Last May, Cleveland area voters decided to extend for 20 years a 4 1/2 cents sin tax on each pack of cigarettes. While everyone knew the revenue (plus an alcohol tax) would be used to upgrade the Browns’, Cavaliers’ and Indians’ sports stadiums, no one had decided who would get how much. One politician said they should tie part of the projected $260 million payout to team performance. Saying it was a win tax, the idea would have created a rather unique sin tax incentive.
Where are we going? To a closer look at cigarette taxes.
Let’s just start by looking at Chicago. The highest in the U.S. at $7.17 a pack, their cigarette tax funds four levels of government.
The source of the tax per pack in Chicago:
- federal: $1.01
- state: $1.98
- county: $3.00
- city: $1.18
But it is not quite that simple.
Because of elasticity and smuggling, the increased revenue from a cigarette tax increase can soon decline.
Called elastic demand, when price rises, our spending can contract considerably. As a result, a higher tax does not necessarily mean more revenue. You can see below that as average prices climbed, sales diminished and tax revenue started to slip:
Meanwhile, tax rate differences create the incentive to smuggle cigarettes from low tax to higher tax regions. When Illinois’s tax rates increased, smuggling spiked to 20.9% from a low 1.1% of consumption.
Below, the blue states show cigarettes leaving and orange indicates inbound packs. The Tax Foundation tells us that in 2013, the Missouri state tax was just $.17, Idaho’s was $.57 whereas New York’s cigarette tax was $4,35 a pack.
Our Bottom Line: Tradeoffs
When Harry Truman asked for a one-handed economist, he might have been talking about cigarettes.
In a report on a hypothetical rise in the federal cigarette tax, the Congressional Budget Office (CBO) tells us that smoking less saves lives and reduces healthcare expenses. But on the other hand when people live longer, Social Security and Medicare expenses increase. On the one hand, too high a sin tax diminishes the revenue it can generate. But on the other, when it is too low, people continue their unhealthy behavior.
So, whether we expect a sin tax will make the Cleveland Browns win more games or raise revenue for their home city, it will never be quite that easy.