CRS REPORTS ON LUXURY TAXES.

                          Louis Alan Talley

Given the various restraints on instruments available for raising revenue, some have suggested turning once more to the excise tax. The United States has long and varied experience with excise taxation. When a primary objective of excise taxation is to make the share of income taken by taxes increase more than income, 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."

A review of the use of excise taxes on luxury goods to raise revenue and generate progressively distributed tax payments produces the following conclusions:

o the primary economic effect of excise taxes is to interfere with the private sector's consumption and production decisions; they are desirable taxes when such interference is the Government's goal, as with regulatory taxes, but they are not well suited to producing a progressive distribution of tax payments.

o in the available expenditure data arrayed by income class quintiles, we could not discover any sizable revenue bases that were progressively distributed.

o further disaggregation of expenditure categories would possibly reveal progressive excise tax bases, and progressive bases could be generated for many goods by exempting lower- priced items.

o in U.S. history, excise taxes have proven very successful instruments for raising revenue in times of war or fiscal emergency; such taxes have frequently been targeted on goods thought to be luxuries, but judgments as to what constitute luxuries have been highly subjective.

o at present, the U.S. uses excise taxes at the Federal level primarily for raising the price of goods whose private prices do not reflect their social costs, such as alcohol and tobacco, or as user charges for public goods, such as the gasoline tax used to fund highway construction.

o most other countries include some form of luxury taxation in their tax systems; but the designation of "luxury" goods is subjective and varies considerably from country to country.

o excise taxes can be collected at the manufacturing, wholesale, or retail stage of production, each stage having different economic and revenue effects.

                          TABLE OF CONTENTS

The large Federal deficits of the 1980s which have continued into the 1990s have caused the Congress to consider raising taxes, particularly on higher-income persons. A major unresolved issue is the choice of a tax base. 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.

For example, in the United States in the twentieth century, income has been the primary tax base of choice when revenue generation is a goal. In addition, an income tax can be manipulated to achieve a desired income class distribution by adjustment of the tax rate structure. Commodity taxes, 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.

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 may exist currently. While perhaps the simplest way to raise Federal revenues would be through increases in income tax rates, adherents remain committed to continuing the low tax rates as passed in the Tax Reform Act of 1986 (P.L. 99-514). One proposal, to eliminate the "bubble" (by providing a third rate of 33 percent and extension through upper income levels) while still actively discussed was defeated in the House of Representatives as recently as the fall of 1989. Thus, at this time, it appears more difficult than usual to adjust the income tax rate structure to achieve the two goals of revenue generation and distribution of tax payments to higher-income persons. ¹

ECONOMICS OF EXCISE TAXES

This section provides a brief discussion of the economics of excise taxes, emphasizing the second-best nature of excises as revenue-raisers targeted on high-income individuals. It reiterates the economic judgment that the primary effect of excise taxes is to interfere in the private sector's consumption and production decisions.

Usually, a government wants to raise revenue in a manner that minimizes the effect on the private sector's 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. An excise tax distorts consumption choices. Both taxes impose what economists term "welfare losses."

Excise taxation is the preferred tax instrument in two situations: (1) when the Government's primary objective is to interfere in private sector decisions and thereby alter the private sector's 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

The first situation occurs 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.

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, and revenue collections are small. If consumers are not sensitive to price, consumption of the taxed good and external costs remain nearly the same, but the Federal Government has revenue to finance an attack on these external costs.

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. Because the taxes are not designed to match revenues with social costs, one may suspect 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.

USER CHARGES

The second situation in which an excise tax is the preferred Federal tax instrument occurs when the Federal Government 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 revenues to finance Federal highway expenditures and airline ticket excise tax revenues to finance airport expenditures are examples. Such taxes are often earmarked or designated for trust funds for their public purpose, as the transportation taxes are. Again, the distributional consequences are of subordinate concern because tax payments are seen as compensated by benefits from public spending. ²

OTHER USES OF EXCISES

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. There were no substitutes for 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. A more recent example is the tax imposed on gas guzzler cars.

Second, 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 toilet preparations.

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, the advent of "penalty" excise taxes have become law. Such penalty taxes include the tax on excess lobbying expenditures made by charitable organizations, or the excess contributions or early withdrawal of funds from an Individual Retirement Account.

DEFINITION OF A LUXURY

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

The first, and more rigorous, definition of a luxury good depends upon 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 further requires that the good be one on which the lower economic classes spend little or nothing (that is, it has an income elasticity substantially in excess of one).

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, the policymakers who devised the taxes knew almost nothing with certainty about the distribution of purchases of the products they proposed to tax. Even today, when surveys of consumer habits and characteristics are common, there is little information. 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. ³ Exempting lower-priced items, or a given dollar amount of each purchase, from tax could create a progressive distribution of tax for many expenditures; but that, of course, reduces the size of the tax base (and there are virtually no data on purchases by amount spent per item, so measuring such a tax base would be virtually impossible).

NECESSITY

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 some "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, of course, any income class can be prone to spending on luxury goods and therefore subject to taxation; any tax imposed based on this definition is less likely to be progressive with respect to income; and the tax base is greatly expanded.

DISTRIBUTION OF THE TAX BURDEN

The attempt to define luxury goods by reference to their income elasticity involves two additional problems: some luxury consumption goods are purchased by businesses rather than individuals, so that the income class of the actual taxPAYER is not known; and, even when the payer is definitely identifiable, the person who PAYS a tax is not necessarily the person who really bears the BURDEN of it.

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

In addition, this report speaks of TAX PAYMENTS from a tax on the consumption of luxuries; no effort is made to identify luxury goods on the basis of the distribution of the TAX BURDEN that results from the imposition of the tax.

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 cause real income to rise 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 further reduced, although it is in turn offset somewhat by lower income tax payments. And if the economy's overall output is affected, gross national product may fall and further reduce aftertax incomes. ⁴

U.S. HISTORICAL EXPERIENCE WITH EXCISE TAXATION ⁵

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 in time of war. It is only recently that excises have been used extensively for the control of social costs and for user charges, except for the excises on tobacco and alcohol. The history of most twentieth century United States excise taxes is summarized in table 1 (at the end of this report).

THE EARLY REPUBLIC

Federal internal taxation 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 refining 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

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.

THE CIVIL WAR

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.

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, which presumably reflected 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

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, the most important of which were those on liquor, tobacco, oleomargarine, and playing cards.

WORLD WAR I AND AFTER

The financing of 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 percent to 28 percent 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.

The collapse of income tax receipts in the Great Depression led to one of the largest tax increases ever enacted in 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, toilet 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 toilet preparations and jewelry.

WORLD WAR II

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, toilet 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, film and refrigerating equipment, and washing machines were all classed as luxuries and taxed accordingly.

KOREAN WAR

Most of the World War II excises were still in effect when the Korean War broke out 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. Various tax rate extension acts continued these Korean War excise taxes through the early 1960s.

DECADE OF THE 1960s

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, as well as certain 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 the Federal acquisition of such lands.

The Excise Tax Reduction Act of 1965 (P.L. 89-44) reduced excise tax rates, many over a period of years. The purpose of the Act was to help 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.

The late 1960s saw mounting budgetary pressure triggered by 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 THE TRUST FUNDS

The Airport and Airway Trust Fund was established in 1970 to modernize the airway facilities and equipment and provide for safety of the airport system. The fund was financed with new and increased aviation user excise taxes.

The late 1970s and 1980s saw the establishment of many trust funds financed with excise taxes on related products and the introduction of another sumptuary excise on "gas-guzzler" cars designed to reduce social costs. Many of these trust funds have been established because of deficit reduction pressures brought about by the passage of Gramm-Rudman-Hollings law to balance the Federal budget and the desire to offset new or existing expenditure responsibilities. A brief summary of the trust funds established since 1978 follows:

1. The Inland Waterways Trust Fund uses funds derived from an excise tax on fuel used by vessels in commercial waterway transportation plying inland and intracoastal waterways. The Act establishing this fund was passed in 1978.

2. The Deep Seabed Revenue Sharing Trust Fund is supported by a tax of 3.75 percent of the "imputed value" of hard mineral resources removed from deep seabeds. This fund was established in 1979.

3. The Hazardous Substance Response Trust Fund set up in 1980 is mainly supported by excise tax receipts on crude oil and taxable chemicals sold by a manufacturer, producer, or importer. The trust fund and related taxes expired and were reestablished by the Superfund Revenue Act of 1986 (P.L. 99- 499). Also established under this Act was the Leaking Underground Storage Tank Trust Fund with taxes imposed on gasoline, diesel fuel, and other types of fuels.

4. The Aquatic Resources Trust Fund was established under the Deficit Reduction Act of 1984 (P.L. 96-369). It is funded by excise taxes on sport fishing equipment, outboard motors, sonar devices, and special motor fuels and gasoline used in motor boats.

5. As part of the Water Resources Development Act of 1986 (P.L. 99-662) a new excise tax is imposed on the value of cargo loaded or unloaded from commercial cargo vessels. This tax funds the Harbor Maintenance Trust Fund.

6. The Oil Spill Liability Trust Fund became effective under the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239). The financing is obtained from an excise tax of 5 cents per barrel on domestic and imported crude oil and imported petroleum products.

7. Import duties on plywood and lumber finance the Reforestation Trust Fund established in 1980.

HISTORICAL SUMMARY

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.

The present excises are minor sources of Federal receipts representing 3.4 percent of Federal receipts in FY 1989. Excise taxes are estimated to constitute 3.4 percent of receipts in 1990; 3.2 percent in FY 1991; 3.1 percent in FY 1992 and 1993; 3.0 percent in FY 1994 and only 2.9 percent in FY 1995. ⁶ No present Federal excise tax is defended on"ability-to-pay" grounds as a tax on higher- income consumers.

EXAMPLES OF U.S. EXCISE TAXATION OF LUXURY GOODS

This section is devoted to a more detailed look specifically at the excise taxation of luxury goods, describing some examples from U.S. historical experience with those excise taxes which have been classified by some as taxes on luxury goods. Several insights emerge from the discussion. First, the level of aggregation of data on consumption by income class makes the choice of the luxury tax base very subjective. Second, the subjective 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.

Past policymakers often made very subjective decisions about what products should be subject to excises. It is difficult to look back on their decisions and say with any confidence just which products were taxed for what reasons. A more detailed examination of two 20th Century excise tax enactments that were discussed briefly in the preceding section, the Revenue Act of 1918 (P.L. 254, 65th Cong.) and the Revenue Act of 1932 (P.L. 154, 72nd Cong.) makes it clear, however, that some judgments about the "luxury" nature of goods were being made.

REVENUE ACT OF 1918

The Revenue Act of 1918 was one of the most comprehensive of the wartime acts. It included no new taxes on alcoholic beverages, which by then were illegal, but it included heavy taxes on the manufacture or importation of tobacco products and taxes on bottled soft drinks (10 percent of sales price) and fountain soft drinks, sodas, ice cream, and other ice cream parlor products (1 percent). There was a 1 percent 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 presumed 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 percent tax.

The Act included a series of manufacturers' excise taxes, such as: trucks, 3 percent; passenger automobiles and motorcycles, 5 percent; sporting equipment, 10 percent; "chewing gum or substitutes therefor," 3 percent; candy, 5 percent; firearms and ammunition and hunting knives, 10 percent; "portable electric fans," 5 percent; hunting and shooting garments and riding habits and articles made of fur, 10 percent; "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 percent; and many other items.

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-percent tax on playing cards were included among the stamp taxes.

The maximum yield from these taxes was reached in fiscal year 1920, when they totaled $1.25 billion, 22 percent 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 distributed $223 million from manufacturers' taxes, $45 million from the retail taxes, and $550 million from the admissions, stamp, and other taxes.

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 percent of Federal receipts, almost all from these sources.

REVENUE ACT OF 1932

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 percent of sales price), radios and accessories and household mechanical refrigerators (5 percent), and a tax was also imposed on safe deposit boxes (10 percent of rent). The retail excises were not reinstated, but jewelry, furs, and cosmetics were subjected to a 10 percent manufacturers' tax.

For fiscal year 1934, excise taxes made up almost 56 percent of the Federal Government's depression-reduced receipts. Excise tax receipts totaled $1,288 million, distributed $425 million from tobacco taxes, $385 million from manufacturers' taxes, $259 million from the again-growing alcohol taxes, and $218 million from admissions, stamp, and other excises.

CONCLUSIONS ABOUT "LUXURIES"

One of the reasons for imposing these taxes was to raise revenue, and at this the taxes must be considered a success. The particular products selected for taxation, however, were obviously not selected to maximize revenue yield, so there must have been 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 some definition or another.

In the Revenue Act of 1918 (P.L. 254, 65th Cong.), many of the taxes could be assumed to have been for the purpose of suppressing unnecessary civilian consumption for defense reasons. Several of the taxes, however, such as the retail taxes on clothing, were imposed only on articles exceeding a specified price (rather high prices for that time), thus generally restricting the tax base to the higher income classes. The retail taxes actually raised very little revenue, only about $45 million in 1920 from all the retail taxes combined.

In 1932, the only national emergency was financial, the economic collapse 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, thus presumably 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 presumably passed forward to all of the businesses' customers in price increases whenever possible and thus were spread across all income classes.

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. ⁷ 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. All in all, the historical record offers very little guidance in choosing luxury excises for today's economy.

FOREIGN EXPERIENCE WITH LUXURY TAXES ⁸

This section summarizes the use of luxury taxes in some developed countries. This brief review generally confirms the conclusions of the U.S. historical record as to the subjective nature of the definition of "luxury."

All developed nations except the United States have a broad- based consumption tax at the national level. These broad-based consumption taxes include value-added taxes, retail sales taxes, manufacturers' excise taxes, and wholesale sales taxes. Many economists recommend a single rate for a VAT in order to minimize administrative costs and reduce economic distortions. ⁹

Excise taxes are common in the developed countries; all the countries of Western Europe, Canada, and Japan impose either excise taxes, value-added taxes (VATs), or both. The excises are, like the earlier U.S. taxes, often based on the presumed "luxury" nature of the goods. Most of these countries have taxes on entertainment as well as having high excise taxes on alcohol and tobacco products.

Canada imposes a manufacturer's sales tax (13.5 percent) plus excise taxes on manufactured products including household appliances, radios and TVs, sporting goods, jewelry, and watches. The Canadian Government has proposed that the current manufacturer's excise taxes be replaced by a VAT in 1991. Japan, which recently instituted a 3- percent general consumption tax, also imposes high excise taxes, with rates ranging from 5 percent on beverages and electronics equipment to 15 percent on cameras and to 30 percent on luxury automobiles, certain sports equipment, and precious stones. The list of Japanese excises reads rather like the extensive U.S. excise taxes of World War II, with obvious attempts to distinguish "luxury" goods.

Most of the nations of Western Europe have value-added taxes, and most of the VATs 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, Sweden, and the United Kingdom, frequently impose excise taxes on"luxury" items in addition to their regular VAT.

There is no more consistency in what is regarded as a luxury in other countries than there is in U.S. history. Even in the Common Market countries, where a conscious effort has been made to coordinate 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 necessity for making somewhat arbitrary choices of "luxury" goods that has faced U.S. policymakers.

AT WHAT STAGE OF PRODUCTION SHOULD THE TAX BE LEVIED?

This section provides a brief discussion of the economic implications of the level at which the tax is collected -- retail, wholesale, or manufacturing. In general, any choice brings benefits and costs. 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, or on sale of the good at the retail level. 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

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.

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.

A third problem can arise when the tax is levied at the manufacturing level. Any nonprofit or other entities that are exempt from the tax will require some special treatment to avoid paying the tax. Some administrative difficulty is unavoidable.

POINT OF SALE

Two related problems arise when the tax is levied at the point of sale to the final consumer. Both administrative costs and the potential for evasion increase as the number of collection sites increase 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. This approach, however, makes it necessary to find a way to eliminate the tax for nonprofit organizations and uses (such as on the farm) otherwise exempt from the tax.

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 for evasion of the tax base. But it increases the effective tax rate, creates an incentive to restructure the manufacturing process to avoid the tax, and ensnares tax-exempt organizations in the tax base. If the tax is placed at the point of sale administrative costs are higher and the potential for evasion increases.

                               TABLE 1.

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

/c/ An additional 0.1 cent per gallon excise tax was imposed to finance the Leaking Underground Storage Tank (LUST) Trust Fund. The tax terminated after August 31, 1990 when it reached its net revenue target for termination. (Internal Revenue Service Announcement 90-82, released June 27, 1990.)

² For additional discussion of this issue see: U.S. Library of Congress. Congressional Research Service. Federal User Fees.: An Overview. Report No. 89-625 E, by Julius W. Allen. Washington, 1989. 28 p.

³ U.S. Department of Labor. Bureau of Labor Statistics. Consumer Expenditure Interview Survey.: Quarterly Data, 1984-87. Table 20. Quintiles of Income Before Taxes: Average quarterly expenditures' of all consumer units, Interview Survey, Fourth Quarter, 1987. Washington, U.S. Govt. Print. Off., 1989. p. 24.

⁴ The Congressional Budget Office has made an effort to estimate the distribution of the tax burden that would result from a one billion dollar increase in each of seven existing Federal excise taxes. See U.S. Congressional Budget Office. The Distributional Effects of an Increase in Selected Federal Excise Taxes. Staff Working Paper. January 1987.

⁵ Historical information based on: Retner, 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. Background Material and Data on programs within the Jurisdiction, of the Committee on Ways and Means. WMCP: 99-2, 99th Cong., 1st sess., February 22, 1985.

⁶ U.S. Office of Management and Budget. Budget of the United States Government, FY 1991. Jan 1990. p. A-286.

⁷ 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.

⁸ Material for this section was compiled by Wayne Morrison, Analyst in Internal Trade and Finance, Economics Division, CRS, based on: Guides to European Taxation. Vol. IV, Value-Added Taxation in Europe, International Bureau of Fiscal Documentation, Amsterdam, The Netherlands, 1986; Diamond, Walter H. Foreign Tax and Trade Briefs. Matthew Bender, 1990; and Deloitte Haskins and Sells. International Tax and Business Service. Updated periodically.

⁹ For a detailed discussion of a VAT see U.S. Library of Congress. Congressional Research Service. Value-Added Tax: Concepts, Policy Issues, and OECD Experience, Report No. 89-638 E, by James M. Bickley. Washington, 1989. 39 p.