Recession Ushers in More Tobacco Taxes

Clipping away at a $590 million deficit, Rhode Island this April raised its taxes on cigarettes by $1 to $3.46 a pack – the highest rate in the country. With the backing of its governor, a former tobacco lobbyist, Mississippi in May imposed its first tax hike on smokers in more than two decades – up 50 cents to 68 cents a pack – and is already considering another increase.

For lawmakers scrounging to balance state budgets in a recession, tobacco taxes were one of the most popular options on the table this year. Seven states – Arkansas, Florida, Hawaii, Kentucky, Mississippi, Rhode Island and Vermont – tapped smokers’ wallets to help fill their budget gaps, up from two states in 2008. More than 20 additional states debated whether to follow suit, according to the National Conference of State Legislatures.

But there are growing signs that tobacco, which generated about $19 billion for states in revenues from sales and excise taxes last fiscal year, might not deliver the new money state lawmakers are hoping for.

In a double-whammy for smokers, the federal government on April 1 also imposed a 62-cent increase in its cigarette tax, raising it to $1.01 a pack, and a bill that President Barack Obama is expected to sign this month would provide the Food and Drug Administration (FDA) sweeping authority over the tobacco industry. Together, the two federal moves are likely to depress cigarette sales – already in decline – that every state counts on for extra cash.

According to the Tax Foundation, a nonpartisan research group, the federal hike in cigarette prices could hold down sales and dent states’ tobacco tax receipts by $1.6 billion next fiscal year. In addition, the Congressional Budget Office estimates that the proposed FDA regulations could slash states’ tobacco excise revenues by an additional $20 million in 2010 – and up to $300 million by 2014.

Those projected losses spell trouble for state budget writers, who witnessed diminishing returns from tobacco taxes even before the federal government’s latest actions. Between 2003 and 2007, 39 of 57 tobacco tax increases at the state level fell short of lawmakers’ revenue expectations, according to the Altria Group, parent company of tobacco giant Philip Morris.

New Jersey’s experience epitomizes this growing problem. After state lawmakers increased their cigarette excise by 17.5 cents in 2006, the state’s tobacco tax revenue actually dropped $22 million, according to the NCSL. Despite those numbers, New Jersey Gov. Jon Corzine (D) in May proposed an additional 12.5-cent hike in smokers’ taxes to help plug his state’s expected $1.2 billion deficit, a proposal he hopes state lawmakers will include in their forthcoming budget.

Recent research in other states further draws the connection between higher tobacco taxes and shrinking cigarette sales. In Louisiana, previous tobacco tax hikes – the highest and most recent of which was 12 cents in 2002 – sent smokers to neighboring states, encouraged cigarette stockpiling, diminished tobacco sales and returned less revenue than lawmakers anticipated, according to the state’s Legislative Fiscal Office. The Louisiana House this month introduced – but narrowly defeated – a 50-cent increase in taxes on cigarettes.

In Illinois, analysts at Illinois State University calculate that a proposed $1 cigarette tax hike could produce a 32 percent to 35 percent drop in sales, and thus tax revenues, because disgruntled smokers would travel to neighboring states to purchase cheaper tobacco goods. The proposed tax increase, aimed at generating new revenue for health care for low-income Illinoisans, is currently stalled in the state House.

“It is shown that [tobacco taxes] are almost revenue neutral; it’s not going to generate as many dollars as projected,” admitted Illinois state Sen. Terry Link (D), one of the bill’s sponsors. “I look at it in a different way. …  If we decrease the amount of smoking by raising taxes, we may also be saving on the health-care front, which saves the state money.”

That’s why state health departments tend to celebrate tobacco taxes as hard-fought victories. In New York, where the state cigarette tax is $2.75 a pack, health officials say that a combination of higher taxes and smoking bans have lowered health-care costs statewide.

According to Beth Goldberg, a public affairs manager at the state Health Department, New York’s anti-smoking measures have led to an 8 percent reduction in heart attack hospital admissions since 2003, saving state health-care providers more than $56 million. Moreover, smoking in New York decreased 12 percent from 2007 to 2009, according to a June report by the state Health Department.

New York isn’t alone. In the six months after Michigan Gov. Jennifer Granholm (D) signed off on a 75-cent tobacco tax hike, the state’s Department of Community Health noticed an almost 400 percent jump in calls to its Tobacco Quit Line, according to the governor’s office.

But while states have long-term financial and health reasons to discourage smoking, they remain hooked in the short term on these “sin taxes” – excises on vices such as smoking, drinking and gambling that are politically easier to increase than sales or income taxes.

“You have to go back decades to see states with such budget shortfalls,” said Sujit CanagaRetna, a state budget and tax expert at the Council of State Governments . “A sin tax is a low-hanging fruit. Politicians are more prone to go down that path because doing so is just not as onerous.”

Other experts, however, regard these short-term budget patches as part of a larger problem. One leading anti-tax activist, Grover Norquist of Americans for Tax Reform, said a better solution to burgeoning budget gaps is to cut state spending.

“Any problem of overspending that could be passed on to cigarettes could be fixed by just spending more wisely,” Norquist said. “The problem with the tax increase isn’t just that it’s a tax increase, … it is that the tax is what you did instead of reforming state government.”