Reforming Rental Car Excise Taxes

by Garrett Watson, Tax Foundation, March 26, 2019

Key Findings

• State and local governments have used car rental excise taxes to raise revenue, including for projects like stadium construction and amateur sports funding. Forty-four states levy rental car excise taxes. Most states also permit county and municipal governments to add a rental car tax, which may range from a flat-dollar surcharge to an ad valorem percentage of the value of the car rental.
• Car rental excise taxes are levied in concert with state and local sales taxes, airport concession fees, and vehicle license and registration recovery fees. This has created a byzantine structure of taxes and fees, with effective tax rates on consumers often exceeding 30 percent.
• Excise taxes on car rentals are unsound tax policy, as they narrowly target one industry in the hope of exporting the tax base onto nonresidents. This has negative effects for residents when they pay higher prices for rental car services. States also experience lower economic growth when travelers adjust their behavior to avoid the tax. Evidence shows that travelers reduce their demand for car rentals when taxes rise and travel across state lines in search of a better deal.
• The sharing economy has given people the opportunity to rent out their own cars through peer-to-peer car-sharing arrangements. Peer-to-peer car sharing is projected to grow from $5 billion in 2016 to $11 billion in 2024—20 percent growth per year. This has led to discussions about whether to levy car rental excise taxes on car sharing. Instead of extending poor tax policy onto new business models, policymakers should reevaluate the tax regime imposed on car rental services. States that have not incorporated car rental services into their sales tax bases should do so, and states with rental car excise taxes should repeal them.

Introduction

Travel and tourism are an important source of economic growth and tax revenue for state and local governments. Representing 2.7 percent of U.S. gross domestic product, the travel and tourism industry employed 5.4 million people in 2016.[1] Individuals travel for both work and leisure. Approximately 70 percent of travel expenditures are for leisure purposes, with the remaining 30 percent representing business travel.[2] Most travel and tourism comes from domestic trips: there were 2.2 billion domestic U.S. visits in 2017, compared to 76 million visits from people abroad.[3]

The economic importance of travel and tourism to the American economy has led state and local governments to consider how the tax code should treat nonresidents. Renting a car is an important aspect of American travel, giving visitors the flexibility they need to get to their destinations. State and local governments have used this as a revenue opportunity, creating a byzantine tax regime that targets rental car users and, by proxy, travelers from outside the taxing jurisdiction.

The rise of the sharing economy has impacted car rentals as it did other industries, including those driving taxicabs and providing short-term accommodations. Peer-to-peer car-sharing firms allow people who otherwise would not have the opportunity to rent their cars to participate in the car rental market. Like the case of ridesharing, incumbents argue that new economy firms are not on a level playing field and that the existing tax regime should equally apply to car-sharing businesses.

This paper provides an overview and assessment of rental car excise taxes, their negative economic effects, and how policymakers should reform how car rental taxes work. It will also explore how policymakers should treat new economy firms providing a platform for car sharing, as many states are beginning to explore ways to incorporate car sharing into their tax codes. This paper will argue that excise taxes on car rentals should be repealed and the broader tax regime reformed to conform to the principles of sound tax policy.

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