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Issue Brief


Tobacco Taxes: Problems, Not Solutions, for Taxpayers and Budgets

July 31, 2013
By Diana Oprinescu


After the politicking and debate associated with their passage has died down, what are the actual consequences of cigarette and other tobacco tax increases? The following National Taxpayers Union Foundation (NTUF) study examines the budgetary impact of these policies.

Proponents of cigarette tax increases often claim that only a “sinful” minority, smokers, will be affected by them. However, tobacco tax hikes entail serious fiscal consequences for smokers and non-smokers alike, for five major reasons [1]:

  1. States with low cigarette taxes have lower overall tax burdens
  2. Tobacco tax hikes are rarely used to cut other taxes
  3. Tobacco taxes don’t forestall other tax increases
  4. Tobacco tax hikes may encourage other tax hikes down the road
  5. Cigarette taxes don’t spur economic growth

This paper demonstrates these conclusions to be valid regardless of a fluctuating economy (expansion, recession, recovery), and brings additional evidence to support the hypothesis that cigarette taxes represent an unreliable source of revenue.


1. States With Low Cigarette Taxes Have Lower Overall Tax Burdens

The most recent statistical data available shows that states with the highest cigarette taxes in the nation often have remarkably higher-than-average tax burdens; conversely, in states where cigarette taxes are lowest, total tax loads are almost always below the national average.

Table 1: Per Capita State and Local Tax Burden for High Cigarette Tax States

State

Per Capita State and
Local Tax Burden (FY 2010)

Per-Pack Cigarette Tax 
(as of 1/1/11)

New York $6,375 $4.35
Rhode Island $4,627 $3.46
Washington $4,261 $3.03
Connecticut $6,984 $3.00
Hawaii $4,396 $3.00
New Jersey $6,689 $2.70
Wisconsin $4,379 $2.52
Massachusetts $5,422 $2.51
D.C. $5,991 $2.50
Minnesota $4,727 $2.46
Vermont $4,154 $2.24
Alaska $3,214 $2.00
Arizona $3,006 $2.00
Maine $3,807 $2.00
Maryland $5,234 $2.00
Michigan $3,503 $2.00
Average $4,798  
U.S. Average* $3,442  
Difference $1,356  

*Excluding the 15 states (plus the District of Columbia) listed in this table

Source: compiled from Tax Foundation data [2], [3] 

More specifically, in the 16 places[A] where the per-pack cigarette tax was highest, the average per capita state and local tax burden was $1,356 above the national average. This means that the tax pressure on residents of high-cigarette tax states was 39.4 percent heavier than the U.S. average in fiscal year 2010.

On the other hand, when analyzing the 15 states with the lowest per-pack cigarette tax in the nation, the total tax burden was $892 below the national average (or 21.6 percent less).

Table 2: Per Capita State and Local Tax Burden for Low Cigarette Tax States

State Per Capita State and Local Tax Burden (FY 2010) Per-Pack Cigarette Tax (as of 1/1/11)
Missouri $3,328 $0.17
Virginia $4,336 $0.30
Louisiana $2,851 $0.36
Georgia $3,222 $0.37
Alabama $2,740 $0.425
North Dakota $3,733 $0.44
North Carolina $3,535 $0.45
West Virginia $3,029 $0.55
Idaho $3,101 $0.57
South Carolina $2,760 $0.57
Kentucky $3,027 $0.60
Wyoming $3,721 $0.60
Tennessee $2,707 $0.62
Nebraska $3,853 $0.64
Mississippi $2,625 $0.68
Average $3,238  
U.S. Average* $4,130  
Difference   -$892  

*Excluding the 15 states listed in this table. Source: compiled from Tax Foundation data [4]

These results strongly support the hypothesis that cigarette tax hikes are associated with the political tendency of raising taxes on other activities and products, which affect smokers and non-smokers alike.


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

One argument sometimes made in favor of tobacco tax hikes holds that such an increase encourages general tax cuts; however, such arguments are disproved by statistical evidence.

It can be possible for some tobacco tax hikes to be compensated by cuts in other taxes – for instance, in fiscal year 2010, a revenue action that increased the tobacco tax in Texas was offset by other tax decreases, leading to a net reduction of $18 million. It is much more common, however, for tobacco tax hikes to be followed either by other tax increases, or by tax cuts that are worth less than the tobacco tax increase.

Table 3: States with Revenue Actions that Included Tobacco Tax Hikes and Same-Year Tax Cuts

Fiscal Year Number of States with Tobacco Tax Hikes Number of States with Complete Tax Cut Offsets
2013 4 1
2012 3 0
2011 7 0
2010 17 1
2009 1 0
2008 8 0

Source: compiled from National Association of State Budget Officers data [5]

Thus, between 2008 and 2013, only two out of 40 revenue actions that raised the tobacco tax were followed by cuts in other taxes. Furthermore, if the results presented in a 2008 National Taxpayers Union (NTU) study are also accounted for, it can be seen that only four of 103 tobacco tax increases between 2001 and 2013 (less than 4 percent) were offset by other tax cuts. The conclusion that states imposing tobacco tax hikes don’t refund the revenue elsewhere, but spend it instead, is therefore strongly reinforced.


3. Tobacco Taxes Don’t Forestall Other Tax Increases

Not only are tobacco tax hikes not offset by cuts in other taxes, but they also tend to be followed by revenue actions that raise taxes on other products and services within a short period of time.

Table 4: States Increasing Net Annual Tax/Fee Burden in the Two-Year Period Following a Tobacco Tax Hike

Fiscal Year Number of States with Tobacco Tax Hikes Number of States with Subsequent Tax Increases
2011 7 5
2010 17 10
2009 1 1
2008 8 7
2007 4 2

Source: compiled from National Association of State Budget Officers data [6]

As shown in Table 4, between fiscal years 2007 and 2011, 25 of 37 tobacco tax increases were followed by additional tax hikes. If the findings of the previous NTU study are also considered in the tally, a total of 66 out of 96 tobacco tax increases between fiscal years 2001 and 2011 were followed by other tax hikes during the next two years. This means that, in almost 70 percent of cases, tobacco tax hikes also affected non-smokers because other tax increases followed.


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

Why are tobacco tax hikes likely to encourage other tax increases in the long run? To begin with, politicians often justify such actions by saying that they can use the additional revenue to plug budget deficits and/or fund programs in areas like health care or education.

Furthermore, states often fail to provide accurate estimates of how much money they will collect from cigarette tax hikes. As revenues usually fall short of these projections, additional taxpayer money is sought in order to continue to fund the programs and avoid budget cuts.

Table 5: Revenue Estimates from Tobacco Tax Hikes As Compared To Actual Tobacco Tax Revenues

Calendar Year When the Tax Increase Took Effect Number of States with Cigarette/Tobacco Tax Hikes* Number of States Where Revenue Projections Were Met
2011 5 1
2010 5 2
2009 14 4
2008 8 2
2007 9 2
2006 6 0
2005 11 6
2004 7 2
2003 15 6
2002 19 3
2001 2 1

*Data for a small number of states that increased the cigarette/tobacco tax could not be found, but the impact on the overall result could only be negligible.

Source: compiled from budget documents, bills, and statistical data provided by the Department of Revenue in each state, and FTA data [8]

As shown in Table 5, initial revenue projections were met in only 29 of 101 cases where cigarette/tobacco taxes were increased between 2001 and 2011. This means there is a 70 percent chance that a revenue estimate will be missed.  Moreover, as only 18 of 60 revenue projections were met between 2001 and 2006 (again, a 70 percent chance of failure), these estimates remain equally unreliable in an “up,” as well as in a “down” economy.

There are several possible reasons why revenue estimates are usually missed. Even while elected officials make promises about a golden pot of revenues, the percentage of adults who smoke has been declining [7]. The latter fact alone makes accurate forecasts difficult, especially on a state or local basis. Thus, there is an inevitable tension between supporters’ claims that tax hikes will both lead to bigger treasuries for governments and encourage less smoking. Indeed, political leaders may have the incentive to exaggerate revenue outcomes in order to initially enlist more constituents in favor of the tax.

Second, consumers often supplant cigarettes with alternative products that are taxed at lower rates. For instance, after a 2013 cigarette tax hike, store owners in Minnesota began to stock smoking alternatives such as E-cigarettes or “roll-your-own,” for which demand was on the rise [9]. At the federal level, the 2009 cigarette tax hike led to market shifts from roll-your-own to pipe tobacco and from small to large cigarettes, with federal revenue losses estimated to range from $615 million to $1.1 billion [10]. Third, high taxes encourage either cross-border shopping, leading smokers to make their purchases in neighboring states with lower taxes, or smuggling. For example, media reports show that many New Yorkers used to ride the ferry to neighboring Vermont in 2010, where they paid only $22.40 instead of $43.50 in taxes for one carton of cigarettes [11]. As for smuggling, a study by the Mackinac Center for Public Policy in Michigan estimated that New York was the highest net importer of smuggled cigarettes in 2011, which accounted for 60.9 percent of the total market [12].

The anti-tobacco lobby usually responds to such arguments by saying that cigarette tax hikes always lead to at least some increased revenue for states [13], even if actual collections sometimes fail to meet the initial targets. However, this is not always the case – probably the most notorious counterexample is New Jersey, where cigarette tax revenues dropped by $52 million right after a tax hike in 2006 [14].


5. Cigarette Taxes Don’t Spur Economic Growth

Finally, the argument that cigarette taxes foster economic growth by bringing additional revenue to the state budget is also contradicted by recent data.

Table 6: 2011-2012 Percentage Change in Real GDP Growth for 2009 Tobacco Tax Hike States (by Date of Enactment, Calendar Year)

States with Tobacco Tax Hikes Enacted in Calendar Year 2009* Real GDP Percentage Change 2011-2012
Arkansas 1.30
Connecticut -0.13
Delaware 0.19
Florida 2.43
Hawaii 1.61
Kentucky 1.42
Mississippi 2.36
New Hampshire 0.52
New Jersey 1.33
North Carolina 2.68
Pennsylvania 1.71
Rhode Island 1.40
Vermont 1.15
Wisconsin 1.45
D.C. 0.73
Average 1.34
U.S. Average** 2.43
Difference -1.09

* Slightly different results could be obtained if the states with cigarette tax increases are listed by fiscal, instead of calendar year; however, our findings indicate that there is no positive causal relation between cigarette tax hikes and real GDP growth.

** Excluding the 14 states (plus the District of Columbia) with tobacco tax hikes listed in this table

Source: compiled from Bureau of Economic Analysis data [15]

Thus, on average, the state-level governments that enacted tobacco tax increases in 2009 had a lower growth rate (1.09 percent less) than those that didn’t implement such increases. This casts serious doubt on the pro-tax argument, according to which governments are able to spur growth by boosting taxes.


Conclusion

The foregoing research provides considerable evidence that tobacco tax hikes tend to increase the overall tax burden, are rarely associated with general tax cuts, and, rather, are frequently followed by other tax increases. Also, they do not facilitate economic growth.

Furthermore, tobacco taxes encourage the growth of government regardless of whether the business cycle is in its expansionary or in its recessionary phase. The analysis presented in this paper supports the hypothesis that revenues obtained from tobacco tax hikes are unpredictable, because estimates are rarely met. Ultimately it can be concluded that tobacco taxes affect non-smokers as well and that taxpayers bear high costs when the size of government expands on the basis of such an inconsistent revenue stream.


[A] This section analyzes 16 (instead of 15) areas with the highest cigarette tax rates because there are five states that tie for the last place (Alaska, Arizona, Maine, Maryland, and Michigan). 


Sources 

[1] Kristina Rasmussen, “Debunking the "Tax Thee, But Not Me" Myth: Five Reasons Why,” NTU Issue Brief 167, March 20, 2008, http://www.ntu.org/news-and-issues/taxes/excise-tax/debunking-the-tax-thee-myth-for-tobacco-taxes.html.

[2] Tax Foundation, “State Cigarette Excise Taxes, 2009-2013,” February 27, 2013, http://taxfoundation.org/article/state-cigarette-excise-tax-rates-2009-2013.

[3] Tax Foundation, “Facts & Figures 2013: How Does Your State Compare?,” March 18, 2013, http://taxfoundation.org/article/facts-figures-2013-how-does-your-state-compare.

[4] Ibid.

[5] The National Association of State Budget Officers, “Fiscal Survey of the States: Archives,” Fall Reports, 2006 to 2012, http://www.nasbo.org/publications-data/fiscal-survey-of-the-states/archives.

[6] Ibid.

[7] Centers for Disease Control and Prevention, “Vital Signs: Current Cigarette Smoking Among Adults Aged ≥18 Years —United States, 2005–2010,” September 9, 2011, http://www.cdc.gov/mmwr/pdf/wk/mm6035.pdf#page=21.

[8] Federation of Tax Administrators, “The Tax Burden on Tobacco,” Historical Compilation, Volume 46, 2011, http://www.taxadmin.org/fta/tobacco/papers/Tax_Burden_2011.pdf.

[9] CBS Minnesota, “Looming MN Cigarette Tax Hike Spurs Buying Frenzy,” June 11, 2013, http://minnesota.cbslocal.com/2013/06/11/looming-mn-cigarette-tax-hike-spurs-buying-frenzy/.

[10] United States Government Accountability Office, “Tobacco Taxes: Large Disparities in Rates for Smoking Products Trigger Significant Market Shifts to Avoid Higher Taxes,” April 2012, http://www.gao.gov/assets/600/590192.pdf.

[11] National Taxpayers Union, “Vermont Selling A Lot More Than Cheese,” July 15, 2010, http://www.ntu.org/governmentbytes/taxes/vt-cig-sales.html.

[12] J.D. Tuccille, “President Obama's New Cigarette Tax Will Fuel an Already Booming Black Market in Smokes,” Reason Hit & Run Blog, April 18, 2013, http://reason.com/blog/2013/04/18/president-obamas-new-cigarette-tax-will.

[13] Campaign For Tobacco-Free Kids, “Raising State Cigarette Taxes Always Increases State Revenues,” January 3, 2013, http://www.tobaccofreekids.org/research/factsheets/pdf/0098.pdf.

[14] National Taxpayers Union, "An Open Letter to the Pennsylvania Senate: Oppose the Massive Philadelphia Cigarette Tax Hike!," June 26, 2013, http://www.ntu.org/in-your-state/pennsylvania/philly-cig-hike-6-26-2013.html.

[15] Bureau of Economic Analysis, “Regional Data: GDP and Personal Income,” updated June 6, 2013, http://www.bea.gov/iTable/iTable.cfm?reqid=70&step=1&isuri=1&acrdn=1#reqid=70&step=1&isuri=1.