Excise Tax

What Is an Excise Tax?

An excise tax is an indirect tax placed on a particular good, service, or activity rather than on general spending. Unlike a sales tax that applies to most retail purchases, an excise tax targets a defined category such as gasoline, tobacco, alcohol, or airline tickets. Governments use these taxes to raise revenue or to discourage consumption of products they consider harmful or costly to society. For that reason, they are sometimes informally called "sin taxes."

How Excise Taxes Work

Excise taxes are usually levied at a specific point in the supply chain, often on a manufacturer, producer, importer, or distributor rather than the final buyer. The tax may be a fixed amount per unit, such as per gallon or per pack, or a percentage of the price. Businesses typically build the tax into their selling price, so consumers pay it indirectly.

The business that sends the payment to the government and the person who ultimately bears the cost are not always the same. Economists study this division through tax incidence. How much of an excise tax shifts onto buyers depends largely on how sensitive demand is to price, a measure known as price elasticity of demand. When buyers respond little to price changes, as with some necessities, more of the burden tends to fall on them.

Why It Matters to Investors

Excise taxes can affect companies that make or sell taxed products. A rise in an excise tax can increase producers' costs, reduce sales volume, or squeeze profit margins, depending on whether those costs can be passed on to customers. Investors in sectors such as energy, tobacco, alcohol, and transportation often watch these taxes closely.

Excise taxes have advantages and drawbacks. They can provide a fairly predictable source of revenue and may influence behavior. However, because they often fall on goods that lower-income households spend a larger share of their income on, they can be regressive tax in effect. They also apply to narrow categories, so they generally raise less total revenue than a broad-based tax such as a value-added tax.