Independence Day Brings Fireworks Taxes to Light

July 1, 2014

With Independence Day around the corner, millions of Americans will be purchasing celebratory fireworks to shoot off on July 4. However, fireworks, like many other products, sometimes have significant government costs built into their price. This July 4, consumers in at least 3 states (Texas, Indiana, and Michigan) will pay excise taxes on fireworks, and consumers in the vast majority of states will face fireworks price tags that include often high license fees paid by distributors.

Fireworks are subject to state sales taxes in almost every state. However, many states have historically regulated or banned fireworks for various reasons ranging from noise pollution and disturbance of the peace, to concerns about errant rockets setting fields and forests ablaze. Exactly how much fire damage is caused by fireworks is debated: the National Fire Protection Association claims they cause tens of thousands of fires each year, while the US Fire Administration notes that fireworks fires actually incur just a fourth as much dollar loss per reported fire, and a fourth as many injuries per fire, and far fewer fatalities (so few the average is indistinguishable from zero).

Whatever the case, there may be some justification for a tax on some fireworks where they are legal. Wildfires can spread rapidly across property and even state lines, and can begin with just a few sparks. Reasonably, then, many states dedicate funds from fireworks taxes and license fees towards firefighting and fireman training. This is a textbook example of what is called a “Pigouvian tax.” Named after the English economist Arthur Pigou who first articulated the idea, Pigouvian taxes are intended to raise the cost of goods that damage third parties when they are consumed. Revenues from Pigouvian taxes are then used to compensate the people who were damaged.

There are a few caveats to this generally sound tax policy principle, however. States should be transparent about these taxes. Currently, states use a mixture of strict regulations (and in New Jersey, New York, Massachusetts, and Delaware, outright bans), high annual permit and licensing fees, and other regulatory barriers to deal with externalities caused by fireworks usage. States charge annual distribution licensing fees ranging from minimal costs to cover necessary paperwork to up to $5,000 a year in some cases. These hidden fees make it hard for consumers to know what they’re really paying to cover externalities.

States also require various amounts of extra insurance (reasonable for what are essentially explosives stores), but in some cases those requirements can be prohibitively high for any but the largest sellers, amounting to millions of dollars of insurance for an individual fireworks store. The end result of these requirements is big box fireworks stores with less competition among each other (and, if they ever did have an accident, the result is an even bigger problem than in a smaller store).

Furthermore, as noted, fireworks fires tend to do less damage than other fires. In any Pigouvian tax, it’s important that the tax rate be set based on how much damage is actually done. If revenues exceed damages by a large amount, then tax and fee rates may be too high, leading to the over-taxation of fireworks.

Altogether, state fireworks tax policies (at least in the states that don’t ban fireworks) fit the broad outlines of what most tax policy experts would say is a reasonable excise tax. There is a clearly-defined, measurable externality, and revenues from taxes and fees in most states are dedicated to pay for controlling and reducing those externalities. There is room for improvement, but the taxes certainly aren’t nearly as onerous as excise taxes in other areas.

Read more on excise taxes here.

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