The problem with raising revenue from cigarettes that we want people to stop smoking

Our recent blog post discussing one example of the unintended consequences of trying to modify personal behavior through the tax code made us wonder how Minnesota’s own big experiment along those lines was working out: our major increase in cigarette taxation.

As you may remember, policymakers increased both cigarette excise and wholesale taxes during the 2013 legislative session. The new combined excise/wholesale rates more than doubled the old rates and were projected to bring in approximately $400 million in additional general fund revenue. Yet many claimed the new revenues — so essential to balancing the FY 2014-15 budget — were a byproduct of the real policy motivation: getting people to stop smoking. Whether you believe such claims were sincere, disingenuous, or a little of both, the fact is this decision was based on the win/win proposition of being able to raise considerable general fund revenue and achieve a social purpose at the same time.

How has this all turned out? According to MMB, net cigarette and tobacco tax collections were $607.1 million in the first year after the rate hikes, exceeding revenue forecasts by nearly $14 million. For perspective, that’s about half of Minnesota’s corporate income tax collections that year. Yet, over this same period the Department of Revenue estimates cigarette pack sales in Minnesota declined by nearly 30% from roughly 227 million in FY 2013 to about 163 million in FY 2014. From these indications, things seem to be going according to plan.

But adjustments to higher levels of taxation can take time, and there is evidence to suggest that the behaviors behind these numbers are more complicated than they may seem. For starters, collections over the first three months of the current fiscal year (FY 2015) are now trailing projections by nearly $17 million, or 13%. Although some of this might be attributable to a downtick in usage (from 19% of adults in 2011 to 18% of adults in 2013 according to the CDC), it also appears many Minnesotans have gotten more resourceful in maintaining their habit.

Then there is this rather remarkable finding from a recent report that came across our desk that was funded by a group of cigarette wholesalers and retailers. It examines the economic consequences of the 2013 cigarette tax increase and suggests that while cigarette consumption may have staying power, Minnesota’s cigarette tax collections may not. According to the report, based on store-level data, per capita cigarette sales in Minnesota border regions, already feeling the effects of existing border differentials, “collapsed” with the increase — down 42% along the North Dakota and Iowa borders, 35% along the South Dakota border and 27% along the Wisconsin border. Meanwhile, border state sales in counties near several larger Minnesota cities increased over 60%. We’ve reproduced a figure from the study below that shows this change.

Even Minnesota’s interior “pink” region — featuring per capita sales declines of 8%- 30% — may entail a much more complicated narrative. As the report notes, consumers have many alternative sources to more traditional outlets for cigarettes and tobacco products, including overseas counterfeit vendors, Native American smoke shops (where the tax issue has been problematic for decades), and illegal smuggling which the Department of Revenue has called “the obvious wild card.

Trends in tax avoidance and resulting shortfalls in projected revenues may get worse over time because of a unique and controversial policy feature. Minnesota is the only state in the nation that annually adjusts its per pack excise tax (now at $2.83) for inflation. Tax experts generally regard automatic inflation adjustments as bad tax policy save for those very rare “benefits tax” situations in which revenues directly and exclusively finance the costs of the service provided (like a gas tax.) Minnesota has essentially decoupled cigarette taxes from efforts to pay for the public costs associated with smoking. Only about 5% of cigarette tax collections are now dedicated to paying for health-related programs – the rest fund general government operations.

Which in turn raises a bigger set of tax questions. How wise is it to support the general obligations of government by increasing reliance on a revenue source that is not only volatile and avoidable but also intended to decline over time? And even if cigarette revenues do prove to have greater staying power despite the increasingly challenging economics and abundant opportunities for avoidance, shouldn’t important general fund programs like education be paid for with broad-based general taxes on society rather than being foisted upon a disproportionately poor minority of its citizens? Collecting significant revenues for the benefit of all at the expense of a marginalized minority because the political cost is low in some ways redefines the concept of what a “sin tax” is.

This post was written by Mark Haveman and originally published on Fiscal Fitness, the blog of the Minnesota Center for Fiscal Excellence.

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Comments (9)

  1. Submitted by Todd Hintz on 11/07/2014 - 12:16 pm.

    Smoking

    I’m sorry, but I don’t have a lot of sympathy for people who smoke. It’s not like it’s any secret that it’s bad for you and people know they shouldn’t start in the first place.

    As far as taxes go, they’re very easy to avoid: don’t smoke. The tax may fall disproportionately on the poor, but those are precisely the people who shouldn’t be smoking in the first place. Even ignoring taxes for a moment, the habit is still expensive both in terms of the impact to people’s health as well as their pocketbook.

    And if the tax goes up over time as it’s adjusted for inflation and that prompts fewer people to smoke, then we’ve got an even bigger winner.

    According to the CDC in 2012 18% of people in Minnesota who smoke, which is in line with the national average. Looking at Gallop numbers from 2013, we’re at 15.8%–the third lowest state in the nation. The worst is Kentucky at 30.2%. Our bussies to the west, North Dakota, smoke at a rate of 18.5%.

    I would say we’re doing something right here in the Great Frozen Northland if our rates are that low.

  2. Submitted by Robert Moffitt on 11/07/2014 - 01:04 pm.

    Look a closer look at the policy’s goal

    It was not, as you said, “getting people to stop smoking.”

    The goal of raising the tax on tobacco products was to reduce the number of young people from using tobacco. Multiple studies have shown that young people are particular sensitive to the price of tobacco — raise the price, and many will quit or simply never start.

    With adults, already hooked, the decrease is still there, but at a much smaller rate. Still, keeping the next generation off tobacco is a lofty goal that we all should agree on. If there is a technique that works — and we know this does — than we should use it.

    I speak on this subject in greater detail in this article in City Pages: http://blogs.citypages.com/blotter/2013/06/lung_associations_bob_moffitt_looks_forward_to_july_when_cig_taxes_go_up_160_per_pack_interview.php

    • Submitted by E Gamauf on 11/09/2014 - 07:47 am.

      Rather than taxes, does it make sense to limit profit?

      Maybe its the cigarette industry itself that should be curtailed.

      If the argument is:

      Taxing smokers is an undue burden,
      an alternative might be to limit the profit portfolios of the drug dealers involved –
      and prevent them more directly from passing on the price of doing business to their consumers.

      That may not be viable to do for myriad reasons, but why isn’t it part of the discussion?

      The fact remains that somebody is making big bucks off an addiction. Whatever the market will bear.
      The addicted are being punished for something that is legally sold.

      The tobacco settlements were quite a number of years ago.
      Should those be re-adjusted?

    • Submitted by Pavel Yankovic on 11/10/2014 - 05:01 am.

      Robert,

      with all due respect, the goal of taxing cigarettes is to raise revenue.

  3. Submitted by Dan Berg on 11/07/2014 - 02:24 pm.

    They all are

    “Collecting significant revenues for the benefit of all at the expense of a marginalized minority because the political cost is low in some ways redefines the concept of what a “sin tax” is.”

    Almost all taxes are created with this same methodology. Divide people into small enough groups so they can be taxed while never having loud enough voices to be electorally significant. After repeat that process over and over again for decades we have a tax system that is opaque and corrupt. Corrupt in a much more insidious way than simple graft. It is beyond morally debased beyond repair. The current tax regimen is played as tool for morality rather than way of funding government. People making arguments on how to use taxes for moral purposes are not focused on how to make an understandable and efficient tax system and should be ignored completely.

    The cigarette tax is a great example of this. It is a self defeating system as far as revenue is concerned. The more success it has the less revenue it creates. As an instrument of a moral crusade it might have some effect but why should we allow that to be done with the tax code? For those who say it is about smokers paying for the extra costs they place on the medical system should take a look at the actual facts. Smokers cost less on average over their life to care for because they die earlier. They also save tax payers money on Social Security and Medicare, Medicaid costs for the same reason.

    The cigarette and other types of sin tax is the worst type of paternalism. People hoping to benefit themselves, for whatever set of aesthetic, monetary or other reasons. at the expense of a group that isn’t big enough to push back. All under veil of being for the benefit of the effected group. If people make bad decisions that don’t cost you anything they are free to do so. Get over it.

    • Submitted by E Gamauf on 11/09/2014 - 08:05 am.

      Taxing anything then, is “paternalistic?”

      What is different about a “sin tax” than other taxes?
      The boundaries of that concept needs to be defined.

      “Sin Tax” defined before the term is tossed around too much more & compounded with “paternalistic.” There is no relative value we can assign to “paternalistic.” What are its units of measure.

      “Marginalizing people” is a resonant comment.
      I think you present it in an interesting form. Nevertheless, taxing cigarettes takes it out of the realm of “moral crusade,” because it doesn’t directly ban the behavior, it simply applies a higher cost.

      I support an adult’s right to smoke, though I sometimes dissuade the behavior in friends & family.

      “Smokers cost less on average over their life to care for because they die earlier. They also save tax payers money on Social Security and Medicare, Medicaid costs for the same reason.”

      Do old smokers simply spontaneously combust in a puff of smoke?
      The ones I have known, the ones who suffer medical complications, still have a hefty impact on all medical services, BOTH public & private.

      I would ask to see the numbers you have run to explain the relative impact that
      smokers have for so graciously dying early.

  4. Submitted by Josh William on 11/07/2014 - 03:36 pm.

    Incentive

    Raising the price of cigarettes is not a deterrent. It may be for casual or young smokers, but for those who are truly addicted (and have smoked for decades), it only hurts their wallets.

    If the state wants to continue deceiving everyone that higher prices means a healthier population, so be it.

    • Submitted by E Gamauf on 11/09/2014 - 07:38 am.

      Price points aren’t a big deterrent?

      Probably not in the case of smoking.
      It has that in common with other addictions.

      It might be argued that smokers should feel some regular pain, even if its only another dollar a pack.
      Certainly that’s nothing compared to the cost of OTHER medications people take.

      Should the same hold true for alcohol [abuse] & do we need Prohibition Mark II?

      Do we really need to deter smoking further in the first place,
      or do people have a right to hurt themselves as they see fit to do?

      A recent candidate for senate (Mike McF) came out in the one debate, supporting a business’ right to blood test employees for nicotine. Something about that tactic has an ominous feel to it as intrusions go, yet it may be more effective than increasing the price of cigarettes again.

      The impact of smoking is sizable (duh).
      Smokers don’t pay a share of health insurance costs in ratio with the impact of their elective behaviors & that is the point of intersection with non-smokers.

      Is there a “Universal Law” dividing line to tell us when its alright to intercede & when not to do so?
      What actually does work as a deterrent?

  5. Submitted by Susan Maricle on 11/08/2014 - 12:52 pm.

    Poison as a cash cow

    Imagine if DDT had been allowed to remain on the market — but instead of banning it, DDT was simply taxed prohibitively with the goal of getting users to stop using the product.

    Why, then, are cigarettes allowed to remain on the market.

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