Sin Tax Definition and How It Works

What Is a Sin Tax?

A sin tax is an excise tax on specific goods and services due to their ability, or perception, to be harmful or costly to society. The tax comes at the time of purchase. Some items that often have a sin tax include tobacco products, alcohol, and gambling.

Sin taxes seek to deter people from engaging in socially harmful activities and behaviors. They also provide a source of revenue for governments.

Understanding Sin Taxes

Sin taxes are typically added to liquor, cigarettes, and goods that are considered morally hazardous. Because they generate enormous revenue, state governments favor sin taxes. Society accepts sin taxes because they affect only those who use sin taxed products or engage in sin taxed behaviors. When individual states run a deficit, a sin tax is generally one of the first taxes recommended by lawmakers to help fill the budget gap.

A sin tax is a type of Pigovian tax, which is levied on companies that create negative externalities with their business practices. Sin tax proponents maintain that the targeted behaviors and goods produce negative externalities. In other words, they foist an unfair burden on the rest of society. The effects of alcohol and tobacco products increase healthcare costs driving up the cost of insurance for everyone. Also, compulsive gambling compromises the security and well-being of stable home life, children, and families of the gambler.

One purpose of a Pigovian tax is to create an incentive to reduce negative externalities. This means that the sin tax seeks to lower or end the use of harmful products by making them more expensive to buy.

In many cases, these taxes are effective, especially with younger consumers who have less disposable income and are still developing their habits and preferences. For example, taxes on cigarettes can decrease rates and smoking and improve public health outcomes. A 10% tax on cigarettes lowers the demand for cigarettes by 4%. But the effect is even more pronounced for adolescents and teens: a 10% tax lowers smoking rates by nearly 12% for 12 to 17-year-olds.

Taxes on alcohol have been found to reduce general alcohol consumption, but the effect is even more pronounced among heavy drinkers. A seminal study on the impact of alcohol taxes found that a hypothetical 25-cent-per-drink tax would reduce alcohol consumption by 9.2%; however, it would reduce heavy drinking (including binge drinking and alcohol-impaired driving) by 11.4%.

Real-world applications have confirmed this prediction. When Maryland implemented its first increase in alcohol taxes in decades, the state's rate of car crashes involving drivers who had been drinking gradually decreased by 6%. Among drivers ages 15 to 34 years, the rate was double that—a 12% decrease.

History of Sin Taxes

Sin taxes in the United States have been in use since the 18th century. Tobacco was one of the first consumer goods ever taxed in America, first by the British before the Revolutionary War and later by the new government in the 1790s.

The federal government began taxing tobacco during the Civil War, and since then the level of this tax has varied depending on the income needs of the government. In 1951, the federal tax on cigarettes rose from $0.07 to $0.08 per pack of cigarettes to help finance the cost of the Korean War. In 1983, it was doubled to $0.16 per pack. In 1921, Iowa was the first state to implement a tobacco tax; North Carolina was the last in 1969. There are also tax rates that are applied to non-cigarette tobacco products such as snuff and chewing tobacco.

The first tax on alcohol in the United States was levied on distillers in 1792 to help pay for the costs of the Revolutionary War. The tax led to protests and riots. After the end of National Prohibition in the United States in 1933, most states enacted excise taxes on alcohol, including beer, wine, and spirits. These rates increased from 1933 to 1970. However, the value of alcohol taxes indexed for inflation has declined since the 1970s due to insufficient and infrequent increases.

Criticism of Sin Taxes

Imposing a sin tax does not come without criticism. Small-government conservatives argue that a sin tax represents an overreach of government. Critics allege that by singling out specific products or services for additional taxation, the government is engaging in social engineering and taking on the role of a nanny state.

Similarly, pundits on the left take issue with a sin tax because it tends to create a disproportionate effect on the poor and the uneducated. For example, there is empirical evidence that the rate of smoking is inversely related to education. Dropouts and high-school graduates have a higher probability, based on historical usage data, to use tobacco products than those people with advanced degrees.

Moreover, sin taxes are typically regressive taxes. This means that the less money a person makes, the more significant a percentage of their income these taxes consume. A pack-a-day smoker who makes $20,000 per year spends the same money on cigarettes, and therefore, the same on cigarette taxes, as one who makes $200,000 per year. However, the taxes the lower-income consumer must pay represents a more substantial portion of their paycheck.

Some studies of sin taxes, though, have shown that lower-income consumers are more likely to change their behavior in response to sin taxes, resulting in paying less as a result. The people who pay more due to sin taxes are often higher earners. The 2008 study of a hypothetical alcohol excise tax, for example, found that the people most impacted by the tax would be employed, college-educated, and earning $50,000 per year or more.

Examples of Sin Taxes

Sin taxes in the United States have been levied on consumer goods like alcohol and tobacco since before the U.S. was a country. There are also new sin taxes being enacted due to changing laws around recreational drug use and gambling,

Cigarettes

In the United States, the federal government, all 50 states, Washington, D.C., and hundreds of counties, cities, and localities tax cigarettes as well as other tobacco products. In 2022, the federal cigarette tax was $1.01 per pack; state cigarette taxes ranged from $0.17 per pack in Missouri to $4.35 in Connecticut and New York.

Alcohol

As of 2022, federal tax on alcohol is $0.58 per gallon. The District of Columbia and all fifty states except Utah also impose excise taxes on beer, ranging from $0.02 in Wyoming to $1.29 in Tennessee. The federal excise tax on wine is $1.07 per gallon, while state taxes range from $0.20 in Texas and California to $2.50 in Alaska. The federal excise tax on distilled spirits is $10.80 per gallon, while state taxes range from $1.50 in Maryland and the District of Columbia to $14.25 in Washington.

States that do not have excise taxes have state control systems in place for both retail and wholesale distribution. These states typically use price markups, which also increase the government revenue, but not sin taxes.

Gambling

At the federal level, income from gambling must be reported on your tax return. You must either have tax withheld from your gambling winnings or pay estimated tax on your winnings, which will be reported on a tax form W-2G.

Tax treatment of gambling varies widely at the state level. New Hampshire, for example, has a 10% tax on all gambling winnings. Gambling income can come from a variety of sources, such as poker, slot machines, bingo, lotteries, and keno. Other states do not impose a tax on gambling winnings but may allow their cities and localities to do so. Washington State, for example, has no state gambling tax. But the city of Seattle has several different tax rates for gambling, depending on the type of game in which you won your money. These range from a 2% tax rate on winnings from amusement games to 10% from gambling at fundraising events.

Recreational Marijuana

Since California legalized medical marijuana in 1996, more states have followed suit with both medical and recreational forms of cannabis and cannabis-infused products. Many states that have legalized recreational marijuana tax growers, sellers, or consumers. In some states, all three are taxed.

As of 2022, sixteen states taxed recreational cannabis purchases at the retail level. These tax rates range from 6.35% of total sales in Connecticut to 37% of total sales in Washington state. These costs are generally passed onto consumers in the form of higher prices. However, only Arizona has a specific cannabis excise tax, which is 16%.

Vaping

E-cigarettes were first sold in the U.S. in 2007, and their use has risen as smoking traditional cigarettes has fallen. Smoking e-cigarettes, or vaping, is especially popular among teens and younger smokers.

Thirty states, as well as the District of Columbia, Puerto Rico, and the U.S. Virgin Islands have a tax on e-cigarettes. These can be taxes on the wholesale cost, purchase price, or liquid volume of the e-cigarette. Taxes per volume range from $0.01 per vapor volume in Ohio to $0.40 per milliliter in Connecticut. Indiana has a 15% tax on gross retail income from e-cigarettes, while Puerto Rico levies a flat $3 tax on each e-cigarette purchased.

Sports Betting

In 2018, a Supreme Court on the Professional and Amateur Sports Protection Act allowed states to decide whether to allow betting on sports. However, sports betting is always subject to federal excise taxes, whether or not it is legal in your state. Unauthorized sports betting is subject to a higher sin tax rate.

Sports betting that is legal in your state is subject to a 0.25% federal excise tax on the amount you wager. Sports betting that is not authorized in your state is subject to a tax of 2% of the amount you wager.

State tax rates on sports betting can vary depending on how you place your bet (retail or mobile). Rates range from 6.75% in Nevada to 51% in New York and Rhode Island. Arkansas divides its tax rate based on how much you bet, taxing 13% of the first $150 million, then 20% above that.

The Bottom Line

A "sin tax" is a tax levied on products or activities that are considered harmful or undesirable. These taxes are typically implemented to discourage consumption of the taxed products or to raise revenue for the government. Examples of products and activities that are often subject to sin taxes include tobacco, alcohol, gambling, and unhealthy foods. Sin taxes are sometimes justified on the grounds that they can help reduce the negative social and health impacts of the taxed products or activities. Some critics argue that sin taxes disproportionately affect lower-income individuals. However, studies have not always shown this to be true.