Pennsylvania Governor Tom Corbett (R) signed a bill this week allowing Philadelphia’s school district to raise cigarette taxes by $2. This comes after Pennsylvania considered several different cigarette taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. increase proposals. The statewide cigarette tax rate is $1.60, near the middle of the pack nationwide. Adding $2 on top of that is an enormous tax wedge, one of the largest such local cigarette taxes in the nation. The tax increase is projected to yield between $55 and $90 million in new revenues, to close an $80 million funding gap. Unfortunately, not only is this unsound tax policy, but the main effect will probably be to boost black- and gray-market trade in cigarettes. The real winners here aren’t school officials, but cigarette sellers just outside of Philadelphia.
Using cigarette taxes to fund education is problematic. Whatever social costs cigarette smoking may have, surely the way to compensate those costs is to spend money raised on tobacco education and tobacco-related health spending? Spending the money on education makes a vital social service financially dependent on an extremely volatile (and declining) revenue stream. Indeed, as we wrote about a previous plan to expand preschool using cigarette taxes, cigarettes and preschoolers just don’t go together.
Does anyone really want to tell their children that their school was only possible because other people were smoking? And when the state’s schools are dependent on cigarette sales, how can state tobacco education efforts not have a conflict of interests? While it might be politically expedient to isolate a small unpopular group (smokers) to pay for a service to a popular group (students), education is a broadly accessible core public service—so we should pay for it with broad-based taxes with reliable revenue streams, like property taxes.
Aside from these concerns, a high tax rate in a small geographic area creates ripe opportunities for illicit trade. Independent research has previously found that illicit trafficking of cigarettes has relatively little impact on smoking in Philadelphia, but has a huge impact in higher-taxed areas like New York City and Washington, DC. If taxes increase in Philadelphia, smuggling could too. Research we published by the Mackinac Center for Public Policy likewise shows relatively little net smuggling from Pennsylvania, while, in New York, smuggled cigarettes account for over 50 percent of cigarette consumption.
If Pennsylvania raises its taxes, incentives to smuggle will more than double. Smugglers could purchase cigarettes just outside of Philadelphia, and bring them in for sale within the city, reaping large profits over a very short distance. These revenues can often flow to organized crime, or lead to other incidents of violence. Thus revenues may prove to be less than expected, while the costs of a tax increase (in terms of increased illicit trade) may be higher than expected. As long as it’s easy and lucrative to smuggle cigarettes, raising taxes on them will have a primary effect of subsidizing smugglers. Some of those smugglers may come from other states, such as Virginia, so Pennsylvania may actually lose some state sales to out-of-state purchases.
We wrote previously that signing a cigarette tax increase would break the governor’s promise not to raise taxes in Pennsylvania. At the time, it looked like he might at least get a trade out of it, swapping pension reforms for a new tax. But this week, the law was signed without such a trade.
In sum, this huge local cigarette tax hike to pay for education creates an unfortunate link between tobacco sales and the education of children, confusing the state’s own message about tobacco usage. The revenues will likely be unstable in the future, subjecting schools to frequent budget shortfalls. Even if revenues do not disappoint too much, smuggling will almost certainly increase, fueling black-market revenues, and potentially even criminal organizations. The combination of these features, in addition to more fundamental problems with high excise taxes on a politically vulnerable population like smokers, makes Governor Corbett’s cigarette tax hike a textbook case of unsound tax policy.
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