revenue generation and shifting the distribution of tax payments to higher- income persons. ¹ Accordingly, Congress found it desirable to reintroduce luxury excise taxes as part of the federal tax system. Those luxury excise taxes introduced in OBRA90 (high-cost cars, boats, aircraft, jewelry and furs) were designed to raise revenues from higher income taxpayers.

[7] With the election in 1992 of a President and a Congress committed to lowering the federal budget deficit, the political landscape changed. The passage of the Omnibus Budget Reconciliation Act of 1993 (OBRA93) (P.L. 103-66) included both spending cuts and tax increases. The single largest revenue component was the increase in income tax rates on upper-income individuals. OBRA93 repealed all but one of the luxury excise taxes imposed just two years before under OBRA90. The single luxury excise tax that remains from OBRA90 is that imposed on cars ² that cost more than $36,000 ³ (albeit at a lower tax rate than originally enacted in 1990).

ECONOMICS OF EXCISE TAXES

[8] This section provides a brief discussion of the economics of excise taxes, emphasizing the limitations of excises as revenue- raisers. It includes the economic judgment that a primary effect of excise taxes is to influence private sector consumption and production decisions.

[9] Usually, a government seeks to raise revenue in a manner that minimizes the effect on private sector consumption and production decisions. No tax available to the federal government completely avoids interference with these decisions. An income tax distorts the choice between work and leisure and may distort the choice between saving and consumption. ⁴ An excise tax distorts consumption choices. Both taxes impose what economists term "welfare losses."

[10] Excise taxation is the preferred tax instrument in two situations: (1) when the government's primary objective is to influence private sector decisions and thereby alter private sector consumption and production decisions; and (2) when the objective is to raise revenue for public provision of services which primarily benefit users of the taxed good.

EXTERNAL COSTS

[11] "External costs" refers to cost incurred when the private sector's production or consumption of a good imposes costs on society which are not reflected either in the price charged to consumers or the income earned by capital and labor. A price or factor payment that does not reflect these "external" costs causes too much of the good to be produced and consumed. Levying an excise tax on the production or consumption of a good or service usually has the effect of increasing its price relative to other goods that may be consumed.

[12] The revenue generated by the tax depends very much upon how sensitive consumers of the taxed good are to higher prices. If consumers are sensitive to price changes, the taxed good is used less, external costs decrease, but revenue collections are small. If consumers are not sensitive to price (demand is "price inelastic"), consumption of the taxed good and external costs remain nearly the same, and the federal government has gained revenue to finance a reduction of these external costs.

[13] Taxes on cigarettes and liquor are frequently justified on the basis of such external costs. Consumption of these goods is relatively insensitive to price, and the taxes generate substantial revenue. On the other hand, these taxes are not designed to match revenues with social costs, giving rise to many analysts suspecting that the policy goal is actually revenue generation. Although concern may be expressed about the distribution of these tax payments by income class, this concern is tempered by the realization that tax payments are related to the costs the consumption imposes on society. These taxes are often called "sumptuary" taxes or "sin" taxes. ⁵

USER CHARGES

[14] "User charges" refers to excise taxes when the federal goverment provides a service related to a product whose users are the primary beneficiaries of the government service. In this case, an excise tax serves as a user charge, so that the persons benefitting from the service provide the financing for its provision. This use of excise taxes has occurred frequently in the transportation area. The use of gasoline excise tax ⁶ revenues or the tire excise tax ⁷ revenues collected from heavier vehicles to finance federal highway expenditures are examples. Such taxes are often designated for trust funds for their public purpose. Again, the distributional consequences are of subordinate concern because tax payments are seen as compensated by benefits from public spending. ⁸

OTHER USES OF EXCISES

[15] Excise taxes can also be used for other purposes. First, for example, in time of war, the raw materials used for producing certain goods may be judged to be scarce and have a higher value for war production. In such circumstances, an excise tax on private goods may be imposed to discourage their consumption and leave a supply of raw material at relatively low cost for war production. A commonly cited example is the increased excise tax rate imposed on rubber at the time of World War II. At the outset of the war, there were no substitutes for natural rubber and no domestic rubber supply. Since rubber was a necessary commodity for our war effort, this tax was used as a means to discourage domestic consumption. In this manner, the person using more rubber would be paying a greater tax burden than those persons saving this valuable commodity.

[16] Also, revenue needs have often been met by levying excise taxes, particularly on goods judged to be luxuries. Examples often cited include excises that were imposed on furs, jewelry, luggage, and toiletry preparations.

[17] The federal government also classes wagering taxes as excise taxes, and some regulatory excise taxes are collected on products such as foreign insurance policies. In recent years, "penalty" excise taxes have been increasingly used. Such penalty taxes include the tax (as an intermediate sanction on charitable organizations) imposed on insiders who benefit from private inurement ⁹ and excess contributions or early withdrawal of funds from a retirement savings account.

DEFINITION OF A LUXURY

[18] A good can be defined as a "luxury" for two quite different reasons. One is that the good is associated in some way with the upper economic classes; the other is that the good itself is by its nature not a "necessity." Before describing taxes on luxury goods, it is necessary to consider briefly what is meant by "luxury."

INCOME ELASTICITY

[19] The first, and more rigorous, definition of a luxury good relates to its "income elasticity." Income elasticity measures the relationship between spending on a good and income. If spending on the good increases more than proportionately with income, demand for the good is income-elastic, and it can be classified as a luxury good by this definition. A more restrictive definition requires that the good be one on which lower income groups spend little or nothing (that is, it has an income elasticity substantially in excess of one).

[20] To impose a "luxury" tax based on goods with high-income elasticities, it is necessary to know something about the distribution of expenditures by income class. For most of the history of U.S. excise taxation, however, there was little hard data on the distribution of purchases of the products that were taxed. Today, when surveys of consumer habits and characteristics are common, hard data is still limited. The primary government source of data on consumption patterns is the Consumer Expenditure Interview Survey (CEIS) prepared by the U.S. Department of Labor, Bureau of Labor Statistics. In the most detailed CEIS tables examined for this report, there were no sizable consumption expenditures that were progressively distributed across all five income classes when the consumption data were broken down by income quintiles. ¹⁰ Exempting lower priced items, or a given dollar amount of each purchase, from taxation could create a progressive distribution of taxation for many expenditures; but it would also reduce the size of the tax base. There are virtually no data on purchases by amount spent per item, so measuring such a tax base would be virtually impossible.

NECESSITY

[21] Given this shortage of information, a second definition of "luxury" has been used. This definition considers luxuries to be goods that are not regarded as necessary for a "normal" standard of living. The excess can be either in quality (such as clothing that includes fur), price (the good exceeds a certain price), or the perceived frivolous nature of the item (jewelry, playing cards). By this definition the tax base of luxury goods is greatly expanded. Indeed, this definition was the one used for imposition of luxury taxes on high-priced cars, boats, aircraft, jewelry and furs under provisions of the Omnibus Budget Reconciliation Act of 1990. With the lone exception of the tax on high-priced cars, all these taxes have since been repealed.

DISTRIBUTION OF THE TAX BURDEN

[22] The attempt to define luxury goods by reference to their income elasticity involves two additional problems: (1) some luxury consumption goods are purchased by businesses rather than individuals, so that the income class of the actual taxpayer is not known; (2) even when the payer is clearly identifiable, the person who pays a tax is not necessarily the person who bears the greatest burden of it.

[23] Many luxury consumption goods are purchased by businesses as fringe benefits for their employees. First-class airline tickets purchased by businesses for their executives are examples. To the extent that purchases of taxed goods are business expenses, any excise tax paid would also be a business expense and most likely passed on to customers in the form of higher prices. Thus, the true payer of a "luxury" excise tax on business purchases could be the business' customers (assuming the business could pass along the tax), and the distribution of tax payments could be less progressive than intended.

[24] In addition, this report cites tax payments from taxes on the consumption of luxuries. These citations do not identify luxury goods in terms of the distribution of the tax burden that results from the imposition of the tax.

[25] The distribution of the tax burden depends on all of the income changes resulting from imposition of a tax, whether the changes are caused by a taxpayer's use of his income (consumption patterns) or the sources of his income (how he earns his money). These changes are caused not only by the decrease in real income caused by price increases on the taxed goods, but also by decreases in the relative prices of numerous other goods. These relative price decreases tend to increase real income and offset some of the income decrease caused by the luxury tax. In addition, aftertax business receipts decline and the composition of output is altered, causing wages and capital income to decline and perhaps also to be redistributed among income classes. Aftertax income is also reduced, although it is in turn offset somewhat by lower income tax payments. And if the economy's overall output is affected, gross domestic product may fall and further reduce aftertax incomes. ¹¹

U.S. HISTORICAL EXPERIENCE WITH EXCISE TAXATION ¹²

[26] To place the excise taxation of luxuries in its historical context, this section provides an overview of the United States' experience with excise taxation in general. The section indicates that most federal excise taxation has been enacted for the purpose of raising revenue, especially in times of war. It is only recently that excises have been used extensively for the control of social costs, as user charges, and for deficit reduction purposes. The excises on tobacco and alcohol are an exception: they have been used continuously as sin or sumptuary taxes. The history of most twentieth century U.S. excise taxes is summarized in table 1 (at the end of this report).

EARLY REPUBLIC

[27] Federal internal taxation (in contrast to customs duties on imports) began in 1791 with an excise tax on the manufacture of distilled liquors, a tax so disliked it led to the "Whiskey Rebellion" of frontier farmers in western Pennsylvania in 1794. Revenue needs caused the addition of other taxes such as those on carriages, manufacture of snuff, and refined sugar. An undeclared naval war with France in the late 1790s led to additional revenue needs. A stamp tax was imposed on legal transactions and a direct tax, apportioned among the states as required by the Constitution, was imposed on real property and slaves. These internal taxes contributed to the defeat of the Federalists in the elections of 1800 and were repealed on April 6, 1802, except for the tax on salt, which was eliminated in 1807.

WAR OF 1812

[28] There were no new internal revenue taxes until the War of 1812. At that time, direct taxes on dwelling houses, land, and slaves were imposed, and excises were levied on carriages, refined sugar, distilled spirits, auction sales, and a number of manufactured items such as household furniture and watches, along with certain stamp duties and license taxes. By 1817, however, all these taxes had been repealed, and no new internal revenue taxes were imposed until the Civil War. From 1817 until 1861, the federal government was supported entirely by customs duties and the sale of western lands.

CIVIL WAR

[29] The enormous revenue needs caused by the Civil War led the federal government in 1862 to levy excise taxes on distilled spirits, beer, tobacco, manufactured products, auction sales, carriages, yachts, billiard tables, gold and silver plate, and slaughtered cattle, hogs, and sheep. There were also stamp duties, occupational licenses, and taxes on railroads, steamboats, ferry boats, railroad bonds, banks, insurance companies, advertisements, and legacies, as well as the first U.S. tax on incomes.

[30] Additional excises were added in 1864 along with rate increases on many of the existing excises. The excises covered so many products that there could be no pretense of these being "luxury" taxes. Many different rates were applied, however. This has been interpreted as reflecting judgments about the luxury status of the commodities. Following the Civil War, a number of Acts between 1866 and 1870 and in 1883 and 1890 reduced rates and eliminated many of the commodities from the tax base.

SPANISH-AMERICAN WAR

[31] In 1898, revenue needs brought about by the Spanish- American War resulted in rate increases on existing excises and the adoption of excises on legacies, stamps, banks, brokers, theaters, bowling alleys, billiard and poolrooms, and other places of amusement. Most of the "war" taxes were repealed by 1902. This left a small number of excises, including taxes on liquor, tobacco, oleomargarine, and playing cards.

WORLD WAR I AND AFTER

[32] World War I saw the revival and expansion of excise taxation through a series of revenue acts between 1914 and 1918. By 1919, excise tax revenues had risen to $1.139 billion from a level of $309 million in 1914. Their relative importance decreased, however, from 46% to 28% of total revenue, because income and profit tax collections increased even more. After the war, tax revisions in 1921, 1924, 1926, and 1928 reduced or repealed most of the excises.

[33] The collapse of income tax receipts in the Great Depression led to one of the largest tax increases ever enacted in a time of peace. The Revenue Act of 1932 (P.L. 72-154) was an attempt to balance the federal budget and thus to uphold the national credit. Nearly half the revenues from this revenue act were expected to come from manufacturers' excise taxes. Many of these excises were on items regarded at the time as luxuries, such as passenger automobiles, toiletry preparations, furs, jewelry, sporting articles, and electrical household appliances. Increased taxes were imposed on theater and other admissions and stock transfers, and new taxes were imposed on telephone, telegraph, and radio messages, bond transfers, and bank checks. Many excises were repealed in 1936 and 1938, including those on toiletry preparations and jewelry.

WORLD WAR II

[34] World War II's approach and the ensuing years saw excise tax rates once again increased, various new taxes introduced, and items added to the base of those taxed. The new taxes were levied on the transportation of persons and property; retail taxes were imposed on jewelry, furs, toiletry preparations, and luggage; and manufacturers' excise taxes were extended to electric, gas, and oil appliances. During that time, items such as phonographs and phonograph records, photographic apparatus and film, refrigerating equipment, and washing machines were all taxed as luxuries.

KOREAN WAR

[35] Most of the World War II excises were still in effect when the Korean War began in 1950. Excise taxes were once again raised for wartime revenue needs, but the rate increases were accompanied by some base changes. For example, many new household appliances were added to the list of those already taxed, but sporting items primarily used by children were removed from the base. Commodities used for business purposes and admissions where the proceeds went to religious, charitable, and education organizations were removed from the tax base. Several tax rate extension acts continued these Korean War excise taxes through the early 1960s.

1960s

[36] The Land and Water Conservation Fund was established in 1964 and financed with federal agency recreation fee collections, receipts from excise taxes on motor boat fuels, and additional appropriated amounts such as revenues from the Outer Continental Shelf Lands Act. This trust provides funds for states to acquire and develop land and water areas and facilities or for federal acquisition of such lands.

[37] The Excise Tax Reduction Act of 1965 (P.L. 89-44) reduced excise tax rates. Many of these rate reductions occurred over a period of years, with the object of helping to sustain the economic expansion then underway. The Congress noted that the excise system had not been developed in a systematic way and that the excises were often discriminatory in their application. This Act marked the end of many of the excises which had been instituted during the depression of the 1930s, World War II, and the Korean War.

[38] The late 1960s saw mounting budgetary pressure from the Vietnam War. The telephone excise tax was increased to its former rate and the scheduled reduction in the automobile excise tax was eliminated. The automobile and telephone excise taxes were extended again in the 1970s.

Era of Trust Funds -- 1970s and 1980s

[39] The 1970s and 1980s saw the establishment of many federal trust funds financed with excise taxes on related products and the introduction of a sumptuary excise on "gas-guzzler" cars that was designed to reduce social costs. Many of these trust funds were established because of deficit reduction pressures brought about by the passage of the Gramm-Rudman-Hollings law to balance the federal budget in order to offset new or existing expenditure responsibilities. A brief summary of the trust funds established in the 1970s and 1980s follows.

     1. The Airport and Airway Trust Fund was established in 1970 to

[40] The 1990s were entered with large and continuing federal budget deficits. In order to increase revenues, excise taxes were revisited with the passage of the Omnibus Budget Reconciliation Act of 1990. A variety of excise taxes became law. There were increases in the sumptuary taxes on alcohol and tobacco products. In the area of regulatory taxes, the list of ozone depleting chemicals expanded and the gas guzzler excise tax doubled. User fee excise taxes such as those on aviation fuel and the tax on transportation by air were increased, with deposits going into the Airport and Airway Trust Fund. Also, gasoline excise taxes were increased, with the increased revenue being used to fund the Highway Trust Fund, the LUST Trust Fund, Aquatic Resources Trust Fund, and a portion of the revenues to be used for deficit reduction purposes. ¹⁶ There was also an increase in the Harbor Maintenance excise tax on the commercial value of cargo loaded or unloaded at U.S. ports. ¹⁷ Finally, luxury taxes on expensive cars, boats, aircraft, jewelry and furs were added.

[41] The National Recreational Trails Trust Fund was established as part of the Intermodal Surface Transportation Efficiency Act of 1991. Revenues were collected from excise taxes imposed on nonhighway recreational fuels, with monies to be allocated to the states for trails and trail-related projects. The 1991 act provided that the funds could be used for the acquisition, maintenance, and restoration of trails, state environmental protection education programs, and for associated program administrative expenses. No revenues were ever appropriated for this trust fund. A part of the Surface Transportation Revenue Act of 1998 repealed the trust fund.

[42] Under provisions of the Omnibus Budget Reconciliation Act of 1993 (OBRA93), excise taxes on fuels used in freight and passenger transportation were revisited. Specifically, this Act imposed a permanent 4.3 cents per gallon tax for deficit reduction. The Act also extended and changed the disposition of some of the revenues from existing fuel taxes. In addition, the Act imposed a 24.4 cents per gallon tax on diesel fuel used by noncommercial motorboats with revenues going into the general fund (now repealed). Also noteworthy was the repeal of the luxury excise taxes on expensive boats, aircraft, jewelry, and furs. The only remaining luxury tax from OBRA90 is that imposed on expensive cars. Under OBRA93 provisions the luxury tax base for cars is indexed for inflation.

[43] The passage of the Small Business Job Protection Act of 1996 changed a number of excise taxes, many for temporary periods. Taxes credited to the Airport and Airway Trust Fund were temporarily extended. Included were a tax on noncommercial aviation gasoline at 19.3 cents per gallon and other aviation fuel tax at 21.8 cents per gallon (with 4.3 cents of this going to the general fund). The tax rates on transportation of persons by air (10%), transportation of property by air (6.25%), and the use tax for international air travel facilities ($6.00) were all reauthorized until December 31, 1996. ¹⁸ A temporary repeal of the excise tax on diesel fuel used in motorboats was effective until the end of 1997. ¹⁹ The prior gasohol blender credit (or refund) was reinstated and made retroactive to October 1, 1995. A tax credit for diesel-powered highway vehicles was repealed as of August 20, 1996. The luxury tax imposed on expensive automobiles was extended but at reduced tax rates. The tax for sales after August 27, 1996, was decreased from 10% to 9%. Thereafter, the tax is reduced 1% per year through the year 2002 -- at which point it expires from law.

[44] A provision included in the Taxpayer Relief Act of 1997 provides that the luxury tax on passenger vehicles does not extend to the subsequent installation of parts and accessories with an aggregate price that does not exceed $1,000. This provision became effective January 1, 1998.

Historical Summary

[45] In summary, federal excise taxes have held varied places in the U.S. tax system. Large amounts of revenue have been raised from a multiple of excises during times of fiscal emergency, principally to pay for wars. Excises were the single largest source of internal revenue for the federal government from 1862 until supplanted by the income tax in World War I. In the Spanish-American War period, they were a larger source of federal tax collections than even customs duties. Thus, a history of our excise tax system is often one that mirrors our wars, serving as an emergency source of funds. Except for sumptuary taxes on tobacco and liquor, excises seem to have been used extensively for the control of social costs and as user charges only in recent years.

[46] The present excises are still only minor sources of federal -- receipts representing an estimated 3.3% of federal receipts in FY1998. Excise taxes are projected to constitute 3.8% of receipts in FY1999; 3.7% in FY2000; 3.7% in FY2001; 3.68% in FY2002; 3.6% in FY2003; and only 3.5% in FY2004. ²⁰

EXAMPLES OF ACTS THAT INCLUDED U.S. EXCISE TAXATION OF LUXURY GOODS

[47] This section is devoted to a more detailed look at excise taxes on luxury goods. Here we attempt to give some examples from U.S. experience with excise taxes which have been classified by some as taxes on luxury goods. Several observations emerge from the analysis. First, the level of aggregation of data on consumption by income class makes the choice of the luxury tax base very subjective. Second, the judgment of what constitutes a luxury good changes over time, making historical precedent a poor basis for choosing the tax base. Third, those goods that fall clearly in the luxury category (consumed primarily by higher income persons) very likely constitute a relatively small tax base and are not likely to yield large amounts of revenue even with high tax rates.

[48] Past policymakers often made subjective decisions about what products should be subject to excises. In retrospect, it is difficult to determine their criteria. This section gives special attention to three of the 20th century excise tax enactments that were discussed briefly in the preceding section: the Revenue Act of 1918 (P.L. 254, 65th Cong.), the Revenue Act of 1932 (P.L. 154, 72nd Cong.), and the Omnibus Budget Reconciliation Act of 1990 (P.L. 101- 508). This review makes it clear that some judgments about the "luxury" nature of goods have been made.

Revenue Act of 1918

[49] The Revenue Act of 1918 was one of the most comprehensive of the wartime excise tax acts. It included no new taxes on alcoholic beverages, which by then Congress had voted to outlaw. It included heavy taxes on the manufacture or importation of tobacco products and taxes on bottled soft drinks (10% of sales price). The act also imposed taxes on fountain soft drinks, sodas, ice cream, and other ice cream parlor products (1%). There was a 1% tax on all general admissions (except to charitable events), plus an additional tax of up to 50 cents per ticket for admissions to "theaters, operas, and other places of amusement." "Cabarets" and "roof gardens" were taxed on the fraction of the bill determined to be for the entertainment. Dues and initiation fees of more than $10 paid to private clubs (other than fraternal orders) were subject to a 10% tax.

[50] The Act included a series of manufacturers' excise taxes, such as: trucks, 3%; passenger automobiles and motorcycles, 5%; sporting equipment, 10%; "chewing gum or substitutes therefor," 3%; candy, 5%; firearms and ammunition and hunting knives, 10%; "portable electric fans," 5%; hunting and shooting garments and riding habits and articles made of fur, 10%; "yachts and motor boats not designed for trade, fishing or national defense, and pleasure boats and pleasure canoes if sold for more than $15," 10% and many other items.

[51] The Act also taxed many items at retail. Jewelry, cosmetics, and patent medicines were taxed regardless of price, but many items of clothing, accessories, and household items were taxed only if sold for more than a specified amount. For example, carpets were taxed only on the amount in excess of $5 per yard, umbrellas in excess of $4 each, shoes and boots in excess of $10 per pair, women's hats in excess of $15 each, and men's hats in excess of $5 each. There was also a series of stamp taxes on such things as the issuance or transfer of stocks and bonds and commodities futures contracts. Taxes on steamship tickets valued at more than $10 and an 8% tax on playing cards were included among the stamp taxes.

[52] The maximum yield from these taxes was reached in fiscal year 1920, when they totaled $1.25 billion, or 22% of federal revenues. Lingering collections of liquor taxes made up $140 million of this sum, and the increased tobacco taxes another $296 million. The remainder was composed of $223 million from manufacturers' taxes, $45 million from the retail taxes, and $550 million from the admissions, stamp, and other taxes.

[53] Gradual repeal of most of the wartime excises during the 1920s left only the tobacco, admissions, and stamp taxes as still significant by 1929. In that year, excises made up only 15% of federal receipts, with almost all of it from these sources.

Revenue Act of 1932

[54] The reinstatement of excises as major sources of revenue came with the Revenue Act of 1932. Most of the World War I manufacturers' taxes were re-enacted, and several items were added. New excises were imposed on matches, gasoline (1 cent per gallon), electrical energy (3% of sales price), radios and accessories and household mechanical refrigerators (5%), and safe deposit boxes (10% of rent). The retail excises were not reinstated, but jewelry, furs, and cosmetics were subjected to a 10% manufacturers' tax.

[55] For fiscal year 1934, excise taxes made up almost 56% of the federal government's depression-reduced receipts. Excise tax receipts totaled $1,288 million, including $425 million from tobacco taxes, $385 million from manufacturers' taxes, $259 million from alcohol taxes (resumed after prohibition), and $218 million from admissions, stamp, and other excises.

Omnibus Revenue Reconciliation Act of 1990

[56] The large and continuing federal budget deficits of the 1980s extended into the 1990s. To increase revenues, excise taxes were reintroduced with the passage of the Omnibus Revenue Reconciliation Act of 1990. Many forms of excise taxes were revisited, including sumptuary, regulatory, user, and luxury taxes all included in the enacted law.

[57] Sumptuary taxes on alcohol and tobacco products were increased. The tax rate on distilled spirits was increased by $1.00 per proof gallon, the tax rate on beer was doubled to $18.00 per barrel, and under the new law rates on wines range from $1.07 to $3.40 per wine gallon. The new tobacco tax rates became effective in two stages with the rate increase set to equal 50% of the existing tax rates, one half the total increase to go into effect in 1991 and the remaining half in 1993.

[58] In the area of regulatory taxes, the list of ozone depleting chemicals was expanded and the gas-guzzler excise tax was doubled. User-fee excise taxes such as those on aviation fuel and the tax on transportation by air were increased, with deposits going into the Airport and Airway Trust Fund. Also, gasoline excise taxes were increased with some of the increased revenue being used to fund the Highway Trust Fund, the Leaking Underground Storage Tank Trust Fund, and the Aquatic Resources Trust Fund, with the remainder of the revenues to be used for deficit reduction purposes. ²¹ There was also an increase in the Harbor Maintenance excise tax on the commercial value of cargo loaded or unloaded at U.S. ports (since found to be unconstitutional).

[59] While no longer defined as a luxury, the telephone excise tax was made permanent at a 3% rate. Luxury taxes on expensive cars, boats, aircraft, jewelry, and furs were added. The excise tax on jewelry and furs was equal to 10% of the sale price over $10,000. A 10% excise tax was also imposed on the sale price of a passenger automobile over $30,000, the sale price of a boat over $100,000, and the sale price of an aircraft over $250,000. The tax was not imposed if the vehicle was used in a trade or business or if it was used by the federal government or a state or local government for police work, fire fighting, emergency medical services, search and rescue, public safety, or public works activities. ²²

[60] Under this tax law, luxury excise taxes were expected to generate only $1.479 billion over the FY1991-95 period. ²³ In contrast, over this same time period, revenues were projected to increase on alcohol products by $8.768 billion, on tobacco products by $5.876 billion, on gasoline by $25.039 billion, and by $11.908 billion from aviation excise taxes. The telephone excise tax was expected to bring in $13.069 billion over this same time frame.

CONCLUSIONS ABOUT "LUXURIES"

[61] One of the reasons for imposing the taxes discussed in the previous sections was to raise revenue, and at this the taxes must be considered a success. The particular products selected for taxation, however, were not always selected to maximize revenue yield, indicating that there were other selection factors. To maximize revenue, one would logically seek to tax goods based on the total spent on them, which probably means taxing some basics, such as food and clothing. It seems more likely that most of the products and services chosen for taxation were regarded as luxuries by one definition or another.

[62] In the Revenue Act of 1918 (P.L. 254, 65th Congress) enacted during World War I, many of the taxes could be assumed to have been for the purpose of reducing civilian consumption in wartime. Several of the taxes, however, such as the retail taxes on clothing, were imposed only on articles exceeding a specified price (considered high prices for that time), thus generally restricting the tax base to higher income classes. The retail taxes actually raised very little revenue, only about $45 million in 1920 from all retail taxes combined.

[63] In 1932, the national emergency was financial, the depression having reduced income tax receipts drastically. The Revenue Act of that year was an attempt to find a tax base other than income from which to raise revenue. The excises chosen were obviously intended in many cases as "luxury" taxes, but the definition being used was often hazy. The tax on club dues and admissions exempted small dues and also dues to fraternal orders, which had the effect of restricting the "dues" part mostly to the upper classes; but most of the revenue from this category of excises came from the tax on movie tickets and other general admissions paid by the general public. Stamp taxes on securities transactions raised large amounts of revenue and fell primarily on upper-income persons, but these were taxes on investment activities, not consumption. Taxes on gasoline, electric power, and telephone service fell as much or more on businesses as on upper-income individuals; as business taxes, they were often passed on to all of the businesses' customers in price increases whenever possible and thus were spread across all income classes.

[64] The excise taxes enacted in 1932 were increased and added to during World War II, and many of them lingered on until 1965. A study of those still around in the early 1960s found that none of them were at that time true luxury taxes, i.e., progressive with respect to income. ²⁴ Probably many of them, such as taxes on electrical appliances, were progressive taxes when enacted, but the goods ceased to be luxury goods as the general income level rose.

[65] The luxury excise taxes enacted in 1990 were all based on sales prices exceeding statutory amounts, suggesting desire to shift some part of the overall tax increase to upper-income individuals. Opponents of that viewpoint contended that the taxes depressed sales and employment in the affected industries and this actually burdened lower-income persons. Congress accepted this contention in 1993, repealing all the taxes except the one on automobiles in the Omnibus Budget Reconciliation Act of 1993. This experience would seem to confirm the difficulty of using "luxury" excise taxes to achieve progressivity. (The tax on automobiles was the only one raising significant amounts of revenue, which was why it was retained. From imposition beginning on January 1, 1991 through FY 1997 over $2.7 billion has been collected from the luxury tax on automobiles.)

FOREIGN EXPERIENCE WITH LUXURY TAXES

[66] This section summarizes the use of luxury taxes in other developed countries. It generally confirms the subjective nature of the definition of "luxury" throughout U.S. history.

[67] All developed nations except the United States levy a broad-based consumption tax at the national level. Furthermore, all developed nations with broad-based consumption taxes levy value-added taxes (VATs) except Australia, which levies a wholesale sales tax.

[68] Excise taxes are common in developed countries. Canada, Japan, Australia, New Zealand, and all the countries of western Europe impose both excise taxes and value-added taxes. The excises are, like the previously described U.S. taxes, often based on the "luxury" nature of the goods. Most of these countries have taxes on entertainment as well as high excise taxes on alcohol and tobacco products.

[69] Most tax economists recommend a single rate for a VAT in order to minimize administrative and compliance costs and to reduce economic distortions. ²⁵ However, most of the VATs of Western European nations have more than one rate of tax. It is quite common for a higher VAT rate to be imposed on such "luxury" items as jewelry, furs, perfumes and cosmetics, automobiles and pleasure boats, home appliances and home electronics, and firearms. Countries that have only one VAT rate, such as Denmark and the United Kingdom, frequently impose excise taxes on "luxury" items in addition to their VATs.

[70] There is no more consistency in what is regarded as a luxury in other countries as in the United States. Even in countries of the European Union, where a conscious effort has been made to harmonize their tax systems, there is considerable variety. Although some of the variation could be due to different patterns of consumption in the different countries, it is more likely that it is due to the same shifting definitions of "luxury" goods evident in American history.

AT WHAT STAGE OF PRODUCTION SHOULD THE TAX BE LEVIED?

[71] This section provides a brief discussion of the economic implications of the level at which the tax is collected. The usual three choices for the level at which to levy the tax are: on the manufacturer when the good leaves the premises; on the wholesaler when the good is sold to the retailer; or on the sale of the good at the retail level. Each choice has benefits and costs. The issues involved can be illustrated by discussing taxes levied on the two extreme cases, the manufacturer and the retailer. (Wholesalers would fall somewhere between the two extremes.)

MANUFACTURING LEVEL

[72] Levying the tax at the manufacturing level raises three problems. First, some manufactured goods have a long inventory life. A considerable time period may elapse between the date the tax is paid (when the good leaves the manufacturer's premises) and the date the good is sold. In effect, the manufacturer incurs an interest cost to borrow the money to pay the tax. The effective tax rate thus is actually higher than the statutory tax rate. It was partly for this reason that the federal truck excise tax was changed in 1983 from a tax on the manufacture of the truck to a tax at time of sale to the user.

[73] Second, a tax levied at the manufacturing level creates an incentive to minimize the tax base by restricting the manufacturing process to the most basic product, and adding options or enhancements later on the trip to the ultimate purchaser. The excise tax on trucks again provides a good example of this problem. When the tax was levied on the manufacturer, dealers and direct purchasers had an incentive to order models devoid of most options. The options desired were then added after receipt of the vehicle. Although it is of course possible to tax these options at the time they are added, an administratively simple excise tax on trucks would no longer exist. The truck excise tax was changed in 1983 to include add-ons in the tax base.

[74] A third problem that can arise when the tax is levied at the manufacturing level is that any nonprofit or other entities that are exempt from the tax will require special treatment to avoid paying the tax. Some administrative difficulty is unavoidable in those cases.

POINT OF FINAL SALE

[75] Two related problems arise when the tax is levied at the final point of sale to the consumer. Both administrative costs and the potential for evasion increase as the number of collection sites increases and the size of the tax base at each of these sites becomes relatively small. The excise tax on gasoline suffered from this problem, and the point of collection for the excise tax had to be moved to the product as it left the refinery (the manufacturing level). This approach also makes it necessary to find a way to eliminate the tax for nonprofit organizations and uses otherwise exempt from the tax (such as farm work).

[76] In summary, levying the tax at either of these levels has its problems. Levying the tax at the manufacturing level minimizes administrative costs and the opportunity to evade the tax. But it increases the effective tax rate, creates an incentive to restructure the manufacturing process to avoid the tax, and ensnares exempt users in the tax base. If the tax is placed at the point of sale, administrative costs are higher and the potential for evasion increases.

² This tax act is discussed in: U.S. Library of Congress. Congressional Research Service. The Omnibus Budget Reconciliation Act of 1993: An Overview of the Tax Provisions. CRS Report 93-810 E, by Gregg A. Esenwein and David L. Brumbaugh. Washington, 1993. 23 p.

³ This amount is adjusted for inflation.

⁴ A discussion of this issue can be found in: U.S. Library of Congress. Congressional Research Service. Behavioral Responses to Proposed High Income Tax Rate Increases: An Evaluation of the Feldstein-Feenberg Study. CRS Report 93-434 S, by Jane G. Gravelle. Washington, 1993. 11 p. A more recent study by Martin Feldstein and Daniel Feeberg is The Effect of Increased Tax Rates on Taxable Income and Economic Efficiency: A Preliminary Analysis of the 1993 Tax Rate Increases. Cambridge, Mass., National Bureau of Economic Research, 1995. 39 p. (NBER Working Paper 5370)

⁵ A discussion can be found in: U.S. Library of Congress. Congressional Research Service. Cigarette Taxes to Fund Health Care Reform: An Economic Analysis. CRS Report 94-214 E, by Jane G. Gravelle and Dennis Zimmmerman. Washington, 1994. 63 p.

⁶ For a history of the federal gasoline excise tax and the programs this tax funds see: U.S. Library of Congress. Congressional Research Service. Federal Excise Taxes on Gasoline and the Highway Trust Fund: A Short History. CRS Report 97-853 E, by Louis Alan Talley. Washington, 1998. 10 p.

⁷ This excise tax is discussed in: U.S. Library of Congress. Congressional Research Service. Federal Excise Tax on Tires: Where the Rubber Meets the Road. CRS Report 97-897 E, by Louis Alan Talley. Washington, 1997. 6 p.

⁸ For additional discussion of this issue see: U.S. Library of Congress. Congressional Research Service. Excise Tax Financing of Federal Trust Funds. CRS Report 93-6 E, by Nonna A. Noto and Louis Alan Talley. Washington, 1993. 39 p.

⁹ This tax is discussed in: U.S. Library of Congress. Congressional Research Service. Taxpayer Bill of Rights 2. CRS Report 96-318 A, by Marie B. Morris. Washington, 1996. 12 p.

¹⁰ See U.S. Department of Labor. Bureau of Labor Statistics. Table 2. Income Before Taxes: Average Annual Expenditures and Characteristics, Consumer Expenditure Survey, 1997. Available: ftp://ftp.bls.gov/pub/special.requests/ce/standard/1997/income.txt

¹¹ For further discussion, see U.S. Congress. Joint Committee on Taxation. Methodology and Issues in Measuring Changes in the Distribution of Tax Burdens. Joint Committee Print No. JCS-7-93, 103rd Congress, 1st session, June 14, 1993. Washington, U.S. Govt. Print. Off., 1993. pp. 60-66.

¹² Historical information based on: Ratner, Sidney. American Taxation. W. W. Norton and Co., New York, 1942; Federal Excise Taxes. The Tax Foundation, New York, June 1956; Worsnop, Richard L. Excise Tax Cuts and the Economy. Editorial Research Reports, Washington, 1965; and U.S. House of Representatives. Committee on Ways and Means. 1996 Green Book, Background Material and Data on Programs within the Jurisdiction of the Committee on Ways and Means. WMCP: 104-14, 104th Congress, 2d session, November 4, 1996.

¹³ Additional information is provided in: U.S. Library of Congress. Congressional Research Service. The Abandoned Mine Land Fund: Grants Distribution and Issues. CRS Report 97-401 ENR, by Robert L. Bamberger. Washington, 1997. 16 p.

¹⁴ For a discussion of this trust fund see: U.S. Library of Congress. Congressional Research Service. Leaking Underground Storage Tank Trust Fund (LUST). CRS Report 97-472 E, by Nonna A. Noto and Louis Alan Talley. Washington, 1997. 6 p. Also see Leaking Underground Storage Tank Cleanup Issues. CRS Report 97-471 ENR, by Mary E. Tiemann.

¹⁵ A court of International Trade decision has been upheld and the harbor maintenance tax as applied to exports has been found to violate the Export Clause of the Constitution.

¹⁶ The deficit reduction portion of the revenues has been redirected to the trust funds by an Act of Congress.

¹⁷ See footnote 14.

¹⁸ These taxes were reinstated until September 30, 1997 by the Airport and Airway Trust Fund Tax Reinstatement Act of 1997 (P.L. 105-2). The taxes were further extended under the Taxpayer Relief Act of 1997 (TRA97) (P.L. 105-34) through September 30, 2007. Under the TRA97, the tax on domestic passenger transportation is lowered incrementally to 7.5%, and the law provides for a new flight segment fee. International flights that begin or end in the United States are subject to a $12 arrival and departure tax. For more information on this Act see U.S. Library of Congress. Congressional Research Service. Aviation Taxes and the Airport and Airway Trust Fund. CRS Report 97-657 E, by John W. Fisher. Washington, 1997. 11 p.

¹⁹ The tax on recreational motorboat diesel fuel was repealed by the Taxpayer Relief Act of 1997 (P.L. 105-34).

²⁰ U.S. Office of Management and Budget. Budget of the United States Government, Historical Tables, FY2000. February 1999. p. 32.

²¹ A provision included in the Taxpayer Relief Act of 1997 returned the General Fund portion used for deficit reduction back to the trust funds.

²² Other exemptions from the tax were added by the Omnibus Budget Reconciliation Act of 1993. That Act provided that parts and accessories installed to enable or assist those with disabilities not be included in the tax base. The Act made clear that cars used by dealers as demonstrators were to have the luxury tax applied to the sales price of the vehicle when sold.

²³ The luxury excise tax collected from sales of high-priced automobiles has produced approximately the same amount of revenues projected in 1990 to be collected from the combined taxes instituted on automobiles, boats, furs, jewelry, and airplanes. In FY 1994 over $475 million was collected from the sale of luxury passenger vehicles. That amount rose to over $519 million for FY 1995.

²⁴ American Enterprise Institute for Public Policy Research. The Excise Tax Reduction Bill, H.R. 8371. Legislative Analysis No. 9, 89th Congress, 1st Session. May 28, 1965. 24 p.

²⁵ For a detailed discussion of a VAT see U.S. Library of Congress. Congressional Research Service. Value-Added Tax: Concepts, Policy Issues, and OECD Experiences, CRS Report 95-500 E, by James M. Bickley. Washington, 1995. 60 p.

/b/ Subject to a tax of 10% on manufacturer's price.

/c/ The Taxpayer Relief Act of 1997 provides that beginning on October 1, 1997, amounts previously deducted for deficit reduction be redirected to the Highway Trust Fund. Additionally, the LUST tax which had terminated on December 31, 1996, was reauthorized for the period October 1, 1997, through March 31, 2005.

/d/ The tax is imposed on the first retail sale and is equal to 10% of the excess of the sales price over $10,000.

/e/ Additional tax increases scheduled to become effective January 1, 1993.

/f/ A luxury excise tax equal to 10% of the excess of the sales price over $30,000 is imposed on the first retail sale of any passenger vehicle.

/g/ The tax is imposed on the first retail sale and is equal to 10% of the excess of the sales prices over $250,000.

/h/ The tax is imposed on the first retail sale and is equal to 10% of the excess of the sales price over $100,000.

/i/ A 10% sales tax was imposed on yachts, motor boats, canoes, etc., which sold for more than $15 under 1919 legislation and over $100 under the Revenue Act of 1921. This tax was repealed in 1924. Also, see listing under ""Miscellaneous Excise Taxes" headed "Uses of Boats."

/j/ The tax is imposed on the first retail sale and is equal to 10% of the excess of the sales price over $30,000.

/k/ The original $30,000 threshold is indexed annually in increments of $2,000. The threshold is $36,000 as of 1/1/99. Under a change in law, the 10% tax decreased to 9% for sales after August 27, 1996. The tax continues to phase down one percentage point each year through the year 2002 when it expires. For tax year 1999 the tax rate is 6%. This excise tax does not apply to a part or accessory installed to enable or assist an individual with a disability.

Note: In the first column the unit for measuring the tax base is indicated in parentheses following the name of the tax. A tax levied as a percentage of the sales price is called an ad valorem tax. A tax levied per physical unit, as in cents per gallon, is called an in rem tax. If the tax is no longer in effect, the last column (1999) indicates when the tax was repealed.