Issue Brief

Granted, the research presented in this paper won't mean much for those who favor higher taxes no matter what, but these findings should resonate with non-smoking individuals who prefer to retain more of their own money.

1. States with Low Cigarette Taxes Tend to Have Lower Overall Tax Burdens

Along with raising revenue for government spending, the Tax Code is often used for social engineering purposes. Tobacco tax increases are touted as a way to "discourage" smoking by artificially boosting related costs. Under this same line of reasoning, one would also look to the states to use tax law to promote favored activities. "Productive" behavior, such as earning an income and owning a home, should therefore be rewarded with low taxes.

However, the "tax behavior we don't like, reward what we do like" outlook doesn't hold true when comparing the relationship between tobacco taxes and a state's total tax burden. States with higher cigarette taxes tend to have higher-than-average combined tax burdens when all state and local taxes are taken into account. Preferred behavior – along with the "undesirable" – tends to be punished with higher taxes! Conversely, states with low cigarette tax rates tend to have lower-than-average total state and local tax burdens.

Specifically, residents of states with the 16[a] highest per-pack cigarette taxes (as of January 1, 2007) had an average per capita state and local tax burden for fiscal year 2006 that was $345 more than the national average. In other words, the general tax bill for residents of high-tobacco tax states is 8 percent above the national average.

On the other hand, residents in the 16 states with the lowest per-pack cigarette tax (as of January 1, 2007) had a state and local tax burden for fiscal year 2006 that was $616 less than the national average. In other words, the general tax bill for residents of low-tobacco tax states is 15 percent below the national average.

Americans hoping to keep their total state and local tax burden low should avoid states with high cigarette taxes. Elevated tobacco taxes may reflect a propensity to tax other types of activity and products, regardless of their positive or negative impact on society and the economy. Non-smokers looking to higher tobacco taxes for a "tax thee, but not me" policy will be disappointed, as living with high tobacco taxes correlates with a "tax we" mentality.

2. Tobacco Tax Hikes Are Rarely Used to Cut Other Taxes

The anti-tobacco lobby makes the case that approving higher tobacco taxes will allow for other tax reductions. One such group argues, "By reducing smoking rates, cigarette tax increases will reduce the large amounts low-income and other state households are already paying in state and federal taxes to cover smoking-caused government expenditures."[6]

Do cigarette tax hikes really provide tax relief elsewhere? There are a limited number of cases where tobacco tax hikes helped to cover decreases in other taxes. For example, in fiscal year 2007 Hawaii saw a combination of tobacco and gas tax hikes offset by cuts in personal income and other taxes, for a net tax decrease of $13 million. In fiscal year 2003, Louisiana increased tobacco taxes and cut sales, personal income, corporate income, and other taxes for a net tax decrease of $30.8 million. Mississippi officials considered increasing their tobacco tax to reduce the 7 percent sales tax on groceries, but the plan was vetoed in 2006 and renewed attempts in 2007 were shelved without action. Tennessee lawmakers lowered the state grocery tax by 0.5 percent in 2008 by using a small portion of the new funds coming from a 42-cent jump in the tobacco tax.

However, it is far more common to find tobacco tax hikes either 1) married with other tax increases, or 2) paired with cuts worth less than the tobacco tax increase.

The record shows that higher tobacco taxes are not commonly used to lower net tax burdens. Most states that increase cigarette taxes don't refund the revenue elsewhere – they spend it.

3. Tobacco Tax Hikes Don't Forestall Other Tax Increases

If tobacco tax hikes don't lead to tax cuts, do they at least prevent other tax hikes that would hit non-smokers?

Once again, this isn't the case. By looking at past state government "revenue actions" – revisions in laws that affect taxpayer liability – it is clear that most states go on to raise additional taxes and fees (including sales, personal income, corporate income, motor fuels, alcohol, additional tobacco taxes, and/or fees) within just a few short years of a tobacco tax increase being approved.

As shown by the above chart, 41 of 59 state tobacco tax increases between fiscal years 2001 and 2006 were followed by tax hikes in the two-year period following enactment. In other words, taxpayers faced a 7 out of 10 chance of seeing another net annual tax hike within two years of a tobacco tax increase. Tobacco tax hikes don't serve as a permanent fix to the over-spending problem many states bring upon themselves, and new sources of revenue are often tapped even after a tobacco tax hike is put into place.

 It's worth noting that many of the above revenue actions took place during a period of strong economic growth, high energy prices (important for states like Montana and Alaska that rely on mineral extraction fees), and hefty budget surpluses. Even in an "up" economy, tobacco taxes have not historically forestalled other tax increases.

4. Tobacco Tax Hikes May Encourage Other Tax Hikes Down the Road

Many recent tobacco tax hike plans have been tied to specific spending boosts, particularly in the area of health and education. If the program expansion of choice is related to state-provided health care (e.g., Oregon's defeated Measure 50), proponents argue that the higher tax is really just a "user fee" for smokers.

However, the non-smoker should look upon the dedication of tobacco tax funds to expensive new government programs with a wary eye. Once spending demands eventually outstrip revenues brought in from cigarette taxes, the non-smoker can expect to be called upon to fill in the budget gap.

Tobacco use rates are declining,[9] and with it, potential tax collection earnings for the state. Even high-tax activists accept that cigarette tax revenues will be reduced over time as smoking declines. These same campaigners even argue that "the state can easily adapt"[10] to such changing revenue dynamics. Non-smoking taxpayers should hope that "easily adapt" translates into proportional cuts in spending. Otherwise, to make up the difference the government will need to rely on a sudden burst of new smokers (unlikely) or tax hikes on other activities and products. Given that many states have balanced budget requirements, someone or something will likely be targeted for new taxes if spending eclipses tobacco tax intake.

Citizens are already seeing new taxes on the horizon in states that approved new spending in conjunction with higher tobacco taxes. Arizona Governor Janet Napolitano was quoted making a pitch to residents to buy cigarettes (but not smoke them) because "we need the money from cigarettes"[11] to fill a $1.3 billion budget hole partly caused by new education spending mandates. Her request may have been tongue-in-cheek, but the need to cover the budget deficit is all too real.

Similar budget warnings helped to derail a 2008 California plan to tie a major run-up in the state's health care spending to a tobacco tax increase of $1.75 per pack. A fiscal examination from the California Legislative Analyst's Office noted that the tobacco revenues connected to this plan "would decline over time because of the well-established ongoing erosion of smoking activity unrelated to this measure."[12] The estimate found that funds from the new taxes would fall short of the program's outlays by anywhere from $300 million to $1.5 billion in its fifth year. Other tax hikes (or, less plausibly, spending cuts) would have been needed fairly soon to cover the program's costs.

This isn't a concern that's limited to the states. In 2006, proponents of expanding federal support for the State Children's Health Insurance Program incorporated a 61-cent-per-pack hike in the federal tobacco tax to "pay" for their plan. However, a Heritage Foundation study[13] found that in five years 9 million new smokers would be needed just to provide enough revenue to keep the program afloat. Over a 10-year outlook, 22.4 million new smokers would be required if the government didn't want to rely on revenue from income taxes, etc., to fund the program. This potential burden to non-smokers was among the key reasons the plan was defeated.

Ironically, schemes that tie dedicated program funding to higher tobacco taxes would make government increasingly reliant on revenues extracted from the very product whose use among citizens it supposedly hopes to extinguish. Unless non-smokers want to pick up the tab later on, they should reject calls for tobacco tax hikes, especially when they are tied to specific high-cost spending programs.

Furthermore, if non-smokers accept tax hikes that target a minority of the population, they are tacitly opening the door for broad-based tax hikes that attack other "politically incorrect" activities, such as enjoying fast food. Once legislators see they can get away with this type of pinpointing, there's no way of telling when and where they'll stop.

5. Tobacco Taxes Don't Spur Economic Growth

Another dubious claim made by pro-tax advocates is that the new revenue brought in from tobacco tax hikes somehow "helps" the economy. Says one such group, "Directing the new state government revenues generated by the cigarette tax increase to reduce state budget deficits or to fund economically productive programs or projects will further strengthen and improve the state's economy."[14] Again, data shows this isn't necessarily the case.

Nineteen states approved tobacco tax hikes in fiscal year 2003 (the largest one-year number in recent history). If the claim that revenue from tobacco tax hikes "improves the state's economy," these 19 states should experience greater-than-average economic growth within a few years (providing enough time for the revenue to circulate through programs, etc.) than states that didn't adopt tobacco tax hikes.

 Comparing the percent change in real (i.e., inflation-adjusted) gross domestic product (GDP) by state between 2005 and 2006 (estimated by the Bureau of Economic Analysis), states that adopted a tobacco tax hike in fiscal year 2003 actually had a lower average growth rate (0.6 percent less) than those states that did not adopt a tax increase.

It makes sense that tobacco taxes don't strengthen the economy because the very act of taxing extracts needed capital resources out of the private market and directs them to less efficient government uses. If elected officials actually had the ability to improve the economy with tax hikes, we'd never experience any economic downturns. As this isn't the case, state legislators can best create an environment favorable to economic growth by promoting noninvasive tax policies.

Conclusion

Whether or not an individual uses tobacco, tax hikes hurt everyone by encouraging the growth of government. As demonstrated in this Issue Brief, high cigarette taxes reflect a tendency to grow total tax burdens. Furthermore, tobacco tax hikes rarely precipitate tax relief elsewhere or even stave off future tax hikes. If tied to new spending, tobacco tax hikes can trigger future tax hikes once cigarette revenues decline. Finally, tobacco tax hikes don't correlate with economic growth.

While tobacco tax increases will assuredly come up as funding "solutions" in the future, taxpayers – smokers and non-smokers alike – would be better served by extinguishing such a notion and instead focusing on cutting the size of government.

Notes