Unforeseen Consequences of Cigarette Tax Increases

Cigarette tax increases are often politically palatable because of the product’s harmful nature, but perhaps the recent $0.62 increase in federal taxes is approaching a level that many people feel is inappropriate. Like other sin taxes, those levied on cigarettes are designed both to raise revenue and to discourage people from smoking. However, the first objective may be more and more difficult to achieve as people quit smoking because of the higher cost or find ways to avoid the tax.

A CNN reporter spoke with Denver, Colorado customers to gauge their reactions to the tax increase. Resident Larry Juke pointed out the regressive nature of such taxes, particularly relevant for a tax increase during a deep economic recession:

“They’re picking on us poor people, the ones that smoke,” Jukes, a 65-year-old who has been smoking since he was a teen, said of the government. “They have been for years.”

Since the most recent increase in federal taxes, Tobacco Haven in Brookline, New Hampshire, has come under scrutiny for a machine it owns that allows customers to make their own cigarettes with a variety of different types of tobacco. The machine is both a novelty and a way for customers to avoid some of the taxes on pre-made cigarettes without having to roll their own. An All Things Considered story explains:

Smokers in a New Hampshire tobacco shop have been lining up to use a commercial roll-your-own machine. The contraption spits out hundreds of cigarettes — for less than half the price of brand names.

But state officials want to pull the plug. They say the shop is now a cigarette manufacturer and can no longer sidestep what it owes the government.

Cigarette taxes are an especially important issue for New Hampshire because many of their sales are to customers who come in from Massachusetts or Maine to avoid the even higher taxes in their own states. A state policy blog explains:

Cigarettes are a higher-margin item and out-of-state customers typically buy other goods as well. For small stores struggling in a difficult economic environment, driving away any customers is a problem. A significant loss in a higher-margin item could make the difference between survival and closing up shop.

As tax increases urge consumers the alter their behavior more and more, customers and retailers grow more willing to resort to illegal behavior to purchase cheaper cigarettes, such as purchasing them online or from stores that do not pay the taxes. A Chicago Tribune article reports:

75 percent of cigarettes smoked in Chicago come from packs that don’t bear city tax stamps. The rate of tax avoidance here dwarfs the national average of about 20 percent, he said. In New York City — the only place in the country where cigarette taxes are higher — the avoidance rate is about 50 percent, he said, still sharply lower than Chicago’s.

Policy makers should keep in mind that as cigarette taxes continue to increase, higher revenue will not indefinitely.

Furthermore, as customers alter their behavior more and more as a result of the tax, the associated deadweight loss will increase correspondingly.