Excise tax: What it is and how it works

Excise tax definition

An excise tax is a tax on the purchase of a specific good or service, such as alcohol, cigarettes or gambling. Some excise taxes are imposed by the federal government, while others are imposed by the state government. Some excise taxes are known as sin taxes since they may apply to goods and services that the government is trying to discourage.

Some products that are subject to an excise tax include:

• Cigarettes
• Alcohol
• Gambling
• Health Insurance
• Telephone service
• Indoor tanning
• Airplane fuel
• Air travel
• Coal

Some states also have an excise tax on gasoline used to fuel your car.

How excise taxes work

An excise tax is similar to a sales tax in that it applies to the purchase of a good or service. But unlike sales taxes, which are generally paid by the consumer, excise taxes may be applied at other points in the supply chain, such as on the manufacturer or retailer of a good. In fact, many excise taxes are charged to businesses, though they likely pass those costs along to the consumer in the product price.

Excise taxes are applied in one of two ways: either as a percentage of the purchase price or as a per-united tax. This type of tax, similar to the sales tax, is an indirect tax. This means that instead of being paid directly to the government like income taxes and property taxes, it’s paid to another party (usually the retailer), and passed along to the government.

Example of excise taxes

One of the most common examples of an excise tax that many people pay is the tax on gasoline. Unlike many other taxes, the gasoline tax is one that’s imposed by both the federal and state governments.

The excise tax on gasoline isn’t a percentage-based tax. Instead, it applies as a per-unit price. The federal gas tax is 18.4 cents per gallon as of this past July. And while the state gas tax differs in each state, the average is 30.63 cents per gallon.

Suppose you put 20 gallons of gas into your vehicle’s gas tank in Wisconsin, where the gasoline excise tax is 30.9 cents per gallon. First, you would pay $3.68 ($0.1840 x 20) for the federal excise tax on gasoline. Then you’d pay $6.18 ($0.309 x 20) for Wisconsin’s excise tax. You would pay a total of $9.86 in excise taxes for your gasoline purchase.

Categories of excise taxes

Excise taxes can be classified as either ad valorem or specific, where one is a percentage-based tax and the other is per unit.

Ad valorem excise taxes

Ad valorem is a Latin term that means “according to value.” An ad valorem tax is one that’s applied as a percentage of the purchase price. For example, there’s an excise tax on domestic air travel that’s 7.5 percent of the ticket purchase price. Because it’s percentage-based, the tax will fluctuate with airline ticket prices. Other examples of ad valorem excise tax include tanning services, heavy trucks and certain health insurance policies.

Specific excise taxes

A specific excise tax is one that’s priced per unit instead of being percentage-based. Because this tax applies to a specific unit of a product, such as one container or one gallon, it doesn’t fluctuate with the price of the product. For example, beer has an excise tax of $18 per barrel (31 gallons), paid by the manufacturer. Other examples of specific excise taxes include gasoline and cigarettes.

Excise tax versus sales tax

Excise and sales taxes are very similar. Both are paid by a consumer on the purchase of a good or service. However, there are several differences between the two.

First, excise taxes only apply to certain products, while sales taxes apply to most or all products in a state. And as stated before, sales taxes are imposed on consumers, while excise taxes may be charged to either consumers or businesses.

Another important difference between excise and sales taxes is the way they’re taxed. First, sales taxes aren’t imposed by the federal government; only state and local governments impose these taxes. And rather than being either an ad valorem or specific tax, sales taxes are always an ad valorem (or percentage-based) tax.

Excise and sales taxes also have a very different purpose for governments. Sales taxes are a major source of revenue for state governments. In fact, after intergovernmental transfers from the federal government, sales taxes make up the next largest source of state government revenue.

And while excise taxes are a source of revenue for federal, state and local governments, the revenue isn’t always their only purpose. Excise taxes that are considered sin taxes are also in place to discourage undesirable activities like smoke, drinking and gambling.

Learn more:

• What is net income? Definition and how to calculate it
• Sales tax: Definition, how it works and how to calculate it
• Sin tax: What it is, how it works and examples