Cigarette Taxes: Where There’s Smoke, There’s Money

By :: February 16th, 2010

A new study by a national anti-smoking group argues that states could raise more than $9 billion in new revenues if they all hiked cigarette taxes by $1-a-pack. The levy wouldn’t come close to balancing recession-ruined state budgets, but it wouldn’t hurt. And, the group says, the higher tax would keep 2.3 million kids from becoming smokers and convince 1.2 million adults to quit, saving one million lives and $52 billion in health costs over the long-run. The study comes from the Campaign for Tobacco-Free Kids.

Sin taxes like this are always a two-edged sword. If government wants to maximize revenue, it can't impose a tax so high that it will discourage too many sinners. On the other hand, if the goal is to discourage the sin, the state would want to maximize the tax rate--or flat ban the activity. Trouble is, if everyone quit smoking, or drinking booze, revenues would eventually dry up.

Two more issues to consider: Very high taxes will encourage smuggling, Internet purchases, and—if neighboring states don’t raise their taxes too--a quick drive across the border to stock up on smokes. Finally, some economists worry that tobacco taxes unfairly target the poor. 

The tobacco-free kids study assumes that every state raises its tax by $1-a-pack. And it recognizes that demand for cigarettes is relatively inelastic—even high taxes won’t discourage many addicted smokers to quit. The paper assumes that a 10 percent tax increase would reduce overall consumption by about 4 percent, and youth smoking rates by 6.5 percent. It also recognizes that higher taxes will increase tax avoidance.

Still, the paper finds that a big tax hike would generate significant state revenues, although the bang for the buck might vary from state to state. It found, for instance, that when Texas raised its tax from 41 cents to $1.41 in 2007, the number of packs sold dropped by 21 percent in the following year, but tobacco tax revenues rose by nearly 200 percent. South Dakota also raised its tax by $1 in 2007, and saw consumption fall by one-quarter and revenues double. In Maine, a $1 tax increase in September, 2005 generated 75 percent higher revenues—perhaps because it was much easier for people to get their cigarettes in New Hampshire, where the tax was much lower ( 80 cents in 2006 vs. $2).

Nonetheless, the paper argues that in every state, higher tax rates more than make up for lower consumption (either less smoking or more purchases somewhere else) and would generate more revenue. And an accompanying poll suggests a tobacco tax would be quite popular.

In a TaxVox post last summer, Ruth Levine looked at the avoidance problem with city-level sin taxes. It is probably less of an issue with states, and the paper suggests people are less likely to take the trouble to avoid the tax over time, due in part to what it calls “smoker tax-evasion fatigue.” Still, this is a matter of some concern.

There are two other problems worth thinking about: Some states that have securitized their tobacco settlement money may receive less income from these deals if their cigarette sales fall. So, while their tax revenues may rise, lower demand may temper their overall revenue benefits. In addition, states such as New Jersey that already have very high cigarette taxes may not see as big a revenue boost from a further increase.    

My colleague at TPC, Kim Rueben, suggests a solution: Increase the federal tobacco tax and rebate some of the money to states. But whatever the design, it is hard to argue with a tax that raises revenue, reduces smoking, or perhaps does at least a little bit of both.    

 

13Comments

  1. Anonymous  ::  5:37 pm on February 16th, 2010:

    I have fond memories of DEFRA in 1984, when I was an intern pulling together the various tax proposals for a summary for my boss. These included an increase in tobacco taxes.
    Smoking results in certain costs to society. Taxes should be high enough to cover these.

  2. Anonymous  ::  8:05 pm on February 16th, 2010:

    Isn't there a way to structure these taxes so that the government doesn't has a financial incentive to keep people addicted?
    It's ironic that politicians claim to detest an activity (for example, making more than $250,000 per year) yet these same politicians will whine incessantly if the source of revenue dries up. That's what happened in California when the bubbles burst, first the dot-com bubble with all those stock option capital gains, then the real estate bubble with all the house flipping profits.
    They claim to want to discourage an activity, but they not so secretly hope and expect that the activity will continue unaffected by the taxes. That game is not fooling many people anymore.

  3. Anonymous  ::  11:24 pm on February 16th, 2010:

    Presumably, fewer smokers may also decrease the number of medical problems. I believe there is at least one state (maybe Massachusetts) that covers quit smoking programs, as it actually saves the state money in medical coverage.

  4. Anonymous  ::  8:10 pm on February 18th, 2010:

    Actually, smokers save government (overall) money because they die earlier. Viscusi has documented this time and time again, yet the myth is still put out there by anti-smoking groups.
    Furthermore, Howard, you are imposing your own moral judgement on what is good behavior and bad behavior. The tax should be set to correspond with the optimal Pigouvian level and nothing more. Beyond that, it's tyranny and should not be tolerated in a free society.
    Suppose some Republican pushed for an abortion tax. Liberals would be up in arms saying that such a tax violates womens rights (her body), but apparently that doesn't apply to what you smoke according to these same liberals.
    You are wrong to say that just because it would reduce smoking that it's a good thing…people get utility out of smoking. If you want to make a systematically irrational argument and appeal to internalities, you can do that. But you don't. You just go with the typical anti-tobacco nanny-state nonsense and say “I think this is bad, so let's tax it.”
    There's a Statue of LIBERTY for a reason.

  5. Anonymous  ::  9:23 pm on August 20th, 2010:

    I have always wondered why the gov't raises taxes on smokers and drinkers to cover all their pork bellying. A small tax on bottled water would produce much more revenue. Water is a valuable commodity. And all those landfills filling up with plastic water bottle! Okay back to the subject . . .
    We're at the point that tobacco is like buying a piece of gold only it is consumed and not an investment. This is reason enough to quit.
    So I have taken the choice to rally people to at least try an electric cigarette to get off tobacco.
    These can at least help you get off tobacco and still satisfy your nicotine habit. And you just watch, those tobacco companies will have their own electronic cig brand here shortly. Because a lot more people will be switching and trying to quit.
    To keep taxing smokers over and over for gov't surplus and their health care plan is just plain criminal. Above poster is right, people will live longer when no one smokes anymore. Then what will they tax next? Junk Food because it makes people obese? Taxes should be evened out amongst everybody.
    I say it's the gov't fault in the first place, why people are addicted to smoking. They allowed the tobacco companies to be the top 3rd industry in this country, more than twenty years ago.
    We, Americans are getting tax to death, there's no enjoyment of the American Dream. It's all about work and pay your bills and taxes!!

  6. Anonymous  ::  11:32 pm on August 25th, 2010:

    It's a certainty that the government is going to tax anything they possibly can. Cigarettes are a polarizing issue, you either love it or hate it. It's no secret that several Americans smoke, and it has drastically risen insurance rates over the years.
    My opinion is let smokers smoke, and make them pay to do it. If I am going to pay higher insurance premiums because you smoke, I want to be compensated for it. Period.

  7. Anonymous  ::  2:56 pm on August 28th, 2010:

    Tobacco taxes are actually encouraged by WHO (World Health Organization) as a very effective way of reducing the number of people who continue smoking. Apparently the high cost of cigarettes is the second most popular reason after the feared dangers of smoking why people make a decision to quit smoking.
    In Japan for instance, the number of people who smoke has dramatically fallen due to the high levels of taxes which tobacco companies pass on to tobacco users. It clearly appears that more and more governments will introduce stinging tobacco taxes in an effort to stop the use of tobacco on a large scale.

  8. Anonymous  ::  3:07 pm on August 28th, 2010:

    The cost of tobacco to society is indeed incredibly high. Besides diseases such as mouth cancer, hypertension, and cervical cancer tobacco has been associated with high absenteeism amongst employees who smoke. This translates to billions of dollars per year in economies.

  9. Anonymous  ::  1:42 am on September 2nd, 2010:

    As an assistant to a smoking cessation therapist, from what I've seen it doesn't really matter how high tobacco taxes go, smokers will continue to buy because they are addicted to a drug. In fact, if you investigate the rates of smoking over the past 10 years with the hikes in smoking taxes, you'll notice that more and more people are smoking even though it has become so expensive.

  10. Anonymous  ::  7:43 pm on September 11th, 2010:

    It is true that cigarettes are a drug and that people are hooked and will continue to smoke despite high taxes, but everybody has a line that if crossed, will push them to quit, which, overall, is a good thing for them and the health of us all, but a bad thing for the tax collector.

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    Very high taxes will encourage smuggling, Internet purchases, and—if neighboring states don’t raise their taxes too–a quick drive across the border to stock up on smokes.

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