The difference between a tax, a fee and a penalty is based on the purpose of the revenue.
- A tax is a levy collected for general government services.
- A fee is levy collected to provide a service that benefits the group of people from which the money is collected.
- A penalty is a levy collected with the express aim of deterring some kind of undesirable behavior.
As tax economist Scott Drenkard explained to me, “This distinction became especially important recently when Justice Roberts went against over a century of tax jurisprudence by declaring the individual mandate to be a tax. It’s not. It’s a penalty.”
Obviously there is a spectrum here. A gas tax, which is used to fund roads, is more akin to a user fee, though they are still generally called taxes.