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This piece orginially appeared as a March 2005 publication from the Washington Policy Center.
A trend has become apparent over the past several years. As state governments impose higher tobacco taxes on cigarettes, the resulting revenue streams have grossly underperformed expectations. Such is the case for Washington and raising tobacco taxes even higher could exacerbate the situation.
In 2001, voters passed Initiative 773, which imposed a new cigarette tax of 60 cents per pack, thus increasing the overall cigarette tax from 82.5 cents to $1.425. The $1.425 state excise tax is now one of the highest in the nation (and this does not include the federal excise tax and state and local sales taxes).
There comes a point when taxes on a product will eventually stunt the overall volume of sales – therefore negating a once-promised high source of revenue. The evidence suggests this has been happening with cigarettes for quite some time.
In fact, many people actually do not pay the average $1.425 tax per pack on cigarettes in Washington—they find ways around it. The Department of Revenue estimates that Washington state loses approximately $220 million in cigarette tax revenues each year through semi-illicit or downright illegal means.
Cigarette Tax Breakdown
State General Fund - 23 cents
Water Quality Account - 8 cents
Violence Reduction/Drug Enforcement - 10.5 cents
Health Services Account - 41 cents
Initiative 773 Health Services Account - 60 cents
Federal Excise Tax - 39 cents
Total Taxes per pack = $1.815
Washington's $1.815 of taxes per pack includes the federal excise tax but not the state and local sales taxes and ranks as one of the higher tobacco taxes in the nation and means the average cost of a pack of cigarettes is now just over $5.
Consumers who want to skirt around these high tobacco taxes usually do one of four things to procure cheaper goods:
1) Cross state lines – In Washington, the average price for a pack of cigarettes is about $1.00 per pack higher than neighboring states. Across the border in Idaho the average cost for a pack of cigarettes is $3.71 and in Oregon it’s $4.14.
2) Purchase cigarettes on Indian reservation lands where taxes (and therefore prices) are greatly reduced
3) Purchase cigarettes over the Internet to avoid excise taxes, or
4) Purchase cigarettes through the black market or through smuggling.
These are just a few reasons why, though cigarette excise taxes have increased greatly over the past decade, revenue projections from these taxes very rarely meet or exceed expectations.
In 2002, Washington’s volume of legal cigarette sales declined by 11%. Several other states that increased cigarette excise taxes in 2001 also saw significant dropoffs in overall legal sales of cigarettes. Illinois dropped off by 28%, Kansas by 22% and Oregon by 7%.
Initiative 773, which raised cigarette excise taxes by 60 cents per pack in 2001, promised higher tax revenue, but actual collections are $2.5 million less than expected. What is more alarming is that in 2002 and 2005 projected revenue vs. actual revenue greatly overestimated revenue collections and in 2003 and 2004 underestimated collections (after four years, however, actual collections are still $2.5 million short of projections).
Essentially, not only are the cigarette tax revenues underperforming but they are also extremely volatile—a very unstable source of revenue. Cigarette sales have been declining about 1-2% each year in the U.S. and further attempts to raise excise taxes result in consumers seeking alternative sources for cigarettes or diminish the volume of product purchased.
The declining volume sales of cigarettes stunt the ability for tax revenue to grow. Unfortunately, the cost for the programs the tax revenue funds, such as Medicaid and public health care, expand exponentially each year.
Each time another cigarette excise tax is levied we face the problem of a diminishing return. Now that consumers pay nearly half of the $5 for a pack of cigarettes in taxes, many will think twice about purchasing a pack legitimately or at all—which could be argued as a step toward overall healthiness—but also wreaks havoc on state budget writers and lawmakers.
Legislators should think twice before patching every budget hole by jumping onto the back of tobacco users. It's risky, unstable and sure to disappoint.