Monday, March 07, 2005

Cigarette Taxes, While Popular, Don't Pay Off

Evidence Shows Declining Revenue Growth Over Time

Ciagrette taxes and other so-called "sin" taxes have often been the quick-fix of choice for state and local governments. Governor Rell has proposed yet another hike in Connecticut's cigarette tax, from $1.51/pack to $2.25/pack. This will be the fourth time in as many years that cigarette taxes will have been raised.

The obvious? If cigarette prices keep rising, people will quit smoking cigarettes. Revenues will stop increasing at such a satisfying rate, and the quick-fix no longer works.

Here's some evidence:

Cigarette tax revenue has followed a similar pattern nationwide, said David Brunori, contributing editor of State Tax Notes, a tax analysis and publishing company in Arlington, Va. In 2002, states raised $8.6 billion in tobacco taxes, he said. That jumped to $11 billion the following year and slowed to $12 billion in 2004.

"Every economist knows this fact: Tobacco taxes and cigarette taxes are not a viable long-term source of revenue," he said. "Each year you have fewer smokers than the year before. The base is shrinking. You'll raise the rates, but there will be no more money to be raised. Politicians have a short-term outlook. They need revenue now." (Singer)

I've complained about "sin" taxes before. It seems unfair to me that people should be taxed for what the state sees as immoral behavior, which is really what is at the heart of the matter. If the state tried taxing a popular unnecessary and addictive substance, like coffee, the outcry would be instant and furious. However, smokers are an easy target. No one is going to defend smokers, who are seen as filthy nasty people who will eventually give everyone cancer.

Now it turns out that this particular "sin" tax won't even work over the long term. We can't keep flogging the cigarette tax forever, no matter how popular it is. Instead, the General Assembly should set its jaw and actually deal with the ongoing budget crisis in a substantive way instead of looking around for easy, popular, transient solutions.

Singer, Stephen. "Rell's budget challenge: Revenue gains fall as cigarette taxes rise". Associated Press 7 March 2005.

ELECTION ALERT: Naugatuck Democratic Mayoral primary today!!!


stomv said...

I disagree with your slight rant, for the following reason:

The public cost of smokers is incredibly high. The medical costs and opportunity costs are enormous, and so while the state's revenue from the cigarette tax may shrink in the long term, it's budget improves in the long term. This article details some of the costs. Another article is here.

Between added medical bills, lost time working, litter, and second hand smoking, society bears a cost of smokers. Taxation helps recover that cost.

As to the question: "Is the smoking tax an appropriate amount?" That's harder. I've seen numbers indicating that the cost to society of smoking a pack of cigarettes is around $2.70. If that number is correct, than taxing cigarettes so that they cost this much results in a societal revenue neutrality, albeit a long term neutrality.

I think a strong case can be made that, in fact, the tax on alcohol must be increased. If the philosophy of cigarette taxes is to be consistent, it should also be applied on alcohol. My guess is that, economically speaking, booze is undertaxed.

A final note: keep in mind that an added benefit of cigarette taxes are that they make it much harder for kids to start smoking at an early age (14 or under). Finding $1 or $2 for a pack of smokes isn't too hard -- finding $5 is quite a bit harder if you don't have a job. Cranking up the cost of smoking makes it much harder for really young kids to be able to buy (as opposed to steal or be gifted) cigarettes.

So, if you are interested in short term revenue models, it's not clear that raising sin taxes is always the answer. However, if you're interested in long term fiscal health, than taxing cigarettes helps keep the state's burden on medical costs down and helps keep people earning income, and hence, paying income tax.

Genghis Conn said...

Hmm. I do see your points (and they're good ones) but I'm still leery of sin taxes as a general idea. The idea of using taxation to recover "public costs" seems slippery... and the costs are only "recovered" in the most roundabout of ways. If we had public health care, the situation would be clearer. However, private insurance premiums for smokers are much higher than those of nonsmokers, as they should be. How much of this public cost is already being recovered by insurers?

My major quibble with the state is that "sin" taxes are an easy solution that don't really solve our budget problems. It isn't sound financial planning, because the revenue is unpredictable.

stomv said...

"However, private insurance premiums for smokers are much higher than those of nonsmokers, as they should be."

Sure, but what about the 50% of bankruptcies that are a result of medical expenses? Surely some of those defaults are related to smoking illnesses... which bring up the cost of health care to all. Then there's medicaid. So, clearly there are direct costs.

There are also indirect costs, but those are more tenuous, and I don't think necessary to keep the argument sound.

Perhaps "sin" tax is the wrong framing. These are taxes where the nominal cost of the good isn't as high as the societal cost, and so the taxation is merely serving to balance the market.

In terms of budgeting, I believe that they are responsible, and predictible in the short term. It's true -- you can't guess how much revenue the cigarette tax will generate in 2020 with as much accuracy as property taxes or perhaps even income taxes. However, the accuracy of cigarette tax revenue in the short run is indeed predictible, and I argue reduces long term costs while simultaneously raising short term revenue.

Hopefully Richard Blumenthal will follow the trend of Michigan and NYC and go after the tax-cheats who are importing cigarettes on the Internet and not paying the exise taxes.

Genghis Conn said...

"Perhaps "sin" tax is the wrong framing. These are taxes where the nominal cost of the good isn't as high as the societal cost, and so the taxation is merely serving to balance the market."

Well said, and I concede the theory.

Whether or not the General Assembly should continue to raise the tax as it has done is, perhaps, a separate issue. The original tax may serve to offset the societal cost, but the increases seem to be set arbitrarily to meet the needs of the budget. Is there a valid formula for calculating what the tax should be? Perhaps it could be indexed to keep pace with inflation and rising health costs.

I still think the General Assembly is using this particular tax as an easy out.

stomv said...

"I still think the General Assembly is using this particular tax as an easy out."

And I wholly agree. I've argued that "sin" taxes do make economic sense, but only if priced correctly.

The state legislature is putting an arbitrary social price on the "sin," with the blatent goal of raising revenue (instead of increasing social welfare or fairness).

I'm sure if a state legislator made sure his state university (UConn in this case) got some money for funding, he could get himself a very thorough, in-depth study articulating the short and long term direct and indirect costs smokers lay on society, complete with upper and lower bounds, futures estimates, etc.

To me, that would be the appropriate way to go about determining what the cigarette tax should be -- at the very least, that should be it's minimum. If you want to argue non-economic social costs are an additional reason to tax, that's not unreasonable.

Additionally, as I said earlier: if the reason is socio-economic (and not budgetary), than they ought to also consider taxes on firearms and alcohol in the same scenarios. Furthermore, fines for things ranging from speeding and DWI might also be considered, at least if the socio-economic cost exceeds the tax/fine.

Ultimately, I like the current gov't trend of raising revenues through voluntary fees and taxes when those activities bear negative costs on society. It helps induce people to behave more efficiently, and the taxes are voluntary to a varying extent. And, it's a far more responsible method to dealing with projected budgetary deficits than what the GOP is doing down in Washington.