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

By , Guest Blogger

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.

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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.

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