Management & Labor

Taxing Smoke and Beers

You've heard it said, no doubt, that states have been a little timid this year about raising taxes to get themselves out of economic trouble. That's true--at least for those who don't smoke or drink.
by | September 2002

You've heard it said, no doubt, that states have been a little timid this year about raising taxes to get themselves out of economic trouble. That's true--at least for those who don't smoke or drink.

While backing away from significant increases in revenue from personal income or broad-based sales taxes, legislatures have launched an assault on a single commodity that is virtually unprecedented in American fiscal history. That commodity, of course, is tobacco.

In the past year, bills to increase the cigarette tax were enacted in 20 states. But it isn't the number of cases that's remarkable--it's the magnitude of the increases. Pennsylvania tripled its tax rate, hiking the average price of a single pack to more than $5. Indiana raised its tariff on smokers nearly four-fold.

As I write this, California Democrats are maneuvering for the biggest hit of all, a law that would levy $3 in taxes on every pack sold in the state, bringing the sticker price close to $7 a pack (rivaling the price in New York City, where the local government slapped on a tax of $1.50 per pack earlier this year, matching the one the state collects).

Legislators haven't been quite so brazen when it comes to alcohol, the other prominent "sin tax" target, but they haven't left it alone, either. Tennessee raised the rate on beer, wine and distilled spirits by 10 percent across the board. Alaska enacted what became known as its "dime a drink" tax, tripling the rate on beer from 35 cents a barrel to $1.07.

Tax increases are normally considered acts of political sacrifice, but to hear many of legislators tell it, voting for these hasn't been particularly painful. In fact, it sounds more like a labor of love. "My proposal is a win-win," said California Assembly Speaker Herb Wesson, who sponsored the mega-boost on cigarettes in that state. "Either people quit smoking, which is good for everyone, or their habits help us balance their budget."

Wesson's explanation neatly sums up the dual attitude that Americans have held for more than two centuries when it comes to regulation of society's most guilt-producing forms of legal activity. There are exactly two arguments for taxing tobacco and alcohol. One is that it brings in lots of money. The other is that it can discourage people from using them. There are times when so-called "sin taxes" are treated mostly as a fiscal proposition, other times when they are portrayed largely in moral terms.

Then there are moments, perhaps including the present, when the two arguments seem to converge. In fact, however, the arguments are not entirely compatible. If a government's main goal is to make money off of tobacco and alcohol, it needs to have people drink and smoke more, not less.

In 1791, when Alexander Hamilton proposed an excise tax on the manufacture of whiskey, it wasn't because he thought farmers were drinking too much. It was to finance the commitment of the new federal government to assume the prior debts of the states. The idea of taxing liquor to raise its price, and thereby reduce consumption, didn't take hold until about half a century later, with the emergence of the temperance movement. But even as these crusaders pleaded for abstinence, the U.S. government was taxing beer at $1 a barrel to help pay for the Civil War. A sudden outbreak of abstinence would not have been in the interest of the Union forces.

Today, states all over the country are depending on revenue from the legal settlement with the tobacco companies, and on the promise of future revenue from the resulting trust fund, to help balance their budgets. The amount of that revenue, nationwide, has been estimated at about $250 billion over 25 years. But the exact take depends in part on the success of the anti-smoking campaigns that much of the money will be used to finance. Should these campaigns reform more smokers than predicted, there won't be $250 million in the trust fund.

If the states are merely using the money on anti-smoking efforts, that's not much of a problem. But if they are using it for other purposes, as many have begun doing, it could be a significant problem. State budgets could find themselves dependent on continuation of the sinful habit they are trying to eliminate.

The same logic applies, in a somewhat different way, to the current round of cigarette-tax increases. Sponsors frequently argue that the higher tax rates will balance state budgets with infusions of new revenue while saving lives by persuading people not to smoke. But it's hard to see how both of those things can happen together. The $1.7 billion that California advocates hope to realize from a $3 tax increase will be sharply reduced if the tax causes large numbers of smokers to quit.

In other words, Wesson is partly right. Whatever happens, California will benefit from the cigarette tax in some way: financially, physically or morally. But it can't benefit in all these ways at the same time.

If there's one thing that has been learned from the taxation, regulation and deregulation of sin in America is that they aren't win- win propositions. They always have unanticipated consequences, some of which are negative.

Other countries have had to deal with equally bizarre consequences, sometimes from restrictions on the use of alcohol, sometimes from loosening up.

Finland rewrote its liquor laws in 1969 to deal with a specific and supposedly well-understood problem: binge drinking. Alcohol had been difficult to obtain in Finland, especially in rural areas, and while the nation's overall rate of consumption was low, drinkers were prone to abuse it on those occasions when they could get it, leading to alarming levels of violent and self-destructive behavior. The idea behind the reforms was to make alcohol easier for people to buy at regulated outlets throughout the country, so that they would learn to drink routinely and responsibly, in the manner of French or Italians, whose consumption is high but whose rate of alcoholism is low.

After five years, the result of the experiment was indisputable. Tens of thousands of Finns had begun drinking every day, not as an alternative to bingeing but as a supplement to it. Not only did consumption of beer increase by 124 percent the first year under the new law but the number of cases of severe intoxication didn't go down- -it went up dramatically.

Scandinavia is, in fact, the world capital of creative alcohol regulation. Burdened in the 19th century by a drinking problem far more serious than one in the United States, the Nordic countries began trying virtually every possible scheme to control it. Some, like the Finnish experiment, have been disasters. Some have worked.

Norway and Finland actually instituted Prohibition in the 1920s, but abandoned it relatively quickly. Sweden narrowly voted against Prohibition, but then enacted the infamous "Bratt Liquor Control system," under which every adult was given a fixed ration of alcohol to purchase each month, and had to carry a passbook to buy it in a government store. Universally despised--and never shown to be very effective at controlling excess--the system was abandoned in 1955, and its creator, Dr. Ivan Bratt, fled to France in disgrace.

Since then, Sweden and Norway have relied on essentially the same system: extremely heavy taxation, along with stringent drunk-driving laws. The total tax take on a bottle of beer in Sweden is nearly 50 percent of the purchase price; on a bottle of vodka, it is 90 percent. The threshold for driving while impaired is a blood alcohol level of .02. That is one drink, even for a drinker the size of a football lineman.

The combination of these stringent laws appears to have worked better than any of the previous approaches; Sweden today has the lowest rate of alcohol consumption among any of the countries in western Europe, and the lowest alcohol-related death rate.

If there's one piece of policy wisdom that's hard to dispute in this area, it's that changing the tax rate does have an effect on consumption levels. It has a large effect. If any doubt remained on this point, it has been erased over the past few months in New York City.

On July 1, the new tax law went into effect there, adding $1.50 to the price of a pack of cigarettes and lifting it above $7 in most places. The first month, city dealers sold 15.6 million packs, barely half the number they had sold in July 2001. Of course, some people who stopped buying cigarettes in Manhattan were simply buying them outside the city or on the Internet, so it's premature to assume that New Yorkers are giving up the habit in droves.

Still, it's pretty clear that so steep a decline couldn't take place without some significant change in people's habits, so the tax can probably be judged an early success by one of the two standards being invoked: It is indeed discouraging smoking. Not only that, but it is bringing in money. With cigarette sales down by half, the city still took in $12 million more in the first month with the tax in place than it had been taking in before.

It's not hard to see why: The previous city tax on cigarettes was eight cents a pack; now it is $1.50. New York has proved that by raising the rate by nearly 2,000 percent, it can have a noticeable impact on the beleaguered local treasury. If it had opted for a less dramatic increase, say a mere 1,000 percent, the numbers wouldn't look nearly as good. And my guess is that they will start to go down pretty fast once more people realize they have other options besides buying cigarettes in the city for $7 a pack.

New York's experience suggests that California and other states may indeed reap a quick windfall from the huge boosts in cigarette taxes that they have enacted or are contemplating. In the long run, though, it will be playing a much trickier game.

Ultimately, there's no getting around it: Bad habits are expensive. But getting rid of them can carry problems with it as well.

Alan Ehrenhalt
Alan Ehrenhalt  |  Contributing Editor
aehrenhalt@governing.com  | 

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