Alcohol Excise Taxes: Simplifying Rates Can Enhance Economic and Administrative Efficiency

Published by the Government Accountability Office on 1990-09-27.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                      United States
                      General Accounting    Office
                      Washingtqn,   D.C. 20548

                      General    Government      Division

                      B-241041,                  .-
                      September 27,199O

                      The Honorable Lloyd Bentsen
                      Chairman, Joint Committee on Taxation

                      The ,Honorable Dan Rostenkowski
                      Vice Chairman; Joint Committee on
                        Taxation                                                                                      .,
                      Congress of the United’itates
.                     We have been reviewing the activities of the Bureau of Alcohol, Tobacco
                       and Firearms (BATF). One of our objectives was to examine economic (.’
                      inefficiencies and administrative problems associated with the current
                      alcohol excise tax system. This report documents that information and
                      builds on related information in our prior reports on restoring excise
       ,’             taxes to, past levels’ and improving compliance with’ occupational taxes.2
                      The report was prepared, not at your request, but pursuant to GAO’S
                      basic statutory-authority. We undertook the effort to assist Congress as
                      it considers ,possible excise tax changes during ‘the current budget delib-,
                      erations; A detailed description of our objective, scope, and methodology:
                     ‘comprises appendix I.

    3ackground        tobacco products and certain firearms -taxes that generated a total of
                      over $10 billion infiscal year 1989. (See app. II for a list of the excise
                      taxes collected by BATF.) Early excise tax rates were generally estab- “,
                      lished by Congress to generate revenue-especially to meet wartime
                      revenue needs. The current excise tax rates were developed on an ad
                 _ ._..-,hp_~b~~.o.~~rt~.y~~cs        .a& do rlst.ref!ixta     comprehen@ve approach I
                      considering such factors as economic efficiency and ease of
                     As discussed in our 1989 report, many excise tax rates are based on per                               1!
                     unit amounts rather than a percentage of the product’s price and have
                     generally not been changed to account for inflation. Most excise taxes on
                     beer, wine, small cigars, cigarette papers, and some firearms have been
                     imposed at their current rates for almost 40 years or more. Since 1951,
                     for example, inflation has increased prices by about 400 percent. Thus,

                     *Tax Policy: Revenue Potential of Restoring Excise Taxes to Past Levels (GAO/GGD89-62, May 9,
                     2Tax Administration: Complianceand Other Issues Associated With Ockpationai Excise Taxes
                     (GAO/GGD-86-49, June 6,1986).

                     Page 1                                                  GAO/GGD-90-123    Alcoht$ Excise Taxes

                                  ,’                                                                                  ‘-
    these per unit excise taxes impose a lower tax burden today than when
  they were last changed. Accordingly, excise taxes have’generated a-;
   declining percentage of all tax revenues (3.6 percent in fiscal year :
    1989-down from 8.3 percent in fiscal year 1969). In addition to
: updating the rates to‘.reflect inflation, some organizations have stated
   that raising alcohol and tobacco excise taxes could decrease consump-
   tion of these products,’ thereby reducing the associated adverse health
  ,effects and other social costs.3

    The rates for alcohol excise taxes vary considerably by type”df &d&e
    therefore, beverages with the same alcohol content are taxed at dif-’
    ferent rates. Distilled spirits are taxed at $.20 per ounce of alcohol while
    bee.r‘is taxed at $.05 per ounce and table wine at $.Ol per ounce. Wines
    with. similar alcohol content are also taxed differently, depending on
    whether they are table wines, artificially carbonated wines (such as
    wine coolers), or-sparkling wines.
   Before i980, all ingredients (including.wine, flavors: and distilled.“;
   spirits) were taxed individually before being combined into a final
   product. The Distilled Spirits Tax,Revision Act of 1979 changed the
. taxes so they are levied on the final product. To compensate distilled “’
   spirits producers who used lower-taxed ingredients (i.e., wine and
   flavors), Congress.amended the Internal Revenue..Code,~~.US.C! 5OIO)
   to provide a tax ,credit. :Products such as cordials, liqueurs, blended
  whiskeys, vodka, and gin are eligible for this tax credit. The credit
   allows: distilled spirits producers to derive up to 50 percent of the
  alcohol content of their beverage from lower-taxed wine and up to 2.5
  percent of the alcohol from lower-taxed flavors, leaving a required mink
  imum of 47.5 percent of the alcohol derived from distilled spirits. Se&
  tion 5010 reduces the, effective tax rate for distilled spirits products
  containing wine and flavors substantially below the $1.2.50per proof-
  gallons tax rate for distilled spirits.         .

  In addition to the excise taxes, BATF also administers the special occupa-
  tional taxes imposed on all businesses that manufacture or sell alcohol,

 3Federal Taxation of Tobacco,Alcoholic Beverages, and Motor Fuels (Congreasional.BudgetOffice,
 June 1990) and TeenageSmoking: Higher Excise Tax Should Significantly Reduce the Number of
 Smokers (GAO/RRD-89-119, June 30,1989).                                                                    ,’
 4A flavor is a food additive that is either neutral or can impart both taste and aroma to a beverage
 but when tasted aloneis unfit far use as a beverage.
 5A proof-gallon is a gallonof 100 proof spirits (50 percent alcohol by volume). The tax on distilled
 spirits of lower or higher proof is $12.60 per gallon multiplied by the ratio of the proof to 100.

 Page   2,                                                   GAO/GGD-99-123      Alcohol   Excise   Taxes
                                      ’                                                                        i

                    B-241041                                                                                   i



                    tobacco, or,firearms. Originally established in the 1800s to generate rev-
                    enue for the Civil War, these taxes generated about $129 million in ‘fiscal
                    year 1989--primarily from the 420,000 alcohol retailers BATF has.identi-
                    fied. as liable: for the tax. BATF took over responsibility for collecting spe-
                    cial.occupational taxes from the Internal Revenue Service (IRS) in July
           .        1987, and the ,Omnihus.&ulget Reconciliation Act of 1987 increased
                    these’&& effective January 1988 (see app. III).                               ‘,

Results in Brief   the nation’s fragmented alcohol excise tax structure. The tax rates were
                   developed on an ad hoc basis without apparent consideration for their
                   collective effect of altering the industry’s product development and cost
                   structure or on ~~~F’~,administrative burden in implementing these .

                   The differential tax rates on alcohol products result in similar products
                   being taxed. differently. For example, table wine is taxed at a-rate 95
                   percent lower than sparkling wine because the latter was at one time
                   viewed as a “lux~ry’~ product. Further, tax differences resulted in a tax
                   credit that has promoted the development of more costly products man-’
                   ufactured to gain the advantage of special tax treatment.

                   The section 5010 tax credit has provided producers with an incentive to’
                   use wine and flavors in distilled spirits products. These additional ingre-
                   dients can increase the cost of a distilled spirits product by 200 percent
                   or more, but these added costs are’more than offset by the tax .credit.
                   BATF and industry officials told us that these ingredients are sometimes
                   added to obtain the tax benefits, rather’than in resljonse to product
                   requirements, market demand, or cost. Since enactment of the credit,
                   production has outpaced original projections, as have the federal rev-
                   enue losses, which now total about $90 million annually. The tax credit
                   also creates administrative problems, and generally BATF is unable to
                   verify compliance with this tax credit without extensive investigation.

                   We believe that tax rates per ounce of alcohol should be standardized
                   across products to promote more efficient economic decisions by
                   industry and eliminate the need for the credit. Only when taxes are neu-
                   tral as to product can the market emerge as the primary mechanism gov-
                   erning production decisions. Both consumers and taxpayers could
                   benefit from such a change.

                   Page   3                                       GAO/GGD-90.123   Alcohol   Excise   Taxes

                        ‘B-241041                                                                   :,


                           The special occupational taxes BATF administers have become controver-
                           sial since BATF began identifying and contacting retailers who had been
                           unaware of their obligation to pay the tax. Special occupational taxes
                           are also cumbersome to administer because they require collecting rela-
                           tively small amounts ($250 annually for alcohol retailers) from a large’
                       ‘. .number..of taxpayers:~~~~ spent a relatively higher amount of resources
                           to collect special. occupational taxes in fiscal year 1989 ($.08 for every
                           $1 .OOcollected) than to collect alcohol and tobacco excise taxes ($.005
                           for every $1.OOcollected).

                        Several options exist for simplifying special occupational taxes. These
                        options would lower both the compliance burdens faced by thousands of
                        small retailers and the administrative burdens faced by BATF.‘In its fiscal
                        year 1991 budget, the administration has proposed eliminating special,
                        occupationaltaxes on alcohol retailers and increasing special occupa-
                        tional taxes on the lesser number of alcohol producers and wholesalers.
                        An alternative approach, which would eliminate some administrative”
                        costs and small business compliance burdens, would be to eliminate the
                        separate occupational tax and slightly increase (by about 2 percent)
                        existing excise taxes on alcohol, tobacco, and firearms to obtain the
                        same amount of revenue. Yet another approach would be.to collect
                        alcohol special occupational taxes from only producers and importers I
                        (who already file excise tax returns). This could decrease administrative ~
                        costs while maintaining a special occupational tax.

                       Excise tax rates on alcoholic beverages were developed on an ad hoc
Basing Excise Taxes    basis over time to generate revenue for various purposes, such as to
on Alcohol Content     finance wars, and this process has resulted in different rates for various
Would EQuali .ze the   products. Moreover, the rates of taxation have .beeneroded due to infla-
                       tion. For example, as shown in appendix II, most of the .current tax rates
Tax Rates              for beer and wine were last changed in 1951, during the Korean War.
                       The current rates tax beer at about 3.3 percent of the price; it would be
                       about 11.9 percent if it had been indexed since 1951. Table wine is cur-
                       rently taxed at 1.9 percent but would be taxed at 7.1 percent if the rate
                       had kept pace with inflation since 1951.

                       The excise tax rates for distilled spirits, beer, and wine are not deter-
                       mined by the relative alcohol content of each of these products. Rather,
                       distilled spirits are taxed at $12.50 per proof-gallon; beer is taxed at $7

                       Page 4                                       GAO/GGD-30-123   Alcohol Excise T&xes

         .                            E-241041
                                                                                                                                               i ’

                                      to $9 .per barrel;6 and wine is taxed at $.li to $3.40 per wine-gallon.7 ”
                                      Because distilled spirits, are taxed more heavily, they provided 66 per- :,
                                      cent of,the alcohol,excise tax revenues in fiscal year 1989.             .Y.!                           ::             _

‘,                ?        ‘.        When comparing these tax rates on the basis of an ounce of alcohol, “‘2::
                                     distilled s&rits aretaxdattherate      of’$.20 per ounce, beer is taxed at:‘.:;
                                     $.05 an ounce; ,andtable wine (with less than 14,percent alcohol) is &
                  ;                  taxed at, $.Ol an ounce. Taxing the alcohol content in all these beverages
     :       ‘.
                                     equally would. eliminate the current mix of different rates that depend ,;
                                     on,factors such as the type of product or the ingredients used. For ‘.. ,(
                                     example, some wines actually derive most (about 90 percent) of their’
                                     alcohol content from adding distilled spirits to a fermented wine (these ‘,’
                      ,I             are fortified wines). Yet because the final product is classified as a wine,
                                     it is taxed at a lower rate, although most of the alcohol it contains is :?.,
                                     derived from distilled spirits.      0                                     (/’
                                     There are also some significant differences in the current tax rates that:
                                     result in disparate treatment of similar products and therefore affect ‘.,.,
                                     consumers of these products. For example, a table wine that sells for :.,-‘I
                                     $25 a bottle is taxed’at $0.17 a wine-gallon whi1e.a sparkling wine that;,, I,
                                     sells for the same or a lower,price and contains the sameamount of ’ ,”
                                     alcohol is taxed at $3.40 ,awine-gallon. The tax on sparkling wine has
                                     been viewed asa luxury tax. In today’s market, however, premium table’
                                     wines can cost as much or more than sparkling wines, but they are ‘- ; (
                                                                                                             ,,,; ,I
                                     taxed at a rate that is.95 percent lower.                               .:4/’ ;

     Different Alcohol Tax           gress to amend the Internal Revenue Code in December 1980 to provide
     &&es Encoura&                   a tax credit for producers who use wine or alcoholic flavors in their di& ”
     Pirodtiction                    tilled spirits products. It was designed to offset the effect of the differ-
                                     ential tax rates by compensating distilled spirits producers who used
     1,nefficieticies                lower-tax ingredients (wine and flavors) in their products. This tax         ,,I
                                     credit, which producers claim on their excise tax returns, can lower the
                                     effective tax rate for a distilled spirits product from the current rate of
                                     $12.50 per proof-gallon to’as low as $6.30 per proof-gallon.

                                     The section 5010 tax credit acts as an incentive to use wine and flavors”..., g
                                     in distilled spirits products to achieve a lower tax rate. The addition of ‘, r
                                     GOne   barrel contains 31 gallons.
                                     ‘A wke-gallon is a phrase used by BATF to distinguish it from a proof-gallon. It is equivalent to on~~~~~>,.
                                     gallon of wine.                                                                                        .I 1

                                     Page   5                                                    GAO/GGD-90-123     Alcohol . Excise   Taxes
                                                   :    B-241041                                                                                             . ,-

                                ,                                                                                                                                 (i.

                                                        wine and flavors may’comprise up to 52.5 percent of the alcohol content                                         i
                                                        of the beverage+50 percent from wine and 2.5 percent from flavors.                                              i
                                                        These additives can be used in a wide variety of distilled spirits bever:
                                                        ages, such as cordials, preYmixed cocktails, blended whiskeys, gin, and
       “,                                              vodka; without substantially changing the beverages’ character or ta&e.
              L’                                                     ..:..,.,, : .                                             ”
                                                       BATF and private industry officials said that some distilled spirits ma&-                                        ;
                                                        facturers have changed their production processes to Qualify for this :.
,‘,’                                    .,.,           credit. Producers of some commonly used fruit wines said that adding:: ;,
       ; ‘.                                            their wines to distilled spirits products doubles the manufacturing costs                                        ;.
                                                       because the wine additives cost more than distilled spirits. Table 1                                             i
                                                       shows an example BATF provided that illustrates how the tax credit :                                             I-
.-                                                     lowers the total production cost (including taxes). A 42-proof cordial’s ’
                      ‘.                               material costs would increase from $.27 (using only distilled spirits) to                                         I
                                                       $.81 per gallon when using the maximum amount of wine allowed-SO-                                                ‘-1
                                                       percent wine content. At the same time, the tax credit would reduce th,e                                          ;
                                    .                  tax expense by $2.28, thereby lowering the cordial’s total cost by $1.74,:
                                                            *-I, ~..
       ~Table~l:~Comparative Costs Per Gallon,of                                                                                                               I
       a 42-Proof Cordial Containing Various                                                                         Distilled     ‘25 bercent    50 Dercent’  1
       Levels of Wine,                                                              ‘,‘.                               spirits         ’ wine ._-.__..___
                                                                                                                                   _--..-..~            wirje-
                                                       Cost of spirits,                                                   $.27              $20               $13
                                                       Cost of wine       ‘,                                                .oo              34                 .68
                                                       Total cost of materi@s      ‘.                                       .27               54                .81
                                                       Taxexpense                                                         5.25              4.11              2:97.
                                                       Total cost per gallon                                              5.52              4.65              3.78
                                                       Net cost advantqgea                                                 .oo                .87'            1.74
                                                       aNet cost advantage is the overall cost difference between using only distilled spirits in a cordial and
                                                       adding wine ingredients. It is the sum of the additional material costs and the amount of t&x savings.
                                                       Source: Bureau’ of Alcohol, tobacco and Firearms.

                                                       We believe that this incentive provided by the tax credit distorts the
                                                       production process because’it encourages an inefficient allocation of
                                                       resources to make these products. Taxing the ingredients differently
                                                       leads to an inefficient combination of ingredients because production
                                                       decisions are based on tax rates, not on which ingredients are less

                                                       In addition to increasing economic inefficiency, significantly more tax
                                                       revenues are being lost through use of this tax credit than Congress
                                                       originally estimated. When the credit was enacted in 1980, Congress
                                                       estimated that the total credits for both domestic and imported products

                                                       Page6                                                         GAO/GGD9o-123Al~oholExciseTaxes


     .                                  R241041                                                            :


                                       would be about $19 million annually (or about $28 million annually in
                                       1989 dollars). Use of the credit has increased steadily, however, and
                                       BATF'S data show that in fiscal year 1989 the credit amounted to about
                                       $90 million-$60 million for domestic and $30 million for imported
                                       products. Figure 1 shows the increase in tax credits’taken by domestic
                                       manufacturers during fiscal years 1981 through 1989.               ‘,

Fiaure 1: Domestic,Tax Credits Taken
Uider Section 5010                     70     Dollara in millions

                                              1991          i992    1992   1984   1999   1999       1981
                                              Fiscal year

                                       Source: BATF estimates.

The Section SO!.O Tax                  In addition to the revenue loss and economic inefficiencies due to the
                                       credit, BATF also has some problems administering section 5010. Because
Credit Causes                          it would be cheaper for manufacturers to use distilled spirits and a trace
Administrative Problems                of wine or flavors and then claim the credit without actually using the
                                       lower-taxed wine and flavors, it is important that BATF ensure compli-
                                       ance with the provisions of the credit. BATF attempts to monitor the use
                                       of this tax credit by verifying that the wine and flavors were in fact
                                       added to the beverage for the tax credit, but BATF officials told us that
                                       BATF is unable to’adequately ensure full compliance with this credit for.                           ’
                                       several reasons.

                                       First, laboratory tests, while sufficiently detailed to examine parts per
                                       billion of each ingredient, cannot determine the source of the alcohol

                                       Page   7                                                 GAO/GGD-90-133   Alcohd   Excise   Taxes
                                  contained in the beverage. Therefore, a thorough inspection of the corn- _
                                  pany’s,records is required to determine exactly what ingredients were j
                                  used to make the product.

                                   Second, inspecting the records of companies claiming this tax credit can
                                   be relatively complex and time-consuming in comparison with other
                                   alcohol inspections because the inspectors ‘must trace the sources of ‘all
                                   alcohol used in each beverage. Distilled spirits plants ‘may produce sev-
                                   era1different beverages, each taxed at different effective rates, and .,
                                  may also change &products’ formulas. A BATF official said that it is
                                   difficult for inspectors to determine whether the correct amount of tax :
                                  was paid in each instance. When claiming the tax credit, all credits from .:.
                                  the company’s various products are totalled into one line item, so it is
                                  not clear from the tax return specifically for which products the credit ’
                                  is being claimed and how much is being claimed for each product. Veri-
                                  fying the amount claimed requires checking the supporting records. ,_

                                  Third, inspectors do not have the authority to inspect distilled spirits,  1
                                  plants in other countries. As a result, BATF is unable to verify that wine
                                 .or flavors have actually been added to imported products that claim: the
                                  tax credit.

                                 The section 5010 tax credit hasmade using costly wine additives a
                                 viable option for distilled spirits producers, but for BATF it is both diffi-
                                 cult to administer a&enforce. The resources used to produce products                             ’
                                 to meet demand generated by this tax credit could be more efficiently
                                 used elsewhere in the economy. Taxing an alcoholic beverage on the
                                 basis of its alcohol content, rather than on how it was made, would be a
                                 more efficient approach. Such an approach would eliminate any need                               i
                                 forthis tax credit, thus simplifying both the tax system and its
                                 administration.                                                                                  I

-The M-rent Structure.- -.Special
                            ... occupational taxes on alcohol, tobacco, and -firearms businesses--
                        provide a relatively small amount of revenue, although the taxes were
 for Collecting Alcohol originally enacted to generate revenue. Of the almost $129 million gener-
 Special Occupational   ated by these’taxes in fiscal year 1989, $127 million came from.alcohol
                        taxes, $1.6 million from firearms taxes, and about $.2 million from
Taxes 3s Inefficient    tobacco taxes.8 Special occupational tax rates range from $250 for
                                 alcohol retailers to $1,000 for manufacturers and other businesses, as
                                 shown in appendix III.

                                 8Numbers do not add to $129 million due to rounding.

                                 Page 8                                                    GAO/GGD-99-123   Alcohol Excise T&es

                                                                                                                              ’    L


                         Most of the special occupational taxes BATF collected (almost $118 mil-                                   :
                         lion,,or.about 91 percent of the total) are from alcohol retailers.        T1,.
                         According to a BATF official, BATF .has identified about 420,000 of the a”
                         550,000 estimated retailers liable for paying special occupational taxes.                                 1
                         The lists of eligible, taxpayers must be continually updated as companies
                         start or go out .of business;. Alcohol retailers subject to the current spe                               I
                         cial, occupational taxes range from high volume liquor stores to small~$.~
                         “mom and pop?’ grocery stores. Other businesses that sell alcohol (such                                  ,‘-
                         as privateclubs, limousines with a bar or that serve champagne, and,                                      :
                         florists that deliver wine and flowers) are also liable for the special ”
                         occupational tax.

                         Since assuming responsibility for special occupational tax collections s,                                 ;
                         from IRS in July 1987, BATFhas    had problems identifying all of the                                     j
                         alcohol retailers subject to the tax and collecting amounts due from        :
                         them. When BATF took over responsibility for these taxes, it matched : ,..                                i
                         information from ms’ database with state liquor license lists to identify
                         those who, were not paying the tax.9 Some of the noncompliant retailers
                         BATF identified were not aware of the tax and, because they had not paid                                  1
                         for many years, owed substantial sums (including penalties and              L
                         interest). This resulted in numerous complaints to Congress from            :.
                         affected retailers.                                                       .,’ .’                          :

                         These special occupational taxes are relatively costly to administer, par-                                I
                         titularly when considering the small amount of revenue generated. BATF                                    1
                         estimated that it spent $10.3 million to collect the $129 million in special
                         occupational taxesin fiscal year 1989-a cost of $.08 for every $1 .OO ;
                         collected. In contrast, alcohol and tobacco excise tax collections        :i ’                            -
                         amounted to $10.1 billion in fiscal year 1989, and BATF estimates it cost                                 j
                         about $5 1.5. million to collect-a cost of $.005 for every $1 .OOcollected,                               1
                         which was about 16 times lower than the callection cost for special occu-                                 I
                         pational taxes.

Alternative Approaches   In its fiscal year 1991 budget, the administration has proposed elimi-
                         nating the special occupational tax on ret,ail alcohol dealers and
Could Improve Special    increasing the special occupational tax rates for the 11,000 wholesalers
Occupatiotial Tax        and 2,100 alcohol producers. By reducing the number of taxpayers, the
Collections              administration expects that compliance will improve and that the tax
                         will cost less to administer. This proposal, which would involve flat

                         gTax Administration: Compliance and Other Issues Associated With Occupational Excise Taxes
                         (GAO/GGD-86-49,     June 6,1986), page 30.                                                               \,

                         Page   9                                                 GAO/GGD-99-123    Alcohql   Excise   Tax&


-   -                                                -
         amounts applied to wholesalers and producers, was designed to generate
         at lea&$190 million annually-$61 million more than was collected ’
         under the current rate structure in fiscal year 1989.1°

          The administration’s proposal to eliminate special occupational taxes on
         retailers would significantly increase the tax burden for wholesalers and
        ;,producers, who paid approximately $7 million of the $ I29 million col- ’
         lected ‘in fiscal year 1989. Their increased tax liability would be substan-
         tial (from the current rates of $600 or $1,000 to new rates of $12,000
         for wholesalers and either $30,000 or $65,000 .for each manufacturing
         facility). This tax structure would have taxpayers with vastly dissimilar
         incomes paying the same higher amount.

         Industry representatives and BATF said these increases could adversely
         affect small producers who would be unable to pay the increased tax.
         Small’ producers would probably be unable to pass this higher tax on to
         consumers’because they have to price their products competitively in _
         the market. Large producers, on the other hand, could,recoup some of
         the additional cost by increasing prices by only a small amount. The
         industryrepresentatives also question the fairness of taxing compliant,
        taxpayers (producers and wholesalers are issued permits by BATF and.
         thus are easily identified) more heavily because others (alcohol
         retailers) are not compliant.

        Fairness, including the ability to pay, is important to consider in. restruc-
        turing special occupational tax rates. In addition, the purpose of the tax
        should be considered. If special occupational taxes are levied primarily
        to obtain revenue (as when they were first enacted), we believe that a
        better alternative would be to eliminate special occupational taxes alto-
        gether and.increase the excise tax rates sufficiently to offset the
        decrease in occupational tax receipts. Given the current amount of
        ‘alcohol, tobacco, and firearms excise taxes BATF collects (over $10 billion
        in fiscal year 1989), the adjustment required to obtain the $190 million
        that the administration is proljosing would be minimal. Existing excise
        tax rates would have to be increased by about 2 percent to generate this
        amount of revenue. This approach would be more efficient and less
        costly than maintaining separate accounting and collection efforts for
        special occupational taxes.

        loAnother alternative the administration is considering is to require wholesalers to verify that
        retailers have paid their special occupational taxes before allowing them to purchase any alcoholic
        beverages. According to BATF officials, this system would be similar to procedures wholesalers noti
        follow for state liquor licenses and could generate additional revenue by&creasing compliance
        without changing the existing tax structure.

        Page   10                                                  GAO/GGD-30-133     Alcohol   Excise   Taxes


                             On-the other hand; if Congress now intends special occupational taxes to
                             act as a user fee to ,recoup some of the costs associated with regulating
                             these industries, then Congress may not want to eliminate them. An
                             alternative apljroach Gould be to tax alcohol producers and importers
                             and vary the special occubational tax due on the basis of the size of the. ’
                             company; Although this approach differs from the administration’s pro,-
                             posal in that it would not tax wholesalers, it is similar in that it would
                             eliminate the s&&l occupational tax for retailers and would,, therefore;
                             be more efficient and easier for BATF to administer. By not taxing whole;’
              ‘.   :.
                            ‘salers, this’approach eliminates the need for a separate collection mech-
                             anism for’bvholesalers since they do not pay alcohol excise taxes. In
                             addition, producers and importers are the primary “users” of BATF'S regl
                             ulatory ‘activities. As part of this approach, Congress could vary the
                             taxes by establishing several ,categories on the’basis of the size of the
                             company so thatlarge producers and importers would pay a proportion-
                             ally larger share of the tax.

Conclusions                 nomic inefficiencies and administrative problems. Standardizing the tax ;,
                            rates on the basis of the alcohol contained in the product, rather than on.:,’
                            the basis’of what ingredients it contains, would encourage more efficient n’
                            economic decisions by producers and eliminate the need for the section
                            5010’tax credit.       ‘,     ’

                            The special occupational taxes, now primarily paid by alcohol retailers,
                            are both difficult to-collect and administer. The same amount of revenue
                            could be generated and special occupational taxes could be eliminated
                            altogether by slightly increasing existing excise taxes on alcohol,
                            tobacco, and firearms. If Congress does not want to eliminate special _.
                            occupational taxes entirely, collecting them only from alcohol producers
                            and importers and varying the tax on the basis of the size of the facility
                        i   could reduce administration and collection costs.

                            In addition, the excise taxes BATF administers have not been changed for,
                            years, and they impose a lower tax burden than when they were last
                            changed. Indexing these taxes or converting them to rates that represent
                            a percentage of the price of the product would help them keep pace with


                                                                                                                       : ‘,

Matters for           -’            In our opinion, due to the economic inefficiencies and administrative         ‘)
                                    burdens existing under ,the current excise tax rate structure;Congress
Coqjre&hal                          should consider simplifying the structure of alcohol excise taxes. First, ‘_
Consideration              ’        Congress,should consider standardizing alcohol excise tax rates across
                                    productson the ,basis’of the percentage of alcohol in a beverage regard-’
           .‘.1                     less of the mix of in&&&&s, thereby permitting the elimination of the
                                    section 5010 tax credit. ::,                                              ,..
                                 ., Congress should’ also consider the role of special occupational taxes in ‘1 :’
                                    relation to the broader
                                                      ,i       excise tax rate structure. Given the excessive
                               I    administrative     costs and compliance burdens involved in generating re?,
                                    ‘atively ,small. amounts of revenue, Congress should consider changing 1’:’
                                    the special o@cupational tti by either (1) eliminating it with a corre- ,I.,
                                    spnding increase in excise tax rates or (2) collecting the tax from only ‘,
                                    producers andimporters and varying the tax on the basis of the size of ,
                  ,,..’         . the faiility.
                                    As Congress deliberates about the structure of these taxes, it may also,.,
                                    want to adjust the rates to keep pace with inflation as we pointed out in;:,
                                    our 1989 .report on excise taxes.                              I: r-i     t ‘:’

                                   ~ATF  officials reviewed.a draft of this report. They agreed that we accu::
                                   rately presented the information contained in this report, especially the, :
                                   information on the difficulties of administering the section 5010 tax :
                                   credit and the various alternatives for restructuring the special occupa;
                                   tional tax. They also .provided additional information that we incorpo-
                                   rated ,into this report..
                                   We are providing copies of this report to the House Ways and Means
                                   Committee, the Senate Finance Committee, the Director of BATF, and the
                                   Secretary of the Treasury. Copies will be made available to other inter-
                                   ested parties upon r-e&rest.


                                  Page 12                                       GAO/GGLMO-122   Alcohol Excise Taxes
The major contributtirs to this report are listed in appendix V. If’you
have any questions, please contact me on 272-7904;

Pku1.L. Posner
Associate Director, Tax Policy.                             :
  and Adikiistration Issues


Page 13    -                                GAO/GGD-9@133       Alcohol Excise Taxes
Letter                                                                                                     1

.Appendix I ”                                                                                         16
 Objective, Scope, and
Appendix II                                                                                           17
Selected Excise Taxes,                          ‘.
Their CWrent Rates,
and Effective Year of                                                                                      .’
Last Change
Appendix III                                                                                          19
Special Occupational
Tax Rates
Appendix IV                                                                                           20
Summary of GAO’s
May’ 19WReport on
the Revenue Potential
of Restoring Excise
Taxes to Past Levels
Appendix V                                                                                            21
Major Contributors     to
This Report
Tables                      Table 1: Comparative Costs Per Gallon of a 42-Proof                        6
                                Cordial Containing Various Levels of Wine
                            Table IV. 1: Lowest and Highest Revenue Estimates for                     20
                                1989 for Indexed Excise Taxes

Figure                      Figure 1: Domestic Tax Credits Taken Under Section 5010                    7

                            Page 14                                  GAO/GGMO-123   Alcohol Excise Taxes
    *        ‘contents                                                   ‘.

I            Abbreviations

             BATF        Bureau of Alcohol, Tobacco and Firearms,
              IRS        Internal Revenue Service

             Page 16                                    GAO/GGD-99-123   Alcohol Excise Taxes
Appendix I                                                                            ‘1

Objective; Scope; and Methodology                                                           .

                  Our objective was to identify economic inefficiencies and administrative
                  problems relating to excise taxes administered by BATF that may be of
                  interest to Congress as it considers changes to those taxes. Specifically,
                  our review covered the structure of alcohol excise tax rates, the use of
                  the section 5010 tax credit, and the administration of special occupa-            ’
                 ,tional taxes.

                 We based our analysis on information obtained from BATF regarding : 9
                 excise tax revenues, collection processes,.and other issues concerning
                 the section 5010 tax credit and special occupational tax collections. We
                 interviewed BATF officials and obtained budget, accounting, and staffing
             .   data at BATF'S Tax Processing Center in Cincinnati,. Ohio, which is prima-
                 rily responsible for special occupational tax collections. We,reviewed the
                 June 1990 Congressional Budget Office study on the “Federal Taxation         ’
                 of Tobacco, Alcoholic Beverages, and Motor Fuels” as well as’prior GAO
                 reports and various articles on excise taxes and excise tax policy. We
                 met with representatives of the alcohol industry to discuss their views ’
                 on alcohol excise tax credits and special occupational taxes. We also
                 reviewed the legislative history of current excise and special occupa-
                 tional tax rates as well as the tax credit provided by section 5010.       ’ ~
                 We did our work from December 1989 to July 1990 in accordance with             ,       ~
                 generally accepted government auditing standards.

                 Page16                                       GAO/GGD-66423AlcoholExciseTaxes

                                                                                                                       Effective year of Jast
  Type of-tax         -‘.  :                                              Current rati                                                   qhange
  Alcohol              ’                                                                                                         ,,_      _.,.‘,?.
  Distilled spirits                                                       $12,5O/proof gal.                      ‘.‘,;, .’       _.         ” 1985
,,Wines with more than 24 percent alcohol                                 $1.2.5O/proof gal.                                .. I. .;,.,, :,;, 1985
                                                                                                                                     .. .
  Wines                                                                                                                               ‘.._.,:,;i.
     Less than 14 percent alcohol             .’             ,,            $O.l7/wil.,.ne,gal;               ’
     14 percent to 21..percent alcohol                                     $0.67/wine gal.
    21 percent to 24 percent alcohol     ,”                                $2.25/wine gal.                                                  1951
    ‘Artificiallv carbonated wines                                     .,. $2.40/wine g31.                                                  1951
    Champagne and other sparkling wines                                    $3.40jwine’gal.                                                  1951
  Beer                                                            ‘.
    Large brewer&                                                         $9/barrel                                                         1951
     Small brewers                                                        $7/barrel                                                         1977

Tobacco          ‘Y
Cigars           i.
   Small         i?                                                       $0.75/l ,000, cigars                                              1926
   Large                                                                  8.5 percent of wholesale,
                                                                          price, not to exceed
                                                                          $20/l ,000 cigarsa                                                1977
  Small                                                                   $8/1,000 cigarettes                                               1983
  Large                                                                   $16.80/l ,000b                                                    1983
Cigarette papers                                                          $0.005/50 papersC                                                 1917
Cigarette tubes                                                           $0.01/50 tubesC                                                   1917
Smokeless tobacco
  Snuff                                                                   $0.24/lb.                                                       1986
  Chewing tobacco                                                         $O.O8/lb.                                                        1986
  Pipe tobacco                                                            $0.45/lb.                                                        1989

                                                   Page 17                                            GAO/GGD-90-123   +lcohol Excise Taxes

                                  A~p&ijx&          .,      1                                        r ~~       ;    #,,I                        L.,:‘.,                     (
                                  Sel~ExciseTaxes,~e~~cUrrent,Ratee,                     :   .:,       I                        ,           ..      ,,:,. ,,
                                  and Effective Year of Last Change


                                    .    ..’                ”                                                       Effective year, of last                                  1
  Type of tax                                                        Current raie” .’                                            change                                      ~
                                        .I.                                                                                                                                  I
:IFirearms!                                                                                                                   ,.:
  Transfertaxes                                                                                                                                                   ~
                                                                     $200/firearm/transfer                                                       ,jg34         !’ I
    Weaponsiri generab
    Any-o!her weapon’                          ..                    $ti/firearm/transfer                                                        1960
                                                                     $200/firearm                                           ‘~ :                 7952      :.::’             ;
  blqk.ing.fees                    . . .
                                                                                                        *                                                                    !
                                  aThe’$20 ceiling on large cigars was established in 1942.
                                   ., ,.,,
                                  bLarge cigarettes measuring more than 6 and l/2 inches in tength ‘are taxed at.ttie rate prescribed for                                    !
                                  small’cigarettes, counting each 2 and 3/4 inches (or fraction) as one cigarette.                   ..                                      L
                                  &garette papers and tubes measuring’more than 6 and l/2 inches in length:are taxed at $.005/60 and
                                  $.01/60 respectivelyV counting each 2 and 314 inches (or fraction)fas one.paper or tube. Tax does not                                  /
                                  apply to a book or set of cigarette papers containing 25 or fewer papers.
                                  dRefers solely to National Firearms Act taxes currently administered by BATF. Regular firearms and                      :
                                  ammu,nition,are taxed at a percentage of the sales price.
                                  Blnclu.des certain’dangerous   weapons; such as machine guns, silencers, and destructive devices.                            ,:

                                  ‘The term “any other weapon”.is statutorily defined and includes sporting- rifles, fountain pen guns, belt
                                  buckle guns, and cane guns.
                                  Source: Joint Committee on Taxation and relevant legislation,

                                  Page 18                                                          GAO/GGD4W133      Alcohol Excise Taxes
        ..                                                                                ,.
                                         ‘_                                  :

              Type of busiiieqs                                                                             Annual fate I.
              Alcohol                  ,
               Retail dealers (distilled spirits,. wine, or beer)                                                    $250
             , Virhotesale dealers (distilled spirits, yine, oi beer)                                 . ’            $500
:              Bmwers.                            :,                                                               $1,000~
               Nonbeverage drawback claimant               ,                     . ,. ,        v .r          ,.      $500
               User/dealer of industrial alcohol                                                                     $250
               Alcohol fuel plant,                      ,.                                                         $1 SW
               Distilled,spirits plant                                                                             $1 ,OOoa
               Bonded wine cellar, warehouse, or bottling house                                                    $l,OOP
                  Manufacturer of tobacco products                                                                  $1,OOoa.
                   Manufacturer of cigarette papers and tubes                                                       $1 @loa
                  ,Tobacco export warehouse                                                                        ‘$1 ,oooa
                   Firearmsimporter                                                                                   $1,000~
                   Firearms manufacturer                                                                              $1 ,000a
                   Firearms dealer                                                                                      $500
              aThese taxpayers are eligible for reduced rates ($500 rather than $1 ,ooO) if their total gross receipts for
              the most recent income tax year (not just receipts relating to the activity subject to special occupational
              tax) are less than $5tl9,~.
              Note: The Omnibus Budget Rerknciliation Act of 1987 increased &special occupational tax rates.
              Before January 1988, retail alcohol dealers who sold.beer only were taxed at $24 a year, and retailers
              selling wine or liquor were taxed at $54 a year. These rates are now $250 annually. The top special                ..

              occupational, tax rate was increased from $500 to $1 ,OCJrl.          _../.


               Page 19                                                           GAO/GGD-99-133       Alcohol Excise Taxes
    Appendix IV

    Summary of GAO’s ”.. &by1”IQSg
                                ,, Repoti
                                     ,, ” .og~
                                          .’ ,,the’ :
    ‘ReventiePotentid of Restoring lWi& Takes to
    Past Levels
                                  -   ,-- We examined per unit excise, taxes imposed on alcohol, tobacco, gas guz- .
                                          zler cars, certain weapons, and wagering occuljations. Had the excise
                                          taxes covered in our review been indexed to keep,pace with inflation,
                                          the Joint Committee on Taxation estimated that they would have gener-
                                          ated additional revenues of $2 to $13 billion in 1989 and $12,to $75,       ‘,
                                          billion over the 5-y&r period from 1989 to 1993. (See table IV.1.) The’    ,,’
                                          estimates.vary depending on the’ index used and the time period      .
                                          i&axe&         ‘,                                                       ‘I

                                         Besides indexing, &other option for maintaining the real dollar value of
                                         excise tax rates in the future is to convert per unit rates to rates that
                                         represent a percentage of. the price of the product (i.e., ad valorem
                                         rates). These ad valorem rates could be set to produce the same reve
                                         nues as the, indexed per unit rates.                             .,
                                         Beyond the revenueconsiderations involved in a decision to maintain
                                         excise tax rates in real dollar ,terms, tough tax policy issues are
                                         involved. Both proponents and opponents of rate increases strongly
                                         argue their positions. ‘In addition, administrative difficulties may ,be
                                         encountered if rates are indexed or changed to an ad valorem structure. ,.
                                         We do not believe these difficulties are insurmountable.
                                                        ,.    1.
Tab IV;l: Lowest and Highest Revenue Estimates       for 1989 for Indexed E&ise,Taxes              ’
Dollars in millions
                                                                         lndkxing z;;;      d,“”       of last
                                                                                           9                           Indexing since 1965
Excise tax group                                       Current rates      Lowest                       Highest       Lowest             Highest
Alcohol /                                                     $4,292       $5,604                       $6,005        $7,767            $10,607
Tobacco                                                        3,342        3,608                         5,299        5,449               9,868
Gas auzzlers                                                       65          69                            71           69.                 71
Weapons                                                            2            5                             7             2                                2
Wagering occupations                                               8            9                            11            21
Total’ ,,,,                                                  $7,708        $9,296                      $13,393       $13,328                       $20,7;:
                                         aTotals may not add due to rounding.
                                         Note: Figures are the lowest and highest dollar values estimated for the tax regardless of the type of
I     I                                  index used or the date of last change.

                                         Page   20                                                         GAO/GGD&O-123        Alcohol   Excise     Taxes
Appendi; V                                                                                            1

Major Contributors to This Report                                          . “I                     .,          SI,

                            David J. Attianese, Assistant Director, Tti Policy and Admixiistration
GenedGovernment               Issues                ‘..
Division, Washington,       Joseph H. Myers, Assignment Manager
                            Susan Ragland Evaluator-in-Charge
                        ’   Shkon T . Par6 , Evaluator

(268423)                    Page 21                                     GAO/GGD-90-122   Alcohol Excise Taxes


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