California’s Proposed $2 per Pack Excise Tax on Cigarettes

A bill introduced for consideration in an upcoming special session of California’s legislature proposes to add an excise tax of $2 per pack to existing state and federal excise taxes on cigarettes. Proponents estimate that the new tax (levied on distributors) will raise $1.5 billion to help pay the healthcare costs incurred by low-income Californians.

Dream on!

The so-called Save Lives California, a special-interest group whose members include the California Medical Assn., the American Cancer Society, the American Lung Assn. and the Service Employees International Union (SEIU), the last of which hardly represents disinterested publicly spirited bystanders, apparently are ignorant of the principles of public finance.

By imposing a $2 tax per pack tax on California’s cigarette distributors, its proponents seem to think that companies doing business at that (assumed) well-heeled link in the supply chain actually will bear the tax’s burden. But that conclusion is wrong as a matter of economic theory, which teaches that the burden of any tax is independent of the party required by law to remit tax receipts to the government’s coffers. Taxes rarely stick where they first land. Some of the tax burden is shifted forward to retailers (and their customers); some of it is shifted further up the supply chain, including onto the shoulders of employees and other input suppliers.

Berkeley’s selective excise tax of one cent per ounce on the distributors of sugar-sweetened beverages (SSBs) supplies a cautionary real-world example of that point. Only about 22 percent – not 100 percent – of that tax increase was passed forward to consumers in the form of higher retail prices. Why? Because consumers could buy SSBs beyond Berkley’s city limits, switch to un-taxed diet soft drinks, or take advantage of caffeinated substitutes, such as black coffee or unsweetened tea.

While it is true that few un-taxed alternatives to cigarettes are available to smokers, an observation that explains why the proposed tax bill includes electronic cigarettes in the tax base, it also is true that a high tax rate on any good or service supplies incentives leading to the emergence of illegal or underground markets for the taxable item. New York City imposes the nation’s highest selective tax rate on cigarettes. Nearly two-thirds of the cigarettes consumed there either display tax stamps from lower-tax jurisdictions like Virginia or carry no tax stamps at all. Cross-border shopping and smuggling become more enticing the higher is the tax rate.

Cigarette consumption has been declining steadily in the United States since the early 1960s, when the Surgeon General first published medical evidence linking smoking to lung disease. As a matter of fact, cigarettes have been called “coffin nails” since the late 19th century. Revenues generated by the federal excise tax are falling. So, if California’s government thinks it is preventing tobacco-related healthcare issues, its policy proposal is anachronistic at best.

The most likely outcome of California’s tax proposal is that cigarette tax revenue will remain flat or begin to slide. So, what will be the next target of California’s seemingly insatiable demand for additional receipts for financing its expansive spending programs? I leave answers to that question to the creativity of interest groups who will bring pressure to bear on their political representatives.