The Temptation of Sin Taxes
San Francisco Mayor Gavin Newsom recently proposed a new 33-cent tax on a pack of cigarettes to help pay for the city’s annual $10.7 million litter-collection program, which includes removing cigarette butts from gutters, drainpipes, and sewers. Though this litter tax may be unique, San Francisco is not alone in targeting sin taxes this year. At least 25 states want to raise tobacco taxes, and 12 would either create or increase taxes on alcohol. While smoking, drinking, and littering are relatively easy political targets when more tax revenue is needed, raising sin taxes to fill large and growing budget deficits during a recession might be more regressive and less countercyclical than other options. What’s more, in the case of city taxes, they may not raise much additional revenue.
Proponents of sin taxes typically argue that alcohol and tobacco have relatively inelastic demands, and the taxed behavior is associated with additional social costs, particularly for health care. However, there is a trade-off between these two arguments: If the tax deters the “sin,” it will raise less revenue.
Many sin taxes, especially cigarette taxes, can be regressive. In 2008, 34 percent of individuals with incomes between $6,000 and $12,000 said they smoked, compared to only 21 percent of all Americans, according to a Gallup poll. Also, the 2007 Consumer Expenditures Survey reported that individuals in the lowest income quintile spent 1.7 percent of their after-tax income on alcohol, compared to only 0.6 percent for those in the highest quintile.Regressive taxes are even less desirable during a recession, when low-income individuals may reduce other consumption to pay the higher taxes on alcohol and cigarettes. All else equal, one would prefer raising a less regressive tax.
Moreover, since demand for these products is relatively inelastic and tax rates may differ from one neighboring jurisdiction to another, higher taxes may result in more evasion, not less consumption. Michael Lovenheim has used data from the Current Population Survey to show that raising taxes in certain states actually increases cigarette consumption due to bulk purchasing and shifts in where cigarettes are bought. Goolsbee, Lovenheim and Slemrod concluded that tax-free Internet purchases of cigarettes have cut tax revenues by roughly 8 percent.
In what may be more bad news for San Francisco, David Merriman found that among a random sample of littered cigarette packs in Chicago, roughly 75 percent were purchased outside of the city. The average price difference between jurisdictions in Illinois is 49 cents per pack, and Indiana has a 41-cent per pack lower average tax rate than Illinois. California’s tax rates differ even more — on average, by 78 cents per pack across jurisdictions in the state. Therefore, a tax increase on cigarettes in San Francisco might have a hard time putting a dent in the cigarette litter on the streets, or in paying the bill for cleaning it. Rather, it will further encourage people to buy their cigarettes before heading into the city.
In the end, San Francisco may be better off raising fines on those caught littering or selling cigarettes to minors. On the other hand, with San Francisco facing a roughly $500 million budget shortfall this fiscal year, a politically easy tax hike on “sin” might trump equity and efficiency arguments.