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Snloklnb Be111V1or and Policy Conference Series ' The Cigarette Excise Tax Apri ; l 17) 1985 I -1 _ .. . __- Institute for the Study of Smoking Behavior and Policy F tarvard University John F. Kennedy School of Government 79 John F. Kennedy Street Cambridge, Massachusetts 02138 Z H

45 i Foreword ~ In 1983 the federal excise tax on cigarettes jumped from eight to 16 cents I{ per pack. lt had been level at eight since 1951, when the price of a packet of { cigarettes was 19 cents and the tax was 42 percent of that price. By 1982 the price had risen to 75 cents and the tax was down to barely 11 percent of the . price. Over the 32 year period the consumer price index had nearly ! quadrupled. Doubling the tax in 1983 put its real value adjusted for inflation at about half its real value of 1951, and made the tax equal to 18 percent of the 1983 price of 90 cents per pack. The legislation that raised the tax provided for a return to cight cents on October 1, 1985. There are strong signs of Congressional interest in new legislation that would retain the 16 cent tax or even raise it. The motives are several. An obvious one is revenue; the tax generates about $2.4 billion and in the forthcoming years of high deficits, while $2.4 billion isii t much, every bit helps. A second motive, evidenced in sonie of the proposals to earmark part or all of the tax for Medicaid, is to let smokers pay for some of the extra medical costs that their smoking inflicts ou the non-smoking taxpayers and on non-smoking enrollees in health insurance whose premiums usually must cover the extra costs incurred by smokers. And a third motive, increasingly voiced, is the hope that by raising the price of cigarettes a higher tax may induce smokers to smoke less or, better still, induce smokers to quit and non-smokers not to take tup the habit. The timeliness of the issue-the deadline for preventing a 50 percent tax cut being October 1st this year-prompted the Institute for the Study of Smoking 13ehavior and Policy at Harvard's Kennedy Sclwol of Govern- ment to sponsor a conference in Washington last April. It brouglit togrthrr people knowledgeable on excise taxation in general and people knowl- edgeable about cigarettes and smoking. Because cigarette taxation is impor- tant to many state governments, one participant represented that interest. Who Pays? One of the first questions to ask about any excise tax is, Who pays it? A possible answer-namely, the people who smoke cigarettes-might appear too trivial to get us very far. It is not trivial. It may not even be true. In a literal sense the tax is paid by the manufacturer; the "incidence," as econo- mists call it-the actual cost-may fall forward on the consumers of cigarettes or backward on the suppliers of tobacco, or on wages or profit witltin tile manttfacturing companies. In the conference it was generally expected that the effect of the tax would be a corresponding increase in the price of cigarettes. i

s 3 If it is, then while it is obvious that the burden of the tax must fall on rhose who smoke cigarettes and their families, the answer is still not %"acuous because it implies that the tax falls on people who by their 1n1oking may incur medical costs at public expense. This is of interest in the same way that it is of interest that a gasoline tax falls on people who wear out the roads. With most excise taxes the single most important issue in who pays it is tairness. Doc, rhe tax fall equally on rich and poor alike? Does it fall on rich and poor in proportion to their incomes? Does it fall mainly on the rich, or mainly on the poor? There is.a related interest in whether it bears especially "u the elderly, on certain minorities, or on some other population category. Necessity or Luxury? Sometimes another question is asked: is the taxed commodity a luxury or a necessity? By the most common definition a necessity is something that people have extreme difficulty doing without; a luxury is something that they can take or leave. Cigarettes are a paradoxical commodity: they are generally considered not to meet any fundamental need the way food, clothing, shelter, and medical care (to, yet for people who smoke, cigarettes are extraordinarily difficult to give up. There is an irreversibility here. Until one takes up smoking there is no "need," but when one has become a regular smoker it is remarkably difficult to quit. (According to a 1980 survey, more than a third of all smokers had attempted-tmsuccessfully- to) quit during the preceding 12 months; the figure was more than 50 percent for young smokers, aged 21 to 24, both sexes.) The popular notion has always been that it is less fair to tax necessities than to tax luxuries, the idea being that with the luxury one has a choice whether or not to consume the item and pay the tax. Economists have usually taken a different view. They note that two things happen when a commodity is taxed; people both pay the tax on what they continue to r0nsume of the item, and may also reduce the amount they consume or even avoid the tax altogether by giving up that particular item of consumption. Two Burdens Economists point out that there are two "burdens" of taxation here, the financial burden of paying the tax on what one continues to consume, and the burden of escaping the tax by doing without something that one would have preferred to continue consuming. The first of these burdens, the tax actually paid, shows up in the Treasury's revenues; the second burden has been called the "deadweight loss," it being a burden on the consumer but yielding nothing to the Treasury. Economists usually prefer y to tax the items that will generate the least deadweight loss, and to pick ~ items to tax according to the kinds of people-usually measured by their inconus-who consume the item. And this means preferring to tax the i things that people will continue to consume. Here again, cigarettes are different. The "burden" of giving up ciga-; rettes is likely to be of short duration-weeks, months, years perhaps for a~ few-and then the burdens turn into benefits. Most people in this cormtry , who smoke wish they didn't. People who have quit are glad they did. Furthermore, there is probably not much of a "burden" for the people who might become smokers but do not, perhaps because of the higher price of cigarettes. People who simply forgo ever consuming a taxed item because the tax makes the price too high are forgoing an opportunity in a way that yields the Treasury nothing; but if they forgo experimenting with a substance that for many becomes an addiction, the benefit is a lifetime of freedom from smoking. The Poor, The Young, and Other Issues Consumer budget data indicate conclusively that the poor spend a higher proportion of their incomes on cigarettes than people in middle or high income brackets, appreciably more. As a tax, then, the cigarette tax is what economists call "regressive:' But the tax also appears to discourage smoking, and some data indicate that the tax discourages smoking among the poor more than among the well-to-do. The benefits to those who quit, or who are less likely to take up smoking because of the higher tax, can be measured actuarially as several years of added life expectancy. For someone who smokes a pack a day, an eight cent tax increase or decrease amounts to $30 a year. (Those who quit, or avoid taking it up, save $365 per year. ) Two facts deserve emphasis at this point. One is that nearly everybody in the United States who takes up smoking does so at an early age. Nearly all regular smokers became regular smokers by age 21 or 22, most of them several years before that. 'rhe second fact has already been mentioned- half of all young smokers, in any year, seriously try to quit and can't. Tltr sitrgle fttost iiitportrtttt Jittdirtq reported itt tlie cotijerettce pmceedin~s tlieit joNt~u, ntay be this: thegreatest iinrcut r~Jcii~~tretteErrices, and hence ciy~tre~tte t~r~-es, oft smokiny belmarior appears to be on the ynmrgrst qW yrortps. Some other issues deserve attention. An important one is that a large number of young American men, at precisely the age when they may become regular smokers,.are offered tax-free cigarettes at Post Exchange prices on military bases in this country, abroad and on ships at sea. This is a fringe benefit that invites reexanunation. tn

0 ' a 4 Numerous other important topics also deserve attention: Should ciga- rettes be taxed according to their tar and nicotine content? Should tobacco products other than cigarettes, including snuff and chewing tobacco be (axed? Should the proceeds from the cigarette tax be earmarked for a variety of purposes ranging from health education to medical care? What are the likely responses of state cigarette taxes to changes in the federal tax? "hould cigarette taxes be indexed to the consumer price level in the event Of further inflation? All these are important questions. Some of these yuestiotu received attention at the conference; sonie did not. Quite deliberately, I have avoided stating a conclusion or making a recotnmendation in this brief preface. The conference was not convened no promote a tax increase, a tax reduction, or the maintenance of the current tax. If there was a consensus it probably emerges from the discus- •ion reported here; no consensus was made explicit. In any event, legisla- rurs will make up their own minds, no matter what we might recommend. I'he purpose of the conference was to make the best analysis and the best t:actual data that we could discover available to people who must decide. We hope that what is published here will be helpful in that spirit. The conference itself was a lively one. Acknowledgements This conference is the first of a continuing series of conferences intended to examine issues in public policy and behavioral research related to cigarette smoking. The series is sponsored by the Institute for the Study of Smoking Behavior and Policy, a research center dedicated to examining and enhancing the conceptual, analytical and practical linkages between smoking behavior research and policy at all levels. The Institute was established at the John F. Kennedy School of Govern- ment, Harvard University, in April 1984, with the support of the Carnegie Corporation of New York. We are greatly indebted to the Cabot Family Charitable Trust for its support of the overall series and to the Alfred P. Sloan Foundation for providing the funds for this inaugural conference. Tltontas C. Schelling Director The Institnte jor the Study oJSonoking Behavior and Policy John F. Kennedy School oJGoverrnnent Harvnrd Uaiversity v iv

Participants i Robert Batties Senior Program Specialist Office of the Assistant Secretary of Defense (Ilealth Affairs) Washington, DC Frank Cantrel Tax Counsel Senate Finance Committee Washington, DC Philip J. Cook Professor of Public Policy Studies Institute of Policy Sciences and Public Affairs Duke University Durham, NC William Drayton Environmental Safety Washington, DC Ervin S. Duggan Ervin S. Duggan Associates Washington, DC E. Ripley Forbes Special Assistant Subcommittee on Health and the Environment I-louse Energy and Commerce Committee United States Congress Washington, DC Harvey Galper Senior Fellow Brookings Institution Washington, DC Geraldine Gerardi Financial Economist Office of Tax Analysis United States Department of the Treasury Washington, DC Dean Gerstein Study Director Committee on Basic Research in the ' Behavioral and Social Sciences Commission on the Behavioral and Social Sciences antl Education National Research Council Washington, DC Jeffrey Harris, M.D. Associate Professor of Economics Massachusetts Institute of Technology Cambridge, MA Grady Hedgespeth Bureau Chief for Analysis Estimation and Research Massachusetts Department of Revenue Boston, MA Jan L. Hitchcock Research Associate Institute for the Study of Smoking Behavior and Policy Harvard University Cambridge, MA Celia Jaffe Research Assistant Institute for the Study of Smoking Behavior and Policy Harvard University Cambridge, MA Karl Kronebusch Office of Technology Assessment United States Congress Washington, DC Eugene Lewit [)irector of Research and Evaluation New f ersey Medical School Newark, NJ Matthew Myers Staff Director Coalition on Smoking or I lealth Washington, t)C vii

t s s . ? Joseph Pechman Michael A. Stoto Contents 5enior Fellow in Economics Associate Professor of Public Policy lirookings Institution John F. Kennedy School of Foreword ..............................................i Washington, DC Government Harvard University John M. Pinney ..v . . . ements Acknowled Cambridge MA ... .. .. g ......................... Executive Director , Institute for the Stud of Smoking David Sundwall M D. y tiehavior and Policy . , Chief of Staff Participants .......................................... vii I larvard University Senate Health Committee C,uubridge, MA United States Congress Guide to Contents ..................................... xi Washington DC Albert Rees , 1'rrsident Eric Toder One: Commissioned Papers .............................. 1 Alfred P. Sloan Foundation Deputy Assistant Director Excerpts frotn: New York NY Tax Analysis Division , by Eric J. Toder ................ 3 Issues in the Taxation of Cigarettes Congressional Budget Office , Thomas C. Schelling United States Congress Consumption Impacts oja Charkye in the Federal Ciqarette Littauer Professor of Lucius N . Washington DC by Kenneth E. Warner ......................... 16 Excise Tax Political Economy; and Director , , Institute for the Study of Smoking Kenneth E. Warner Behavior and Policy Professor and Chairman Two: The Morning Discussion ........................... 25 Harvard University Department of Health Planning and Cambridge, MA Administration Three: The Afternoon Discussion ........... . . . . . . . . . . . . . 45 Arthur N. Singleton School of Public Health ~ University of Michi an Minorit Chief of Staff g 63 y Ann Arbor MI Appendix ............................................ Committee on Ways and Means , by Eric J. Toder ............... 65 Issnes in the Taxation of Cigarettes United States Congress , Washington, DC Corunmption Inipacts of a Change in the Federal Cigarette Excise Tax, by Kenneth E. Warner ......................... 88 On the Fairness ojCigarette Exicse Taxation, by Jeffrey E. Harris ....1U6 ~;; ix

Dt Guide to Contents Administrative issues, 30, 79-83 Bootlegging: see State taxes Consumption by age, sex, race, income, 29, 35, 76-79 (including Tables 7 and 8), 95 (Table 3), 106-108 (in- cluding Tables I and 2) in response to prices, 29, 32-36, 39 48-50, 72-76, 88-105 Deaths: see Health effects DemanJ: see Consumption Elasticityofdemand:seeConsumption I lealth effects of smoking, 37, 39-40, 42-43, 98-99 Incidence of tax by income, age, race, sex: see Taxes, incidence by income, age, race, sex Lobbies, 53-54 Military services policies, 55-60 tax exemption, 30, 55-57 Nicotine and smoking behavior, 33, 38-39 Prices and consumption: see Consumption recent trends, 36, 70-73 (including Tables 3-5), 90 in response to taxes, 36, 47-48, 93 ~ ltegressivity, 29, 40-43, 76-79 (in- ,' T__( cluding Tables 7 and 8), 84, 106- N 110 , Z Smoking Practices nicotine compensation, 38-39 economizing, 33-34, 48-50 quitting, 37-38, 50 see also: Consumption Smuggling: see State taxes State taxes rates and revenues, 27-29, 66-73 . (including Tables 2, 4, 5, and 6) military exemptions: see Military services interstate smuggling, 30, 55-57, 74-75 relation to federal tax, 31, 36-37, 82-83 Taxes recent trends, 27-28, 66-72 (in- cluding Tables 1, 3, and 5) effect on prices: see Prices current proposals, 51-52 revenues, 27, 67 (Table 1) earmarking,_51-53 incidence by age, income, race, sex, 76-79 (including Tables 7 and 8), 109, (including Tables 3 and 4) Teenagers, 32-33, 35, 39-40, 50, 75-76, 84, 92, 94-98, 100 xl

One Commissioned Papers Participants in the Conference on the Cigarette Excise Tax based their discussion largely on two papers which they had read before the confer- ence-one by Eric Toder of the Congressional Budget Office and one by Kenneth E. Warner of the University of Michigan School of Public Health. This section contains excerpts from those two papers. Their complete texts are published in the Appendix. N 1

. )k Issues in the Taxation of Cigarettes Eric J. Toder Deputy Assistant Director, 7ia.Y Analysis Division, Con,yrrssiottal l3ttdget C)Jf ice .-1 ciVu•ette is the perJrct type of perfect pleasnre. It is e.rqttisite, and it leares oltr tntsatisJied. I l7tat tttorr can one uyattt? -Oscar Wilde, The Picnirr of Doriatt Gray (1891), Chapter 6. I I4trttitr~: The Strryeott Cctteral has rleterrttitted that citarettc sntvkiuq is daqerons to yottr health. -Required statement on package of cigarettes. Introduction ... This paper reviews briefly some of the major tax policy concerns relating to cigarette taxation. Following a review of data on postwar trends in the burden of cigarette taxation in the United States, the paper briefly discusses and evaluates econometric research on the effect of ciga- rette excise taxes on cigarette consumption and reviews evidence on the incidence of cigarette taxes. The final sections of the paper review tax adininistration and enforcement concerns and issues in determining the best level of government at which to impose the tax. Recent Trends in Cigarette Taxation Cigarette excise taxes have been a declining share of both Federal and state excise tax revenues during the postwar period, despite numerous increases in state excise tax rates. Table 1 shows that Federal receipts from cigarette taxation increased in absolute terms from $1.2 billion in fiscal year 1950 to $2.5 billion in 1982, but declined as a share of total revenue from 3.2 percent to 0.4 percent and as a share of the Gross National Product from 0.5 percent to less than 0.1 percent. As a result of the tax increase in Tax Equity and Fiscal ResponsibiliEy Act of 1982, Federal receipts from ciga- rette excise taxes nearly doubled to $4.7 billion in fiscal year 1984, about 0.7 percent of Federal revenues and slightly over 0.1 percent of GNR Federal cigarette excise tax receipts as a share of total revenue and GNP remain below the 1950 level in every year between 1950 and 1975. Table 2 shows that statc cigarette excise tax receipts have grown at a 3 H

I'able 1. Federal *Tax Collections on Cigarettes, Fiscal Years Table 2. State Tax Collections on Cigarettes, Fiscal Years 1950-1984 00 1950-1984 M I Ar igarette Tax Revenues IS millions) . Total Federal Rrvenue (S billions) NP (S billions) Cigarette Tax Revenues as Percent of Total Revenue Cigarette Tax Revenues as Percent of GNP 1,242.8 39.4 265.1 3.15 0.47 1,294.0 51.6 312.8 2.51 0.41 1,474.1 66.2 339.3 2.23 0.43 1,586.8 69.6 361.3 2.28 , 0.44 +i1 1,513.7 69.7 364.2 2.17 0.42 : >;5 1,5(A/.2 65.5 380.6 2.30 0.40 1'66 1,549.0 74.6 411.8 2.08 0.38 1''37 1,610.9 80.0 433.9 2.01 0.37 1''5,i 1,668.2 79.6 443.1 2.10 0.38 1•'i') 1,771.1 79.2 474.4 2.24 0.37 I"IbQ 1,863.6 92.5 497.9 2.01 0.37 I'M 1,923.5 94.4 509.3 2.04 0.38 I'+62 1,956.5 99.7 548.2 1.96 0.36 1963 2,010.5 106.6 578.0 1.89 0.35 1964 1,976.7 112.6 618.2 1.76 0.32 1't65 2,069.7 116.8 659.5 1.77 0.31 I'K>6 2,006.5 130.8 724.1 1.53 0.28 067 2,023.1 148.8 777.3 1.36 0.26 1968 2,066.2 153.0 831.3 1.35 0.25 1')69 2,082.1 186.9 910.6 1.11 0.23 1970 2,036.1 192.8 968.8 1.06 0.21 1971 2,149.5 187.1 1,031.5 1.15 0.21 1')72 2,151.2 207.3 1,128.8 1.04 0.19 1973 2,221.0 230.8 1,252.0 0.96 0.18 1974 2,383.0 263.2 1,379.4 0.91 0.17 1975 2,261.1 279.1 1,479.9 0.81 0.15 1'+76 2,434.8 379.3 2,072.3 0.64 0.12 1977 2,279.2 355.6 1,862.8 0.64 0.12 1'l78 2,374.1 399.7 2,091.3 0.59 0.11 1't79 2,356.1 463.3 2,357.7 0.51 0.10 1980 2,604.4 517.1 2,575.8 0.50 0.10 1981 2,488.2 599.3 2,885.9 0.42 0.0') Nti2 2,496.1 617.8 3,046.0 0.40 0.08 1983 3,4214.4 600.6 3,221.4 0.57 0.11 1984 4,7-19.2 666.5 3,581.1 0.71 0.13 luurcc: The Tobacco Institute, The Tiur Qordru on Tobacco-Historiral Contpi/atiar, vol. 19, 1984, p. 8; Econoniic Repart oJthc President, Washington, D.C., 1985, p. 242; Advisory Contntission on p. 5; Economic Rr port of the President, Washington, D.C., 1985, pp. 242 anJ 318. Intergovernmental Relations, Si,qniJicant Fearnms oJFiscrrl Federalism. 1982-83 Edition, Washington, D.C., January 1984, p. 32. u s c crccnt R P 5tatr as Cigaretteevcn Tax Revenues Revenue GNP of Total as Percent Year (S millions) (S billions) (t billions) Revenue of GNP 1950 413.7 7.9 265.1 5.22 0.16 1951 444.4 8.9 312.8 4.97 0.14 1952 460.3 9!) 339.3 4.67 0.14 1953 477.2 10.6 361.3 4.52 0.13 1954 469.7 11.1 364.2 4.24 0.13 1955 470.2 11.6 380.6 4.05 0.12 1956 532.3 13.4 411.8 3.98 0.13 1957 581.1 14.5 433.9 4.00 0.13 1958 626.8 14.9 443.1 4.20 0.14 1959 706.6 15.8 474.4 4.46 0.15 1960 929.9 18.0 497.9 5.16 0.1') 1961 995.1 19.1 509.3 5.22 t1.=•) 1962 1,085.6 20.6 548.2 5.28 0.'1t 1963 1,132.8 22.1 578.0 5.12 0._U 1964 1,212.3 24.2 618.2 5.1N1 0._'tt 1965 1,327.1 26.1 659.5 5.08 0.20 1966 1,566.6 29.4 724.1 5.33 0.22 1967 1,643.0 31.9 777.3 5.14 0.21 1968 1,915.8 36.4 831.3 5.26 0.23 1969 2,101.8 41.9 910.6 5.01 0.23 1970 2,368.1 48.0 968.8 3.9•1 0.24 1971 2,594.6 51.5 1,031.5 5.03 0.25 1972 2,904.4 59.9 1,128.8 4.85 0.26 1973 3,092.8 68.1 1,252.1) 4.54 0.25 1974 3,225.2 74.2 1,379.4 4.35 0.23 1975 3,284.7 80.2 1,479.9 4.10 0.22 1976 3,4289 89.3 2,072.3 3.84 0.17 1977 3,483.3 101.1 1,862.8 3.45 0.19 1978 3,632.7 113.3 2,091.3 3.21 0.17 1979 3,621.6 124.9 2,357.7 2.90 0.15 1980 3,714.4 137.1 2,575.8 2.71 0.14 1')81 3,850.6 149.7 2,885.9 2.57 0.13 1982 3,922.2 162.7 3,046.0 2.41 0.13 1983 4,117.8 171.0 3,221.4 2.41 0.13 1984 4,233.0 N.A. 3,581.1 N.A. 0.12 Source: The Tobacco lnstitute, The Tav Bnrdrn on Ti~bacco-llistorical CumpiLttiom, vol. 19, 1984, cax N venucs T R 7otal ~ Cigarette i rax ..Igarcuc c .I . 5