What Is a Luxury Tax?

Luxury Tax Explained in Less Than 5 Minutes

Woman looking at price of expensive handbag
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A luxury tax is a tax that’s levied on certain purchases over a specific price that aren’t considered to be necessities in life. As the name suggests, these items are considered luxury items. You may never have to pay this tax because you always have the option of not buying an item that may be subject to it. 

Luxury taxes have changed over time, and the policies behind them are not without criticism. If you plan to purchase a luxury item, you may be intrigued to learn how the tax came about, its history, and how it works now.

Definition and Example of a Luxury Tax

A luxury tax is a type of sales tax that applies only to certain goods or services. It focuses on high-cost items, such as jewelry and expensive vehicles like boats and airplanes. They may come with a luxury sales tax because they are considered to be unnecessary purchases. A luxury tax could be paid by vendors and may or may not be passed on to the consumer.

In 1991, Congress enacted a 10% federal luxury tax on the first sales price of a number of items that sold for more than a specific amount:

  • Furs and jewelry that sold for $10,000 or more
  • Vehicles that sold for $30,000 or more
  • Boats that cost more than $100,000
  • Aircraft with price tags of more than $250,000

The Omnibus Budget Reconciliation Act repealed this tax in 1993, and it was phased out by 2003.

A luxury tax is widely considered to be a progressive tax because it focuses on a certain demographic of wealthy taxpayers, and only applies to purchases that are likely to be made by high earners who can afford them.

How a Luxury Tax Works 

A luxury tax is a percentage that’s added to the purchase price of an applicable product. You don’t have to concern yourself with paying it unless you make that particular type of purchase. The federal government doesn’t collect a sales tax, only states do.

For example, New Jersey imposes a one-time 0.4% surcharge on vehicles that cost more than $45,000 or that have a fuel efficiency rating of less than 19 miles per gallon. So let’s say you purchased a luxury vehicle with a sticker price of $50,000 in New Jersey. You’d pay 0.4% extra on that car since it’s more than $45,000, plus any other state sales taxes and fees.

Revenues generated by the tax are distributed across various government programs that benefit the population at large, not just those individuals that can afford to make purchases that would trigger the tax. Supporters of the tax often argue that it also bolsters the U.S. auto industry because many of these high-priced cars are imported from other countries.

How Much Are Luxury Taxes?

The federal government had a luxury tax on expensive cars, furs, jewelry and more back in the early 1990s. It was 10% until it was repealed. It then only applied to cars at a rate of 3%, until it was phased out. That rate expired as of Jan. 1, 2003.

However, there may be a luxury tax imposed by your state or municipality, and state luxury taxes are not necessarily just imposed on vehicles.

For example, you’ll pay a tax of 9.625% for an alcoholic beverage bought on the premises of a casino in Atlantic City, New Jersey because ordering a glass at a drinking, dining, or gaming establishment would be considered a luxury. If you bought a bottle of wine at a liquor store instead, you’d pay only the state’s Sales and Use Tax.

Check your state’s taxation website to find out if the state, any of its municipalities, or even the counties impose any type of luxury tax.

Criticism of Luxury Taxes

Critics of the luxury tax argue that it has a damaging effect on the market for luxury goods, and that it can’t be relied upon to generate necessary revenues. The tax may depend too much on personal choice. Consumers can simply opt not to make purchases that would incur a luxury tax. 

The federal government figured this out with the 1991 luxury tax of 10%. The tax was imposed with the expectation that it would raise about $9 billion in revenues. In reality, it brought in negligible tax dollars and it was eliminated just a couple of years later.  

Consumers simply changed their buying habits in response to the tax. They bought slightly used yachts rather than brand new ones to dodge the tax, and as a result, the yacht industry suffered significantly in the early 1990s.  

Key Takeaways

  • A luxury tax is a tax that’s imposed as a percentage of a purchase price over a certain threshold.
  • The tax is specifically aimed at “luxury” purchases, those that are not considered essential or necessary to daily life.
  • The federal government imposed a luxury tax in 1991 on boats, autos, private planes, and jewelry, but the tax was repealed just two years later when it adversely impacted certain industries.
  • Critics of the luxury tax claim it is an unreliable source of revenue because consumers have the right to simply not buy products that are subject to it.