Smoking and Drinking: Remedies for State Budgets?
“Sin taxes” are often viewed as budget savers, despite their rather small role in the state budgets. In fiscal year 2016, states raised $25 billion in tax revenues from the two most commonly taxed so called “sins,” like tobacco and alcohol, which represented slightly over 2.7 percent of total state tax revenues. States are more likely to raise taxes on tobacco products than on alcohol, even though both pose a significant public health threat. Since 2000, 48 states increased cigarette tax rates about 130 times, while very few states increased tax rates on alcohol. Despite the increases in tax rates on tobacco, inflation-adjusted tobacco tax revenues declined by 0.8 percent between fiscal years 2008 and 2016. The opposite is true for alcohol taxes. Despite the relatively stable tax rates on alcoholic beverages, inflation-adjusted alcohol tax revenues grew by 12.2 percent over the same period. Tobacco tax revenues declined because declines in consumption more than made up for higher tax rates. The growth in alcohol tax revenues is largely attributable to growth in alcohol consumption.
About the Author
Lucy Dadayan is a senior researcher at the Rockefeller Institute of Government. She has conducted research and coauthored reports on state and local government fiscal policy issues; state spending on public policy programs and the effects of state fiscal capacity and economic changes; among other topics. Dadayan holds a Ph.D. in Informatics from the State University of New York.
“Sin taxes” are taxes on products or services that are perceived as undesirable or harmful. “Sin taxes” traditionally have been limited to alcohol, tobacco and gambling. However, the spectrum of “sin taxes” have expanded in the past decade. Depending on the state and locality, these taxes are also levied on products such as marijuana, e-cigarettes, sugary soft drinks, and fatty snacks, among others.1
Governments impose “sin taxes” both to reduce unfavorable behavior and to generate more tax revenues.2 Imposition of these taxes creates a juxtaposition of competing political and economic interests: reduction of undesirable consumer behavior and growth in state tax revenues. Public policy debates surrounding “sin taxes” are at the crossroads of a troubling ethical issue: the dependence on “sin tax” revenues to finance important public programs and services creates a conflict of interest between the need to protect citizens’ health and the need to continue selling associated products and services. In effect, the government “may itself become the sinner—seeking to maximize its revenue at the expense of its citizens’ health.”3 Most economists argue that “sin taxes” are regressive in nature, as they put a disproportionate tax burden on lower-income consumers.4In some eyes, the introduction and imposition of these taxes, “even those passed with the best of intentions, have undesirable consequences because they contradict basic principles of economics, finance and, most importantly, free choice.”5
This article reviews tax rates and tax revenue trends for two major “sins”: tobacco and alcohol, both of which have a long history dating back to 18th century. In 1776, Adam Smith, the father of modern economics entertained the idea of tobacco taxation: “Sugar, rum, and tobacco are commodities which are nowhere necessaries of life, which are become objects of almost universal consumption, and which are therefore extremely proper subjects of taxation.”6
Despite numerous tax-rate increases on cigarettes and other tobacco products, revenues from tobacco taxes grew for only a few years after tax increases associated with the Great Recession, and have declined in recent years. States have been more reluctant to raise tax rates on alcoholic beverages. However, alcohol tax revenues have grown continuously and strongly in recent years. The most compelling lesson from these trends is that because taxes on tobacco and alcohol are based on the quantity of goods sold rather than on their value, without regular tax rate increases and without growth in consumption, revenues from tobacco and alcohol are doomed to decline. When states opt to increase tax rates on tobacco or alcohol, it often leads to reduction in consumption as some consumers either quit or reduce their intake of cigarettes and alcohol. In addition, tax rate increases on these products may also lead to shifts in consumer behavior and consumption of alternative products.
Tobacco: Tax Rates and Tax Revenue Trends
Tobacco Tax Rates
States levy tax on cigarettes as well as other tobacco products. In addition, some local governments in six states—Alabama, Illinois, Missouri, New York, Tennessee and Virginia–also levy tax on cigarettes. As of January 2017, state cigarette excise tax rates per pack ranged from a low $0.17 in Missouri to a high $4.35 in New York (see Figure A). The state cigarette excise tax rate in a median state is $1.57 per pack. States in the Northeast have higher cigarette tax rates while states in the South have lower cigarette tax rates. The highest local government tax rates on a pack of cigarettes are $4.18 in Chicago and $1.50 in New York City. In addition to state and local taxes, the federal government also levies tax on cigarettes, which is currently $1.01 per pack.
During economic downturns, states often raise taxes on cigarettes in the hopes of generating more revenues. Since 2000, 48 states have increased cigarette tax rates about 130 times. The only two states that have not increased cigarette tax rates in 17 years (since 2000 or earlier), are Missouri and North Dakota. Seven states—Connecticut, Hawaii, Minnesota, New Hampshire, New Jersey, Rhode Island and Vermont—increased taxes on cigarettes at least five times since 2000.
Figure B shows the number of states that raised cigarette tax rates by year. Despite the slow and prolonged recovery of overall state tax revenues in the aftermath of the Great Recession, surprisingly not many states turned to cigarettes. Fewer states raised taxes on cigarettes in response to the 2007 recession than did so in response to the much milder 2001 recession. In general, states have been reluctant to raise broad-based taxes as well as cigarette taxes for many years. States have reduced reliance on tax increases and have been taking other measures to close budget gaps.7 Continued fiscal challenges, however, did prompt 10 states to raise taxes on cigarettes in fiscal year 2016. As of January 2017, another five states also raised taxes on cigarettes, with California having the largest tax rate increase of $2 per pack, with a total tax rate of $2.87 per pack. The median state tax rate on cigarettes increased from $0.34 in 2000 to $1.57 in 2017, or 361 percent in nominal terms.
Tobacco Tax Revenue Trends
Tobacco taxes are usually calculated on a per-pack basis rather than on the price, while general sales taxes are calculated as a percentage of the sales price of a taxable item. Thus, these taxes do not benefit from inflation: when prices of other goods rise, sales taxes rise even if the number of goods sold is the same, but when prices of cigarettes rise, per-pack taxes do not rise, all else equal. Thus, tobacco taxes normally go up or down as cigarette consumption. Because cigarette consumption historically has been declining, cigarette taxes generally decline, except when tax rates change.8 Cigarette tax rates also can have powerful effects on tax avoidance and evasion, so that when tax rates rise, taxed consumption of cigarettes may fall considerably. These effects are outside the scope of this chapter.
State government tobacco tax revenue did not decline during the most recent recession unlike other major sources of tax revenues or overall state government tax revenues. The continued growth in tobacco tax revenues during the recession is mostly attributable to cigarette and tobacco tax rate increases. However, tobacco tax revenue has grown far more slowly than it has following prior two recessions and has even seen declines in the most recent two fiscal years. Eight years after the start of the Great Recession, inflation-adjusted tobacco tax revenue is 0.8 percent below the fiscal 2008 level while overall state tax revenues are 5.1 percent above the fiscal 2008 levels (see Figure C). The weakness and declines in tobacco tax revenues are partially attributable to declines in consumption: cigarette consumption declined from 85.2 packs per capita in 2008 to 48.8 packs per capita in 2014 (the most recent year for which data is available), or by nearly 25 percent.9The declines in tobacco tax revenues in the most recent years are also partially attributable to higher tax rates not only at the state level but also at federal level. In 2009 the federal government more than doubled the tax on cigarettes, raising it from $0.39 per pack to $1.01 per pack.10 The hike in tax rates led to lower consumption, as well as increased evasion and avoidance, eroding some of the gains in tobacco tax revenues.
There is large variation among the states. Table A shows state-by-state inflation-adjusted revenue collections from tobacco tax revenues for fiscal years 2000, 2008 and 2016. The states are divided into two groups: the first group includes the states that had tax rate increases on cigarettes between fiscal years 2009 and 2016 and the second group includes the states that had no tax rate increases on cigarettes for the same period. Twenty-eight states had increased cigarette tax rates between fiscal years 2009 and 2016 and are included in the first group, while 22 states had no increases in cigarette tax rates and are included in the second group.11
State government tobacco tax collections exceeded $17.9 billion in fiscal year 2016, representing roughly 1.9 percent of total state tax revenues. Inflation-adjusted tobacco tax revenues grew in 44 states between fiscal years 2000 and 2008, with the national average of 57.4 percent. The tobacco tax revenue picture, however, is dire for the most recent period. Between fiscal years 2008 and 2016, inflation-adjusted tobacco tax revenues declined in30 states, with the national average of 0.8 percent decline. The declines were particularly pronounced in the states that did not implement any tax rate increases on cigarettes between fiscal years 2009 and 2016. Tobacco tax revenues declined in 21 of the 22 states that had not raised tax rates on cigarettes, ranging from 3.1 percent decline in Oklahoma to 30.7 percent decline in Arizona. North Dakota was the only state that had not raised cigarette tax rates but saw growth of 14.4 percent in tobacco tax revenues, in a period when its population grew by 15.3 percent. The growth in North Dakota could also have been affected by cross-border purchases as the tax rate on cigarettes is only 44 cents per pack, compared to the much higher tax rates on cigarettes in all three border-states: $1.70 in Montana, $1.53 in South Dakota, and $3.04 in Minnesota. Tobacco tax revenues also grew in19 of the 28 states that had increased tax rates on cigarettes between fiscal 2009 and 2016, while revenues declined in the remaining nine states, despite tax rate increases on cigarettes. Tobacco tax revenue growth was particularly strong in Florida, where revenues grew from $498 million in 2008 to $1.2 billion in 2016, or by 143.8 percent. The strong growth in Florida is mostly attributable to legislated changes and increase in tax rates on cigarettes and other tobacco products. If we exclude Florida, inflation-adjusted tobacco tax revenues for the rest of the nation show much steeper decline at 4.9 percent, between fiscal year 2008 and 2016.
The declines in tobacco tax revenues in the most recent years combined with the declines in cigarette consumption leads to the following conclusion: consumers’ thin pockets likely forces them to make healthy choices and quit smoking. It is also possible that some consumers have simply shifted from smoking cigarettes to using e-cigarettes or even smoking marijuana. Both e-cigarettes and marijuana have been recently gaining popularity, with more states turning into legalizing marijuana and more states turning into regulating and taxing e-cigarettes.12
Alcohol: Tax Rates and Tax Revenue Trends
Alcohol Tax Rates
Alcohol tax in the United States has a long history dating back to 18th century when Alexander Hamilton, the first secretary of treasury, proposed the whisky tax. The landscape of alcohol taxation has changed a lot since then. When it comes to alcohol regulation, states are divided into two groups: monopoly states and license states. Currently 17 states have a monopoly system of regulation over the alcohol industry, while the remaining 33 states have license systems. The monopoly states usually control the sale of distilled spirits and in few cases, they also control wine.13These “control” states have a monopoly over distilled spirits sales at the wholesale level and some also conduct the retail sale of distilled spirits. In other words, governments in the 13 monopoly states set a uniform price or a minimum shelf price for distilled spirits sold within the state and engage in the sale of alcoholic beverages through state-run stores. These monopoly states usually have a license system for regulating the distribution and sale of lighter alcoholic beverages, including wine and beer. The license states also regulate alcohol beverages but they allow private enterprises to buy and sell alcohol at state discretion.
The treatment of alcohol taxes varies widely across the states and depends on the alcoholic beverage. Taxes on beer are usually much lower than taxes on distilled spirits, and taxes on wine are somewhere in between. The tax rate on alcoholic beverage can include fixed-rate per volume taxes, wholesale taxes, distributor taxes, retail taxes, case or bottle fees and additional sales tax. In addition, states may apply higher excise tax rates on higher alcohol content beverages.14
Table B shows excise tax rates for beer, wine, and distilled spirits. Beer tax rate ranges from a low of $0.02 per gallon in Wyoming to a high of $1.29 per gallon in Tennessee, with the national median of $0.20 per gallon. In the states that do not control the sale of wine, tax rates range from a low of $0.20 per gallon in California to a high of $2.50 per gallon in Alaska, with the national median of $0.72 per gallon. Finally, distilled spirits tax rate among the license states ranges from a low of $1.50 in Maryland to a high of $14.27 in Washington, with the national median of $3.75 per gallon. The control states usually generate revenues from price mark-ups for distilled spirits.
States in general are less reluctant to increase taxes on alcoholic beverages, than on cigarettes and other tobacco products. For example, since 2008 only six states—Connecticut, Illinois, New York, North Carolina, Rhode Island and Tennessee—had increased tax rates on beer.15 Because of the relatively stable tax rates on alcoholic beverages, alcohol taxes as a share of the pre-tax price of alcohol have fallen significantly over time.16
Alcohol Tax Trends
Taxes on alcohol are usually calculated on a per gallon basis. Therefore, like tobacco taxes, alcohol taxes would grow in response to alcohol consumption or in response to an increase in the tax rate. As discussed above, only a handful of states increased tax rates on alcohol in response to the Great Recession. However, unlike tobacco consumption, the alcohol consumption has been on the rise in the most recent years, which led to growth in overall state alcohol tax revenues.
State government alcohol tax revenue declined only mildly right at the start of the Great Recession, but had seen steady and strong growth since then. Alcohol tax revenue has grown far more rapidly since 2008 than it has following the prior two recessions. In fact, alcohol tax revenues have declined in the aftermath of the 1991 recession. Eight years after the start of the Great Recession, inflation-adjusted alcohol tax revenue is 12.2 percent above the fiscal 2008 level compared to the 5.1 percent in overall tax revenues (see Figure D). The strong growth in alcohol tax revenues are mostly attributable to the growth in consumption: alcohol consumption grew from 2.31 gallons per capita in 2008 to 2.32 gallons per capita in 2014 (the most recent year for which data is available), or by 0.4 percent. However, the consumption growth was not consistent across alcoholic beverage types. Wine and spirits per capita consumption rose by 13.2 and 9.6 percent, respectively between 2008 and 2014, whereas beer per capita consumption declined by 8.3 percent for the same period.17As shown on Table B, the tax rates per gallon are significantly higher on wine and spirits than on beer. Therefore, the strong growth in alcohol tax revenues are likely driven by the strong growth in wine and spirits consumption.
There is large variation among the states. Table C shows state-by-state inflation-adjusted revenue collections from alcohol tax revenues for fiscal years 2000, 2008 and 2016. The states are divided into two groups: the first group includes the alcohol control states and the second group includes the alcohol license states.
State government alcohol tax collections exceeded $7.2 billion in fiscal year 2016, representing roughly 0.8 percent of total state tax revenues. Inflation- adjusted alcohol tax revenues grew in 33 states between fiscal years 2000 and 2008, with the national average of 8 percent growth. Alcohol tax revenues, unlike tobacco tax revenues, showed growth for the most recent time period as well. Between fiscal years 2008 and 2016, inflation-adjusted alcohol tax revenues grew in 38 states, with the national average of 12.2 percent. The growth was somewhat stronger in control states at 16.2 percent between 2008 and 2016, compared to the 10.8 percent growth in license states. Among individual states, New Hampshire had the largest growth at 76.7 percent between fiscal years 2008 and 2016, while Florida had the largest decline at 44.1 percent. In terms of dollar value, the largest growth was in Texas, where inflation adjusted alcohol tax revenues grew by $327 million or 34.7 percent between 2008 and 2016. If we exclude Texas, inflation-adjusted alcohol tax revenues for the rest of the nation show 8.3 percent growth between fiscal year 2008 and 2016.
These “sin taxes” on products such as alcohol and tobacco offer limited revenue growth. The declines in tobacco tax revenues are largely attributable to the declines in tobacco consumption, while the growth in alcohol tax revenues are largely attributable to the growth in alcohol consumption. Between 2008 and 2014 tobacco consumption declined by nearly 25 percent, while alcohol consumption increased by 13.2 and 9.6 percent respectively for wine and spirits, but declined by 8.3 percent for beer.
Many state and local governments continue facing fiscal challenges and officials in those states are turning to new types of “sin” products or behaviors. The most popular new line of these products includes food and beverages that are high in sugar and trans fats. States have also been legalizing and expanding various forms of gambling in the hopes of generating more revenues.18 Finally, more states are targeting legalization of recreational marijuana as a source of additional tax revenue. Before the 2016 elections, recreational marijuana was legal in the District of Columbia and the following four states: Alaska, Colorado, Oregon and Washington. During the 2016 elections four more states—California, Maine, Massachusetts and Nevada—legalized recreational marijuana, while another four states legalized medical marijuana. Legalization of marijuana in the high population state of California will likely pave the path for other states as well.
While states could and would see some revenue from these new forms of taxes, they should be mindful about the future of sin taxes. The history of tax revenues generated from alcohol and tobacco provide an important lesson for policymakers: “sin taxes” only offer limited funds to governments. Moreover, the long-term growth in “sin tax” revenue is often weak and limited, absent of any policy changes.
1 Hoffer, Adam J., William F. Shughart II, and Michael D. Thomas. 2014. “Sin Taxes and Sindustry: Revenue, Paternalism, and Political Interest.” The Independent Review 19 (1): 47–64. http://www.independent.org/pdf/tir/tir_19_01_ 04_hoffer.pdf.
2 Green, Rebecca. 2011. “The Ethics of Sin Taxes.” Public Health Nursing 28 (1): 68–77.
3 Haile, Andrew J. 2009. “Sin Taxes: When the State Becomes the Sinner.” Temple Law Review (Temple Law Review).
4 Reiter, Jendi B. 1996. “Citizens or Sinners?—The Economic and Political Inequity of ‘Sin Taxes’ on Tobacco and Alcohol Products.” Columbia Journal of Law and Social Problems 461–468.
5 Williams, Richard, and Katelyn Christ. 2009. Taxing Sin. Arlington, VA: Mercatus Center, George Mason University.
6 Smith, Adam. 1776. An Inquiry into the Nature and Causes of The Wealth of Nations. Random House, Inc. https://www.marxists.org/reference/archive/smith-adam/works/wealth-of-nations.
7 Boyd, Donald J., and Lucy Dadayan. 2015. The Economy Recovers While State Finances Lag. Albany, NY: Rockefeller Institute of Government. http://www.rockinst.org/pdf/government_finance/2015-06-23-Blinken_Report_Two.pdf.
8 ITEP. 2016. Cigarette Taxes: Issues and Options. Policy Brief, Institute on Taxation and Economic Policy. http://itep.org/itep_reports/pdf/cigpb2016.pdf.
9 See Orzechowski, and Walker. 2015. The Tax Burden on Tobacco. Arlington, VA: Orzechowski and Walker. https://www.taxadmin.org/assets/docs/Tobacco/papers/tax_burden_2014.pdf.
10 Cole, Alan. 2015. Federal Tobacco Tax Revenues are Declining. Washington D.C.: Tax Foundation. https://taxfoundation.org/federal-tobacco-tax-revenues-are-declining.
11 These states might have increased the rates on other tobacco products, which we did not track.
12 Recreational marijuana is legal in eight states— Alaska, California, Colorado Maine, Massachusetts, Nevada, Oregon, and Washington. Currently seven states—California, Kansas, Louisiana, Minnesota, North Carolina, Pennsylvania, and West Virginia—tax vapor products.
13 See National Alcohol Beverage Control Association for the list of “control states” available at: http://www.nabca.org/States/States.aspx.
14 For more detailed information on the history of excise tax rates on alcoholic beverages see information provided by Alcohol Policy Information System at: https://alcoholpolicy.niaaa.nih.gov/APIS_Policy_Topics.html.
16 Parry, Ian W.H., and Jeffrey A. Miron. 2009. “Should Alcohol Taxes Be Raised?” Regulation 32 (3): 10–13.
17 See Haughwout, Sarah P., Robin A. LaVallee, and I-Jen P. Castle. 2016. Apparent Per Capita Alcohol Consumption: National, State, and Regional Trends, 1977–2014. Surveillance Report #104, Arlington, VA: National Institute on Alcohol Abuse and Alcoholism. https://pubs.niaaa.nih.gov/publications/surveillance104/CONS14.htm.
18 Dadayan, Lucy. 2016. State Revenues From Gambling: Short-Term Relief, Long-Term Disappointment. Albany, NY: Rockefeller Institute of Government. http://www.rockinst.org/pdf/government_finance/2016-04-12-Blinken_Report_Three.pdf.