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Cigarette tax increase not necessarily best

My Opinion
Larry DeBoer, Guest Writer

The Indiana General Assembly is in session, and the House has proposed a budget for the 2017-19 biennium. It includes a $1 increase in the cigarette tax, raising the rate to $1.995 per pack. It may or may not pass, the Senate may or may not agree, and the governor will have to weigh in, too. Still, there’s sure to be debate.
So, let’s look at some facts about the cigarette tax.
Indiana last increased its tax rate in 2007, when it rose from 55.5 cents per pack. Indiana’s current 99.5-cent tax rate ranks 16th lowest (36th highest) among the states and Washington, D.C. The U.S. median tax rate is $1.53, meaning half the states have higher tax rates and half lower. The Centers for Disease Control and Prevention has a nice map of state tax rates at The CDC also has a survey showing that 20.6 percent of Indiana residents are smokers. That’s 12th highest in the U.S.
At the current rate, the cigarette tax is forecast to raise $379 million in fiscal year 2018, not including the taxes on other tobacco products. The Legislative Services Agency estimated the added revenue from a $1-tax hike in its fiscal note for House Bill 1490. It projects a revenue increase of $278 million in fiscal 2018. Doubling the tax rate doesn’t double the tax revenue. That’s because the tax is passed on in higher cigarette prices, which causes people to buy less. The higher tax rate is applied to fewer packs sold, so revenue doesn’t double.
The Legislative Services Agency estimates that the tax hike would cause the number of packs sold to drop by about 11 percent. Cigarettes cost about $5.50 per pack in Indiana, with a good deal of variation. A $1 tax on $5.50 is an 18-percent increase. So, an 18-percent price increase causes an 11-percent drop in sales, or a 0.6-percent sales drop for each 1-percent price increase.
That 0.6 is the ‘demand elasticity’ for cigarettes.
There’s been a lot of research on how cigarette sales respond to price changes. One review, in the American Journal of Preventive Medicine, November 2015, put the elasticity at about 0.3 for adults and 0.4 for young people, with a big range around those numbers. The Legislative Service Agency has a bigger response for Indiana.
The tax is expected to cut sales of cigarettes by about 40 million packs. Some of the sales loss will be because people smoke less or because young people don’t start at all. Some will be because smokers cross state lines to buy at lower prices. Kentucky’s tax is only 60 cents per pack, and Ohio’s is $1.60. Perhaps that’s the reason for the Legislative Services Agency’s high Indiana elasticity. Sales drop because people quit and because they move their purchases elsewhere.
That $5.50 price includes about $2 in state and federal taxes, so the price received by sellers would be about $3.50. Those 40 million packs would mean $140 million in lost sales to Indiana retailers. That could reduce employment.
The cigarette tax is a ‘sin tax’ (known in the tax biz as a ‘sumptuary tax’), which is meant to discourage people from doing something harmful. But smoking is addictive, so plenty of people won’t quit, and they’ll pay the added tax. Taxes on consumer spending hit lower-income people hardest because they tend to spend most of their incomes. Upper-income people save more, so, relative to their incomes, taxes on spending don’t hit them as hard.
The Bureau of Labor Statistics’ consumer expenditure survey shows that people with incomes less than $40,000 spend more than 1 percent of their incomes on cigarettes. People with incomes more than $100,000 spend less than 0.3 percent. The increase in cigarette taxes will cost lower-income people a bigger share of their incomes. That’s what’s known as a ‘regressive’ tax.
There are plenty of other possible consequences from a cigarette tax hike. Health care costs would fall with fewer smoking-related diseases. That would cut Medicaid costs to the state, and insurance costs to businesses. Cigarette smuggling probably would increase, which would add to enforcement costs. If people live longer, they’ll continue to contribute to productivity.
Those are the facts. Now, let’s have a debate and decide what’s best for Indiana.
Editor’s note: Larry DeBoer is a professor of agricultural economics at Purdue University.