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Economics of Cigarette Taxes

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06/01/2003Don Mathews

 

When it comes to national trends, Georgia tends to be not a leader but a laggard—which is a fine quality if the country is marching toward Leviathan.

An example of a national trend in which Georgia has been a laggard is the trend in cigarette taxes. Over the past decade, states have been all but chain-raising their cigarette taxes. Nineteen states raised their cigarette taxes in 2002 alone.

All the while, Georgia maintained its cigarette tax at 12¢ per pack.

Last week the Peach State continued to buck the national trend. By a vote of 127 to 47, the Georgia House of Representatives defeated Governor Sonny Perdue's proposal to raise the state's tax on cigarettes from 12¢ per pack to 58¢ per pack.

The national trend in cigarette taxes is a trend that is well worth bucking.

Cigarette taxes vary quite a bit from state to state. Massachusetts imposes the highest tax at $1.51 per pack. New York and New Jersey charge a $1.50 per pack tax. Nine other states impose per pack taxes of at least $1.

Virginia has the lowest cigarette tax at 2.5¢ per pack, though counties and cities in Virginia may impose their own tax of between 2¢ and 15¢ per pack. Kentucky charges the next lowest tax among the states at 3¢ per pack.

The federal tax on cigarettes, by the way, is 39¢ per pack.

All those taxes add up to a pile of money. In 2001, the federal government collected $7 billion in cigarette taxes, while the 50 states collected almost $8.7 billion.

But an ever-rising mountain of revenue from cigarette taxes is not the sure thing that some legislators seem to think it is. Contrary to popular belief, smokers do smoke fewer cigarettes when cigarette prices rise. Economists estimate that, on average, a 10 percent increase in the retail price of cigarettes results in a 4 to 8 percent decrease in the number of packs sold.

And smokers have other ways of dealing with cigarette taxes.

Smokers don't hesitate to cross state borders to buy cigarettes that are taxed at lower rates. In 1994, Michigan increased its cigarette tax from 25¢ to 75¢ per pack. Within a year, 20 percent of the cigarettes consumed in Michigan were purchased in Ohio and Indiana.

Would Georgia smokers be border-hopping for cigarettes if the legislature had raised the state's cigarette tax to 58¢ per pack? No doubt. Georgia's neighbors currently charge the following cigarette taxes: Florida, 33.9¢ per pack; Tennessee, 20¢ per pack; Alabama, 16.5¢ per pack; South Carolina, 7¢ per pack; and North Carolina, 5¢ per pack.

Smokers have also turned to the internet for cigarettes. Cigarette prices charged by internet vendors are substantially lower than those charged by standard "bricks and mortar" retail establishments because internet vendors rarely if ever tack on the sales and excise taxes imposed by the customers' home states.

Most internet vendors buy their cigarettes in low-tax states and then sell the cigarettes in high-tax states. Other vendors avoid state taxes altogether by buying US brands that are manufactured overseas.

Currently, some 200 US websites and another 200 foreign-based websites sell cigarettes to US smokers. Their sales account for about 2 percent of all cigarettes consumed in the US. Forrester Research, Inc., a private consulting firm, expects the figure to reach 14 percent by 2005.

Border-hopping and internet buying are not the only unintended consequences of rising cigarette taxes, however.

Higher cigarette taxes are justified, say their advocates, to discourage people from smoking. And, as we've stated, people do respond to higher cigarette taxes by smoking fewer cigarettes. They also respond by smoking longer cigarettes that contain more tar and nicotine.

This unintended consequence is so pronounced among young smokers that the average daily tar intake among young smokers tends to rise as cigarette taxes rise. Which means that, since tar is the prime carcinogen in cigarettes (or at least is believed to be), higher cigarette taxes may lead to more health problems than low cigarette taxes do.

Federal and state governments pick up a chunk of the medical costs that smokers incur, and that, according to some, is another reason why cigarette taxes are justified. But a full accounting of how smoking affects government budgets must include more than just medical costs.

Smokers, on average, have more health problems than nonsmokers, and so incur greater medical costs than nonsmokers. However, smokers tend to live shorter lives than nonsmokers, which means they spend less time in nursing homes and less time drawing pensions than do nonsmokers.

Those last two items are not trivial. In a recent study, Harvard economist Kip Viscusi estimated that the state of Massachusetts incurred greater medical costs for smokers than for nonsmokers—to the tune of about 5¢ per pack of cigarettes. But the state incurred roughly 20¢ less per pack in nursing home and pension costs for smokers than for nonsmokers.

According to Viscusi's accounting, nonsmokers are a greater strain on government budgets than smokers are. Smokers more than pay their way—even before they pay the cigarette tax!

Raising cigarette taxes has another unintended consequence—an increase in cigarette smuggling.

Cigarette smugglers operate in the same general way that internet cigarette vendors do: they buy cigarettes in low-tax states and sell in high-tax states. The only difference is that the smugglers transport the cigarettes themselves.

Widening differences between state cigarette taxes have turned cigarette smuggling into a booming industry. And if this trend continues, cigarette smuggling may well become as commonplace in the US as it is in Italy, where about 20 percent of cigarettes sold are smuggled, or Spain, where about 25 percent of cigarettes sold are smuggled, or perhaps even England, where as much as 50 percent of cigarettes sold are smuggled.

And just as smokers get hooked on cigarettes, governments get hooked on cigarette tax revenues. Which leaves governments in the strange position of saying, in effect, to citizens, "Please don't stop smoking. We need the revenue."

 

Don Mathews teaches economics at Coastal Georgia Community College  (dmathews@bc9000.bc.peachnet.edu).

Cite This Article

Mathews, Don. "The Economics of Cigarette Taxes." The Free Market 21, no. 6.

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