Everything You Need To Know About Luxury Tax

What is a Luxury Tax?

A luxury tax is a tax that is paid by the super-wealthy when they purchase certain products or services that is considered non-essential or accessible.

It may be charged as a percentage of the price of the product or as a percentage of the amount above a specified level. For example, a real estate above $1 million, or car purchases over $70,000.

Understanding a Luxury Tax

Luxury taxes is one of the most controversial taxes. Sales tax is levied on all buyers for all goods and services. When vharged on essential goods, like food or medicine, they are not looked at nicely and seem burdensome to lower-income consumers, who are forced to pay a higher percentage of their income in sales taxes

But a luxury tax would be levied only on yachts, realestate or jewellery that values more than $1 million. Only who can afford these possess such items. Hence, if they can afford such items, then they should also be able to pay the tax.

Luxury taxes generally fall into two categories:

The ‘Sin-tax’ is one which is put on products like cigarettes and liquor and are paid by every buyer, regardless of income. ANyone who may have an issue with buying it, can stop buying it. By putting such a ax, the government tries to discourage the sale of such products as they are harmful to health. But they also tryto raise revenue from those people who purchase them nonetheless.

Both these taxes are well-accepted by the consumers as they affect only a small portion of the population.

Luxury taxes are also politically controversial. Back in 1991, in U.S. a ‘yacht tax’ was enacted in order to pay down the federal deficit. It not only looked at yachts but also other luxury goods such as private jets, furs, and jewelry, as well as yachts. The tax was abolished in 1993 on the grounds that it killed the yacht industry and many American jobs along with it.

The tax was eventually taken down as it not only affected the yacht industry but also other American jobs.

The Politics of Luxury Taxes

Luxury taxes are generally imposed when the country is going through a war or an economic crisis so as to increase government revenues, or to fund another large expense without raising taxes on the general population. People who are against it, cite their reasons to be loss of job but majority of the population remains unaffected and unconcerned.

A ‘window tax’ was imposed on English homeowners in the start of 1696. The whole idea was that people in big houses have more windows and hence should pay more taxes than those in modest dwellings. Rich people throughout the land promptly boarded up most of their windows.

So What is Luxury?

It is a common notion that luxury tax will affect only the wealthy in the society. But it is also seen that the meaning of luxury changes overtime. As prices rise due to inflation, more people will be subject to this progressive tax.  Ig in governments hand, goods and services that were initially considered as normal or ordinary may also be hit with luxury tax if the government wants to increase its revenue.

For example, the’yacht tax’ lasted only from 1991 to 1993 before being abolished as a job-killer. Expensive homes are a frequent target of luxury taxes, but here the definition of luxury gets blurred. Certain states charge a "mansion tax" on ownership transfers of homes valued at above a certain level.

 In New York the level is $1 million, hence this will affect only the wealthiest buyers who come from places like Syracuse or Rochester, but it's a modest sum for a home in Manhattan.

However, when in Vermont, the mansion tax is applied from $100,000 onwards.  The median home price in Vermont is about $261,000.

The Economic Theory of Luxury Taxes

In theory and Economics, luxury goods are called as the Veblen goods, in the memory of Thorstein Veblen, who famously described the concept of conspicuous consumption. These are those goods for which demand increases as price increases. The more a thing costs, the more coveted it becomes.

Taking this into consideration, as a luxury tax increases the price of a good, the demand for it should increase too. However, in reality, luxury goods have a high income elasticity of demand by definition. Both the income effect and the substitution effect will decrease demand sharply as the tax rises.

Plainly put, some people who yearn to own a yacht will see if they can buy something similar and a smaller version of it, say a canoe