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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Excise Tax

What it is:

Excise tax refers to an indirect type of taxation imposed on the manufacture, sale or use of certain types of goods and products.

How it works (Example):

Excise taxes are commonly included in the price of a product, such as cigarettes or alcohol, as well as in the price of an activity,often gambling. Excise taxes may be imposed by both Federal and state authorities.

Excise taxes usually fall into one of two types:

  • Ad Valorem; meaning that a fixed percentage is charged on a particular good or product. This administration of the tax is less common.
  • Specific; meaning that a fixed currency amount may be imposed depending on the quantity of the goods or products that are purchased. Specific is the most common type.

For example, a bottle of wine that normally costs $10 may have a specific excise tax of $2 imposed on it. As per the intent of the excise tax, the additional cost of the wine is passed onto the consumer, making the retail cost of the bottle $12. While this seemingly does not affect the maker of the wine, who's still gains $10 in revenue, an increase in price does reduce quantity demanded, which would indeed affect his balance sheet.

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Why it Matters:

The implementation of excise taxes allow Federal and state governments the means to raise additional revenue necessary for large projects such as social programs.

Excise taxes are most often levied upon cigarettes, alcohol, gasoline and gambling. These are often considered superfluous or unnecessary goods and services. To raise taxes on them is to raise their price and to reduce the amount they are used. In this context, excise taxes are sometimes known as "sin taxes."

[InvestingAnswers Feature: How to Avoid an IRS Audit]

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