Annette Nellen

New Taxes and Tax Policy

What do fast food, bottled water and video games have in common? They can be taxed. But should they be?

April 10, 2008
by Annette Nellen, CPA/Esq.

In recent years, there have been enactments and proposals for a variety of new taxes at both the U.S. state and local levels. A key impetus for these changes is the need for more revenue to fund state and local governments. While existing taxes could be increased to generate revenue, other sources have been considered for a variety of reasons. This article looks at a few recent examples and how they stack up under the principles of good tax policy.


Sources of new tax revenue are sometimes tied to activities that lawmakers believe may have some type of adverse social policy aspect. In 2005, Detroit's mayor considered a two percent tax on fast food restaurant purchases to help address a budget shortfall (CNNMoney.com, May 2005).

In 2007, Chicago enacted a bottled water tax of five cents per bottle starting January 1, 2008 (2008 tax ordinance (PDF)). Wholesalers collect the tax from retailers with the tax passed along to customers. The tax was originally proposed at 25 cents per bottle with the revenue to address a shortfall in water and sewer funds believed to be partially due to people drinking less tap water (CBS2, August 2007).

In 2008, a one percent excise tax on the sales price of televisions, video games and video game equipment was proposed in New Mexico. The revenues would go into the "leave no child inside fund" to be used for outdoor curriculum programs, "outdoor nature-oriented physical activity programs" for children and similar purposes. The bill, HB 583 (PDF), was estimated to raise about $1.85 million (PDF) annually. Beyond raising revenue, a goal of the proposal was to get children outside and away from TV and video games. The bill died in committee in March 2008.


Both existing and proposed taxes can be evaluated using principles of good tax policy. The AICPA (PDF) has a set of principles for such purposes as does the National Conference of State Legislatures (NCSL). A new tax also raises some legal issues as well as the question of why policymakers need a new tax rather than using an existing one.

Rationale for a new tax: A new tax might be warranted if it eliminates flaws in an existing tax or addresses externalities. For example, as the fuel efficiency of passenger cars improves and some cars don't use gasoline, our existing gasoline excise tax which provides funds for highway maintenance and transit can be perceived as a "flawed" tax. A new tax would likely be warranted to replace (or supplement) the gasoline excise tax.

An example of a new tax that addresses externalities could include a carbon tax to enable prices to better reflect the true cost of activities that generate CO2 emissions. The funds could be used to address CO2 emissions or to reduce other taxes to improve overall efficiency of the tax system.


Bottled water tax

TV/video game tax

Equity (similarly situated taxpayers treated similarly)

Consumers of bottled water are taxed while consumers of other bottled beverages are not (even if they include water).

Consumers of TV and video games are taxed while other indoor-type activities, such as bowling and sewing, are not taxed.

Tax is regressive (greater impact to lower income individuals).

Certainty — clear rules

All size bottles taxed at same rate. Possible uncertainty if not pure water (for example, vitamins added).

Definitional issues likely.

Economy in collection

New forms, procedures and rules needed.


Flat rate per bottle may lead to larger water bottles. Consumers may purchase water outside of city.

Consumers may enjoy TV and video games online or engage in other indoor activities.

Economic growth and efficiency

Likely to make some Chicago businesses uncompetitive with those in other cities.

Earmarking generally not appropriate if there is a weak connection between the taxed activity and its use. Also, park funding becomes vulnerable to TV and video game sales.


Consumers will know of the tax when taxed item purchased. However, they may not be aware of whether alternatives to a tax were possible.

Minimum tax gap

Likely difficult to evade assuming purchases from outside the jurisdiction are exempt.

Appropriate government revenues

Were alternatives explored? Could the city produce less tap water to meet reduced demand, thereby reducing its costs? Given the likely high fixed costs of producing clean water, this may not have been an option. Also, while the city might be able to increase the cost of tap water, that would put the cost on those who did not cause the problem and perhaps make the problem worse (more people may start buying bottled water).

Were alternatives explored? Parks and education are typical government functions and general fund revenues should be considered. In addition, what non-tax alternatives would help meet goal of getting children to spend more time outdoors?

See earmarking issue noted earlier.

A mix of taxes tends to provide better stability; however, these taxes are not significant revenue sources. These taxes likely produce revenues that are easy to estimate.

Legal issues of a new tax: A state's constitution and statute must be examined along with the proposed tax to be sure it is a legal tax. For example, if state law prohibits a sales tax on food, a tax on fast food or bottled water would have to be examined closely to determine if it is the equivalent of a sales tax on food. Similarly, if a state constitution prohibits local jurisdictions from imposing income taxes, any local tax based on gross receipts may be problematic.

Challenges to new taxes are not uncommon. For example, in 2007 the Ohio Grocers Association challenged Ohio's Commercial Activity Tax (a gross receipts tax) as an unconstitutional excise tax on food. It lost the case at the trial level, but an appeal is likely.

A lawsuit has been filed challenging Chicago's bottled water tax. Opponents to the tax argue that it violates state law because it is a tax on food and is not uniform because it does not tax other bottled beverages including ones consisting primarily of water. (See press release of International Bottled Water Association and complaint of four merchant associations.)

U.S. constitutional issues might also be relevant particularly where a tax applies to a subset of businesses, products or transactions. The First Amendment might also be a possible basis for a legal challenge to a tax on video games.

Policy analysis: The following chart applies relevant tax principles suggested by the AICPA and NCSL to the bottled water tax and proposed video game tax.


Chronic budget shortfalls and the unpopularity of rate hikes for existing taxes can lead state and local governments to consider new revenue sources. These sources may target activities potentially viewed as harmful or "easy targets," such as fast food, video games and adult entertainment. Regardless of the problem or revenue need, it is helpful to consider the principles of good tax policy to determine whether a new tax is appropriate and if so, that it is well-designed and fair.

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Annette Nellen, CPA, Esq., is a tax professor and Director of the MST Program at San José State University. She is also an Irvine Fellow with the New America Foundation. Nellen is an active member of the tax sections of the AICPA and ABA. She has several reports on federal and state tax reform and a blog.