Commentary

Hooked on Cigarette Taxes

This article originally appeared in the Washington Post, on February 14, 1999, as

Neither Governor Glendening nor President Clinton seems able to break his addiction to cigarette taxes. Smokers had better have a vise grip on their wallets. Excise taxes on each pack are already 60 cents, split between the feds and Maryland, with a 15-cent federal kicker coming soon. Add 45 cents to pay for the states’ tobacco settlement, 55 cents in Clinton’s upcoming budget, and $1.00 just proposed by Glendening. The total, $2.75 per pack, is surely enough to lure every “entrepreneur” not already busy distributing illegal drugs. Oh yes, the $2.75 doesn’t include still more booty to be extorted from the tobacco companies when the Department of Justice crystallizes its litigation plan, which Clinton announced in his State-of-the-Union Address.

In hot pursuit of that treasure trove, our greedy state and federal executives ignore the destructive effects of their proposals. Put bluntly, higher tobacco taxes are an incitement to black markets, wrongheaded economics and ineffectual at reducing cigarette use by kids.

First, the unavoidable consequence of inflated retail prices will be a flourishing and pervasive black market. No doubt we’ll embark on another war like our endless and fruitless war on drugs. But rather than send troops to obliterate the Colombian coca fields, we’ll find ourselves combing the back roads of Maryland, searching for contraband cigarettes.

Soon after tobacco companies raised prices to pay for the November 1998 settlement, made-for-export Marlboros, Winstons and Camels showed up in U.S. stores and on the Internet at huge markdowns — as much as 25 percent below prevailing market prices. Imagine if consumers were faced with, say, a $2.00 premium because of new taxes, litigation expenses and settlement costs. With 24 billion packs sold domestically each year, that’s $48 billion in potential black-market profits — about eight times the U.S. net income of Philip Morris, Reynolds, Lorillard and Brown & Williamson combined. It doesn’t take a governor or a president to know that those price hikes will spawn illegal dealings dominated by criminal gangs hooking underage smokers on an adulterated product, without the constraints on quality that competitive markets normally afford.

Next, let’s examine the economic and public finance implications of higher cigarette prices. For starters, more than half of any price increases will be paid by smokers with annual incomes under $30,000; only 1 percent will be paid by smokers earning more than $100,000. In other words, cigarette surcharges are brutally regressive; they represent a wealth transfer from generally poor smokers to more affluent non-smokers. If prices rise by $2.00 per pack, a two-pack-a-day smoker will be hit with $1,460 in added expense each year. That’s an enormous burden for a low-income consumer.

What’s worse, the extra burden is wholly unjustified. Federal and state excise taxes on cigarettes already generate more than $13 billion in annual revenue — far more than the smoking-related costs paid out of public coffers. Economists who have examined the data have concluded, without exception, that publicly funded health expenditures are less than current excise tax collections. And if we consider pension and geriatric savings due to premature deaths, total social costs are less than half the prevailing tax bite. That may sound ghoulish, but it’s the government, not tobacco companies, that laments the financial impact on the public treasury. In calculating that impact, both costs and savings must be considered. In a nutshell, tobacco companies and their customers have more than paid their way.

Finally, tax increases and price hikes are unlikely to be very effective at keeping cigarettes away from kids. The latest evidence from Cornell University is that the price elasticity of demand — which measures how sales volume changes in response to price changes — is roughly zero for teens. That is, within reasonable limits, teens will smoke about the same number of cigarettes no matter what the price. Indeed, government statistics show an increase in underage smoking in seven of eight states that have recently raised their cigarette taxes. And in the United Kingdom, where cigarettes are twice as expensive as they are here, the smoking rate for kids is the same as ours.

To put the teen smoking problem in perspective, 44 million adult consumers are being asked to pay higher prices for a perfectly legal product because retailers sell cigarettes to 1 million kids, violating laws on the books in all 50 states. The way to keep cigarettes from kids is to enforce those laws. We should prosecute retailers who sell to minors, demand proof of age and prohibit vending machine sales where youngsters are the primary customers. Instead, our governor and our president persist in their attack on a deep-pocketed and unpopular industry — apparently unconcerned that the extraction of yet more money from smokers’ pocketbooks is plain and simple theft.

Robert A. Levy is a senior fellow in constitutional studies at the Cato Institute.