Nova workboard

a blog from young economists at Nova SBE

Excise Tax: a good or a bad decision?

In the last few months, Portuguese Government has been considering the imposition of an excise tax on products that are harmful for the consumer’s health. A well-known Portuguese newspaper stated that according to the Ministry of Health, this is not only a budget measure, but also a way to fight against health problems. In fact, why these types of taxes are used, and which are its effects?

An excise tax is an inland tax applied on a good produced for sale. These taxes are indirect in the sense that the producer or seller is expected to recover the tax by increasing the price to consumers. However, an excise tax is different from a sale tax or a value added tax (VAT) and we can distinguish in three ways:

  • An excise typically applies to a restrictive range of products
  • An excise is typically more aggressive, representing a higher fraction of the retail price of the targeted products
  • An excise is a per unit tax, costing a specific amount per unit, whereas a sales tax or a VAT is an ad valorem tax, and proportional to the price of the good.

Regarding the news that came out, the excise tax can serve political ends by producing significant revenues at a lower cost and also discourage consume of harmful products that otherwise individuals might over consume in the absence of such a tax. Beyond the Portuguese motivations, there are other reasons to use this kind of taxes. One is to impose tax burdens on those who benefit from government services and the other is to control externalities.

Since Government wants to avoid the consumption of this kind of products, the long run effect of an excise tax is a decrease on the supply of the commodity in which the tax is levied. Consequently, the price that consumers have to pay will increase. We can observe the effect on price and quantity on the following graph:

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Regarding the tax incidence, while the excise tax is imposed on producers, the tax burden may be shared between consumers and producers. The burden of an excise tax depends on elasticities of demand and supply: if demand for a taxed good is elastic, and supply relatively inelastic, then the burden is borne by sellers, whereas buyers bear the burden of a tax on a good or service with inelastic demand and elastic supply.

Regarding the advantages of this tax we can focus on three main points. One is addressing to a healthier society in the sense that discourage people to consume harmful products or at least not do it as often. Second, higher taxes mean higher government revenues which can go toward education, better roads, and also for the healing of the sick. Lastly, it can help in reducing international smuggling. On the other hand, there are also disadvantages related with the implementation of an excise tax. Those who are against sin taxes believe that they should be allowed to make their own decisions regarding what “vices” to consume or not. Second, many argue that sin taxes hurt the poor more than high income individuals since an extra euro tax on a pack of cigarettes eats up a higher percentage of income for a low income individual than it does for a wealthy person. Contradicting the advantages mentioned above, sin taxes may also result in lower revenue in the long-run because people can find alternative ways to consume such products and may induce smugglers to bring cheaper products.

In Portugal, one believes that the effect of an excise tax will hurt the lower class in the sense that they have higher propensity to consume this type of products, which are cheaper. On the other hand, OECD states that these classes are those who benefit more from the health gains that come from here. Once the consequences are inconclusive, we have to wait for the decision of the Government.

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Author: studentnovasbe

Master student in Nova Sbe

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