California Set a Tax Trap for Both Smokers and Quitters

The one initiative which succeeded, in California, will more than triple the state’s current tobacco tax, from 87 cents per pack to $2.87 per pack.

Election day not only brought America a new president, but also voter decisions on a variety of state policies. Specifically, voters largely rejected increases in state tobacco taxes. Of four tobacco tax increase initiatives on the ballot last week—in California, Colorado, Missouri, and North Dakota—all but the initiative in California failed. Golden State voters may come to regret their decision.

E-cigarettes are about 95 percent safer for the user than traditional cigarettes.

As I wrote in Forbes recently, tobacco taxes constitute an unreliable source of revenue. Taxes with broad bases—those which are levied on a wide variety of economic transactions—are the most efficient. Taxes with narrow bases—those which are levied on a specific product, such as cigarettes—are less efficient, as they will nudge cause consumers to buy other products instead and reduce the revenue intake from the tax.

In the case of tobacco taxes, a narrow base makes sense—the government has an interest in deterring people from smoking. Nudging consumers to buy goods other than cigarettes is a feature, not a bug. But this phenomenon also means that if the tax serves its intended purpose, it will not raise as much revenue as anticipated. If fewer people smoke, fewer people will pay tobacco taxes.

The tobacco tax increases on the ballot last week were earmarked for specific projects. Given that tobacco taxes are by construction an unreliable source of revenue, the funding for those projects would have been unreliable. When states pass tobacco tax increases, it would be better to simply direct the funds into general revenues rather than use them to support specific programs.

Voters across most of the country appeared to recognize this, or at least were skeptical of any kind of tax increase. The initiative in North Dakota would have quintupled the state’s tobacco tax, while the taxes in Missouri and Colorado would have doubled and tripled, respectively.

California's Dubious Decision

The one initiative which succeeded, in California, will more than triple the state’s current tobacco tax, from 87 cents per pack to $2.87 per pack. The funds are earmarked for a variety of programs, including tobacco prevention initiatives, early childhood development, physician training at the University of California system, and public health programs.

California wants its tobacco tax to be a lucrative source of revenue, but economics gets in the way.

Quizzically, the initiative both increased cigarette taxes and also implemented equivalent taxes on e-cigarettes, which are not tobacco products but do contain nicotine. According to the Royal College of Physicians, e-cigarettes are about 95 percent safer for the user than traditional cigarettes.

The rationale for increasing California’s tobacco tax thus stands on thin ice. If the tax is intended to reduce smoking rates, its success is dubious—the tax increase on e-cigarettes will neutralize one of the most promising avenues available to help smokers quit. But even if the tax succeeds in driving people away from nicotine products entirely, California will be stuck with the unreliable revenue problem. A tax with a narrow base will not raise as much revenue as anticipated due to people shifting their consumption habits elsewhere.

The only sensible interpretation of California’s ballot initiative is a highly cynical one: California wants its tobacco tax to be a lucrative source of revenue, but economics gets in the way. Policymakers are therefore willing to trap smokers into their bad habits by instituting similar taxes on safer alternatives to tobacco such as e-cigarettes.

This is irresponsible. States should pursue broad-based taxes to raise revenue, and only use narrow-based taxes to achieve specific social ends, such as reducing cigarette use. California hardly needs the money—it ran a $4.9 billion surplus in the 2015 fiscal year, and Governor Jerry Brown signed a $167 billion budget into law earlier this year without making any cuts. The long term is a different story—the state has hefty pension liabilities that appear to grow by the day—but a revenue source as unreliable as tobacco taxes would hardly put a dent in that problem.

Poor tax policy is not unique to California, and the tobacco tax increase may come to be repealed. But in three out of four states, at least, the voters appear to be smarter than the politicians.

Republished from Economics 21.

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