Reason Foundation

Obama’s Cigarette Tax Will Hurt the Poor While Enriching Politicians’ Friends

Posted on April 12, 2013, 2:18pm | Cathy Reisenwitz

CNN is reporting that President Obama wants to raise federal cigarette taxes by 94 cents per pack: 

The tax is being presented as way to fund education and reduce smoking rates. It would raise roughly $78 billion over 10 years.

"The proposed tobacco tax increase would have substantial public health benefits, particularly for young Americans," the president's budget read. "Researchers have found that raising taxes on cigarettes significantly reduces consumption, with especially large effects on youth smoking."

After a 62-cent-a-pack tax hike was passed in 2009, cigarette sales dropped by 10%, according to the Campaign for Tobacco-Free Kids.

The tax is being sold as a way to help the poor, with the revenue supposedly going to early childhood education programs. But if the results of state cigarette taxes are any indication, the tax will disproportionately hurt the poor, fund programs directly connected to politicians and negatively impact small businesses, all while consistently failing to meet revenue goals. 

Cigarette taxes hurt the poor

Cigarette taxes are extremely regressive. The poor pay a larger chunk of their income to the tax than the wealthy. This is further exacerbated by the fact that low-income, low-education and minority populations all smoke more than high-income, high-education and white populations, and by a good bit. Nearly a third of people below the poverty line smoke, while only 18% of those at or above the poverty line do. A tax on cigarettes is therefore paid mostly by society’s poorest individuals. 

Cigarette tax revenue goes to politicians’ friends

In theory the revenue from cigarette taxes helps low-income populations by xyz. But as Reason’s Adrian Moore has pointed out, in reality bureaucrats often use it to fund projects their friends run. 

In California, a cigarette tax was supposed to fund health, safety and educational programs for children. Instead, a San Diego county commission spent at least $67 million of that money to help ensure the continued employment of members of their advisory board. Almost 60% of early childhood grants went to organizations with direct ties to the commission. Another California commission used cigarette tax dollars to overpay a contractor by over a half million dollars. Then $800 million just sat around:

Supervisor Zev Yaroslavsky said First 5 LA was sitting on hundreds of millions of dollars of unspent taxpayer funds, and criticized the staff for a lack of transparency, accountability and competitive bidding.

"It's sitting on over $800 million," Yaroslavsky said. "And some of it for good reason, and some of it for no apparent good reason. It's just been sitting there and accumulating." First 5 LA's annual operating budget is about $180 million a year.

An audit by Harvey M. Rose of San Francisco found First 5 LA's commission was unable to monitor money that was being spent "since monthly programmatic expenditures are not presented relative to a budget." Auditors also concluded the agency was overstaffed while under-spending on programs for children. 

Cigarette taxes don’t raise much revenue

Not only are cigarette taxes regressive, but they often fail to meet their revenue estimates. Reason’s Anthony Randazzo notes “revenue from Gov. Pawlenty’s 2005 tax increase was estimated to generate $174 million per year, but Minnesota's cigarette tax revenue has only increased by an average of $4 million per year—a paltry 2.72 percent of the estimate.” 

Similarly, a 2008 Maryland cigarette tax increase only yielded half the projected additional revenue. 

This Mackinac Center for Public Policy study shows the states which are top destinations for smuggled cigarettes:

1. New Jersey
2. New York
3. Vermont
4. Massachusetts
5. Connecticut 

The Mackinac Center also reports that more than 40 percent of the cigarettes smoked in Rhode Island are purchased on the black market or in other states. That represents a huge loss of revenue to state government and local businesses. In the face of the data, many states are cutting their cigarette taxes.

Taking money from poor people, hurting state businesses, filtering it through bureaucrats who are likely to waste it and funnel it toward connected organizations, and then cutting those programs that do get funded when sales decrease didn’t make sense for states and it doesn’t make any more sense on a national level. 

Louisiana HB 63 Goes Up In Smoke

Posted on May 16, 2011, 7:00pm | Harris Kenny

Earlier today Louisiana HB 63 went up in smoke after it failed to pass out of the state’s House Ways and Means Committee. The wide-ranging tax increase bill essentially sought to increase taxes on all tobacco products by at least 50% by:

• Repealing the sunset on a portion of the tax on cigarettes thereby making that portion of the tax on cigarettes permanent;
• Increasing the tax on cigars invoiced by the manufacturer at $120 per thousand or less from 8% up to 12% of the invoice price, and increase the tax for cigars invoiced by the manufacturer at more than $120 per thousand from 20% up to 30% of the invoice price;
• Increasing the tax on smoking tobacco (cigarettes) from 33% up to 49.5% of the invoice price; and
• Increasing the tax on smokeless tobacco from 20% up to 30% of the invoice price.

According to The Times-Picayune, HB 63 received strong criticism from a coalition of tea party groups, businesses and Governor Jindal himself. Rina Thomas, a Jindal aide, told the Committee earlier today that cigarette tax increases “would be contrary to the work (policymakers have) done over the last three years (to cut taxes.)” The bill’s sponsor (Rep. Ritchie) voluntarily deferred the bill after realizing he had “nowhere near” the seventy requisite votes to override Gov. Jindal’s veto.

Separately Rep. Ritchie sponsored HB 591, which would exclusively repeal the sunset clause for the temporary four-cent levy on cigarettes set to expire January 30, 2012, and passed out of the House Ways and Means Committee on a 10-5 vote. Gov. Jindal also opposes HB 591, arguing intervention by the legislature to repeal the sunset clause constitutes a tax increase.

Tobacco taxes are a convenient target. In fact they are often considered “low hanging fruit” because politicians increase taxes under the false pretense of good intentions. However increasing tobacco taxes won’t solve Louisiana’s budget deficit.

Gov. Jindal has the right idea here, and is pursuing effective governance over political convenience in addressing Louisiana’s $1.6 billion budget deficit. Gov. Jindal was recognized in Reason Foundation’s Annual Privatization Report 2010: State Government Privatization for being a national leader on innovative policy solutions. Below are some government reform highlights from Louisiana (including several proposed by the state’s Commission on Streamlining Government):

• In March 2010, the Louisiana Department Of Administration (LDOA) announced the privatization of property and casualty claims management and loss prevention services, a move expected to result in estimated savings of at least $20 million over five years;
• LDOA is engaged in a three-year program to reduce the state vehicle fleet by 10% per year over the next three years, expanding existing rental car contracts and divesting portions of its vehicle fleet; and
• The Louisiana Department of Health and Hospitals (DHH) is implementing privatization initiatives in developmental disabilities, mental health and substance abuse treatment projected to cut costs by over $50 million in 2010.

The Pelican State’s government downsizing efforts have prompted all three major credit rating agencies to upgrade Louisiana’s bond rating since 2009—at a time when other states have seen downgrades given their shaky fiscal health—and the agencies specifically cited the state’s focus on spending control and streamlining as influencing factors. A higher credit rating alone will save Louisiana taxpayers millions in avoided interest costs over time.

Rather than raise taxes, Louisiana policymakers should continue to focus on implementing recommendations from the state’s Commission on Streamlining Government. For more ideas, see the American Legislative Exchange Council’s State Budget Reform Toolkit, which contains a broad range of creative policy solutions.

Taxes Inducing Black Market Trade for Cigarettes

Posted on April 19, 2011, 2:10pm | Harris Kenny

Reason Foundation has long argued that “sin” taxes on cigarettes are ineffective and regressive; however the latest data shows they are dangerous too. Tax increases at the state level are inducing sharp increases in black market trade for cigarettes, USA Today reports:

A recent wave of state tobacco tax increases, designed to pump revenue into cash-strapped local governments, is inspiring an increasingly dangerous cigarette smuggling industry where big profits lure violent criminal gangs and drug traffickers into the booming illegal market, according to law enforcement officials and court records.

Larrey Penninger, acting director of the tobacco diversion unit of the Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF) tells USA Today:

Everyone out there (involved in trafficking operations) is tapping into tobacco…

• Last year, ATF reported 357 open cases involving tobacco smuggling, compared with a handful a decade earlier.
• During FY 2010, the Justice Department reported 71 new prosecutions referred by (ATF), a 39 percent increase from the year before, according to records compiled by the Transactional Records Access Clearinghouse at Syracuse University in New York.
• Seizures of cash and property also have been rising, from $11 million in FY 2007 to $31.5 million in FY 2009.

ATF’s federal data is noteworthy, however state-level data published in Cigarette Taxes and Smuggling 2010 is even more revealing. Mackinac Center research shows that cigarette smuggling is becoming increasinly common:

The five smuggling destination states with the highest cigarette smuggling rates were Arizona (51.8 percent of the state’s total consumption); New York (47.5 percent); Rhode Island (40.5 percent); New Mexico (37.2 percent); and California (36.3 percent).

With smuggling rates on the rise, the logical question to ask is, “who are the smugglers?” Besides drug dealers, gangs and thrifty (albeit law breaking) individuals, Mackinac Center research finds that higher cigarette taxes induced operatives of the terrorist organization “Party of God”—commonly known as Hezbollah—into black market trade for cigarettes. Hezbollah operatives made hundreds of thousands of dollars purchasing vanloads of cigarettes in North Carolina and smuggling them into Michigan where the difference in price was 75 cents per pack higher. According to the Federal Bureau of Investigation (FBI), profits from black market trade for cigarettes were sent to Hezbollah in Lebanon in the form of cash and equipment ranging from night-vision goggles to laser range finders. This demonstrates how black market trade rewards individuals with dubious motivations who are willing to flagrantly break the law to make money.

Trends in federal and state smuggling data show that it’s time to revisit state taxes on cigarettes. Taxes are inducing black market trade for cigarettes, which creates a more dangerous environment for consumers, diminishes the ability of legitimate businesses to operate and undermines the rule of law. If nothing else, state policymakers should think twice before raising taxes on cigarettes (again) to solve their budget woes.

For more on cigarette sin taxes, see my colleague David Godow’s work here, here and here.

Once Again, Raising Taxes Reduces Revenue

Posted on July 28, 2010, 9:46am | Adrian Moore

Cigarette sales in California plunged to their lowest level in a decade last year as smokers were squeezed by new taxes and restrictions on where they could light up.

. . .

[T]he decline in smoking also means $74 million in tax revenues have disappeared like a puff of smoke, leaving health programs that rely on cigarette taxes to look for other ways to pay for services.

Who'd have thought that could happen.  Oh, that's right, WE would. Back in 2006 a Reason analysis of proposed higher tobacco taxes said:

Tobacco tax revenues will initially cover the costs of new programs and expansion of health care benefits, but as tobacco sales continue to decline, programs founded on California’s tobacco consumers will be left stranded with budgetary needs far above the dedicated revenue stream.

Well, waddya know.