To Boost Economy, Curb Smuggling, Cut Cigarette Tax

Rhode Island, despite its diminutive size, may be poised to have a big impact on how other states deal with “sin taxes” on products like cigarettes and alcohol.

HB-5158, before the state’s House Finance Committee, would reduce Rhode Island’s cigarette tax by $1, from $3.46 to $2.46 per pack. Given recent tax history across the country, this would be a major shift in policy. Collectively, states have raised their cigarette taxes no fewer than 105 times since 2000 without managing to reduce them once.

The nonstop growth of cigarette taxes has been met by a smorgasbord of unintended consequences. High cigarette-tax rates encourage criminal smuggling; hammer a disproportionately poor minority of the population, unfairly increasing the burden of taxation carried by the least well off; and hurt small business through reduced sales, as smokers cross state lines to make their purchases of cigarettes, and possibly bread, milk, candy and other items.

Such downsides as these have driven Rhode Island, along with New Jersey and New Hampshire, to consider cigarette-tax reductions. The Ocean State, in particular, stands to gain financially by reducing this tax. It holds the nation’s second-highest tax rate (behind only New York’s $4.35 per pack) and the third-highest cigarette-smuggling rate. According to the Mackinac Center for Public Policy, 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.

Rhode Island’s last tobacco tax hike, a $1 a pack increase in 2009, was supposed to rake in an extra $13.3 million. But in 2010, the state only brought in about $2 million more in cigarette tax revenue than it did in 2005 – an increase of only 1.4 percent. Collections actually dropped for three out of those five years, only recovering during the recession.

Tax advocates might counter that high rates have improved public health, but even this is uncertain. About 15.1 percent of Rhode Island adults smoke, lower than the U.S. average of 17.9 percent. That might seem like good news for cigarette-tax supporters, but such a crude comparison ignores the success of Rhode Island’s lower-tax neighbors in reducing smoking without high taxes.

New Hampshire, for instance, which has the lowest cigarette tax in New England at $1.78 per pack, almost half of Rhode Island’s rate, has an adult smoking prevalence of only 15.8 percent. That’s just 0.7 percent off Rhode Island’s level and well under the national average. Rhode Island’s high cigarette tax is not a magic bullet for combating smoking, especially with lower-tax states such as Massachusetts ($2.51 per pack) and Connecticut ($3 per pack) a few miles away.

Though the tax’s impacts on public health are ambiguous and its revenue anemic, it has certainly succeeded in hurting Rhode Island businesses. According to numbers from the state’s Budget Office, 14 percent fewer packs were sold in the year following Rhode Island’s 2009 tax hike. That comes to $43 million in sales the state’s businesses had to do without because of higher taxes.

Does this penny wise and pound foolish policy sound familiar? Perhaps the General Assembly should review this information as it debates the merits of Governor Chafee’s tax plan, which would put similar burdens on many more small businesses.

Rhode Island’s immense cigarette tax is an economic albatross around the neck of struggling retailers that isn’t providing any tangible health benefits. A tax cut could help the Ocean State by spurring economic growth and reclaiming sales and revenues from its neighbors. All of these are things that should interest state legislators.

Bill Felkner is the founder and director of policy for the Ocean State Policy Research Institute, a conservative group. David Godow is a research assistant at the Reason Foundation, in Washington, D.C.

This article originally appeared in The Providence Journal on May 10, 2011.