What is a 'Luxury Tax'

A luxury tax is a tax placed on products or services that are deemed to be unnecessary or non-essential. This type of tax is an indirect tax in that the tax increases the price of the good or service and is only incurred by those who purchase or use the product.

The term has remained even though many of the products that are assessed with luxury taxes today are no longer seen as "luxuries" in the literal sense. Today's definition leans more toward "sinful" items, such as tobacco, alcohol, jewelry and high-end automobiles. They are implemented as much in an attempt to change consumption patterns as to collect tax revenues.

Luxury taxes can also be called "excise taxes" or "sin taxes."

BREAKING DOWN 'Luxury Tax'

Luxury taxes were often imposed during times of war to increase government revenues, or as a way to get more tax revenue from the ultra-wealthy. Even though some people complain about the preservation of luxury taxes today, the vast majority of people and lawmakers don't mind charging extra fees for the use of these ancillary-type products consumed by a minority of the population.

There is much debate over whether levying luxury taxes does more harm than good. For example, who is most harmed by a luxury tax placed on an expensive car - the buyer, who presumably has money to spare, or the middle-class worker who builds the car only to see sales fall when the luxury tax curbs demand? In the late 1980s, Canada attempted a large luxury tax on cigarettes, only to find that a substantial and violent black market soon formed to supply smokers. Legal sales (and tax revenues) fell, while more money had to be re-routed to stop the criminal activity.

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