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"Sin" Taxes Hurt Sinners and Saints Alike

by Joshua Culling / /

State budget crises abound these days. California lawmakers earlier this year agreed on a package of huge tax hikes and modest spending cuts to plug a $42 billion budget deficit. Facing a budget gap approaching $20 billion in New York, politicians in Albany were hoping that a constrictive tourniquet of tax increases would stop the bleeding in the Empire State. All told, the Tax Foundation projects that 45 states will confront budget shortfalls through fiscal year 2010, leading politicians to push schemes that raise the most revenue from the smallest number of constituents. Among their favorite instruments of destruction are "sin" tax increases.

Sin taxes -- small, targeted excise taxes on goods such as cigarettes and alcohol -- are among the most politically expedient yet economically counterproductive policy prescriptions for revenue-hungry lawmakers. Governors and legislators boast that by raising the cigarette tax, they are ensuring the health of future generations by discouraging smoking. They also encounter less resistance for such measures than they would over other types of tax hikes, because they are shaking down a small portion of the population (in the case of smokers about 20 percent) to pay for goods and services available to all citizens.

Notwithstanding any moral arguments for or against smoking, drinking, gaming, or consuming unhealthy foods, these distortional tax increases have significantly negative consequences on all taxpayers, whether you "sin" or not. We'll start with the poor.

We all remember President Obama's "firm pledge" on the campaign trail to shelter all Americans earning less than $250,000 per year from any tax increases. He promptly broke that promise on February 4, 2009, signing a 159 percent increase in the federal excise tax on cigarettes to fund an expansion in the State Children's Health Insurance entitlement program. The median income of smokers is $43,723 -- roughly $13,600 less than nonsmokers. And the cigarettes, alcohol, and food that moderate-income households purchase will take a bigger bite out of their finances.

Yet, the smoking poor aren't the only ones affected by increases in sin taxes. They often lead to hikes in taxes that affect broader segments in the population -- sales, personal and corporate income, and a host of "fees." This phenomenon is the result of the unpredictable revenue projections attached to sin taxes. Between FY 2003 and FY 2007, the state excise tax on cigarettes was raised 57 times. Only in 16 instances did the resulting revenue meet estimates.

Such a lopsided outcome shouldn't be surprising. Inflating the price of just about any good or service causes people to use it less, in turn leading to fewer sales. For the government, such a decline also means a drop in expected revenue, and touches off another hunt for more pockets to pick. A study by the National Taxpayers Union found that after 35 tobacco tax hikes between 2004 and 2006, 22 states followed up with subsequent tax increases. Between 2001 and 2006, there was roughly a seven in 10 chance that tobacco was only the first -- not the final -- target of the tax man.

Perhaps the most alarming effect of sin taxes for conservatives is that they allow government to grow largely unchecked by the majority of voters. Taxing a small and politically convenient segment of the population to pay for shiny new spending programs means that others who benefit from those programs aren't necessarily responsible for their cost. It's often easy for uninformed voters to demand things like universal health care when elected officials deceptively assure them that the burden of paying the bills will fall on someone else's backs.

Ironically, it's the rapid growth of government -- funded by new taxes such as these -- that got states in this mess in the first place. Forty-three states faced budget deficits heading into FY 2009, according to the National Conference of State Legislatures, fueled by an explosion of state government spending by over 81 percent during the past 10 years. Rather than come to terms with that problem, state leaders are looking to sin taxes to balance their budgets. Oregon has proposed increasing the beer tax by 1,900 percent. Sixteen states had cigarette tax hikes on the table in their most recent legislative sessions. New York has received much attention for a proposed "fat tax" on sugary soft drinks.

State governments face additional problems with these targeted tax hikes: People buy the products elsewhere. Health advocates often cheer declines in revenue attached to smokes and as evidence that people are using less of them. That's often not the case, as consumers are simply taking advantage of better rates elsewhere. As the Tax Foundation recently noted, a bill in Arkansas even concedes this point by sparing sales of cigarettes in border towns from the full force of a proposed 95 percent cigarette tax increase.

In a few years, when it becomes evident that President Obama's bigger children's health insurance program is running deficits due to declining cigarette tax revenues, taxpayers will be on the hook for another massive government spending program bereft of financing. State governments walking the short-term budget balancing tightrope will see similar deficits in their new programs. The likely response will be taxes -- now in the form of new levies on nonsmokers and teetotalers or later in the form of borrowing against future generations' pocketbooks.

"Sinners" and "saints" among us can agree: These tax increases represent regressive, unstable policy and will lead to harder decisions down the road.

Culling is NTU State Government Affairs Manager. This article appeared in the June 2009 issue of Townhall Magazine.