Today, the U.S. Food and Drug Administration (FDA) unveiled long-anticipated proposed regulations banning the sale of menthol cigarettes and flavored cigars, part of ongoing efforts to support smoking cessation. Critics doubt, however, whether banning mentholated cigarettes will reduce smoking or instead simply channel menthol smokers toward other tobacco products—or smuggled menthols. And states have yet to fully grapple with the potential revenue impacts of a federal ban.
The rule, which now enters a comment period, could be finalized by early next year and, if adopted, would go into effect one year thereafter.
In 2020, menthol cigarettes accounted for 37 percent of the cigarette market and used by an estimated 18.6 million adult smokers, more than a third of all smokers. Banning these products would be a big deal for a lot of people. What matters from a policy perspective is how current menthol smokers respond to a ban.
If a menthol ban resulted in a substantial reduction in smoking, governments would take a revenue hit but public health would improve, a trade many policymakers would be willing to accept. If, however, smokers simply substituted unflavored cigarettes, choices would be constrained without any meaningful impact on public health or government finances. And if, as experience strongly suggests, many current menthol smokers acquire illicit menthol products once a ban is in effect, everyone loses—except the smugglers.
There is already a massive global illicit trade in cigarettes, driven by 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. differentials. Often, cigarettes are smuggled across state lines from low- to high-tax states, but many come from abroad, with one estimate indicating that Chinese counterfeiters produce 400 billion cigarettes per year to meet international demand, some of which end up in the United States. Current menthol bans in Massachusetts, the District of Columbia, and select U.S. cities are easily evaded through what is called “casual smuggling”—the legal (in small quantities) purchasing of these products from neighboring jurisdictions. This is augmented by illicit sales in those jurisdictions.
In Massachusetts, for instance, after the implementation of a flavor ban (which included menthol cigarettes), tobacco tax stamps declined by 24 percent. But this looks like far less of a victory for smoking cessation when considering that New Hampshire tax stamps soared 22 percent, Rhode Island tax stamps jumped 18 percent, and even Vermont tax stamps went up 6 percent. Smoking rates didn’t decline with Massachusetts’ menthol ban—smokers just bought their cigarettes elsewhere.
With a nationwide ban, casual smuggling becomes far less viable an option, but policymakers should expect large illicit markets selling foreign, often counterfeit, cigarettes. These products, which will not be regulated by the FDA, may be more harmful than the regulated U.S. products they replace. And they won’t generate any tax revenue for states or the federal government.
Naturally, many menthol smokers will refuse to turn to smuggled cigarettes, and international smuggling is considerably harder than an illicit trade across state borders—but given that 52 percent of cigarettes sold in New York are smuggled, along with more than 40 percent of cigarettes sold in California and Washington state, we shouldn’t assume the smuggled share will be low. Meanwhile, most of those who give up menthols under a ban will turn to unflavored cigarettes or other tobacco products, preserving government revenue but yielding little change on the public health front.
State lawmakers recognize that a reduction in the sale of legal, taxed cigarettes will reduce their tax revenues, though it’s difficult for them to anticipate how many sales will be lost to the illicit trade under a menthol ban. Many policymakers, however, have failed to appreciate a second source of revenue loss.
States receive payments from the Master Settlement Agreement (MSA), a legal settlement between the tobacco industry and state governments which yields about 75 cents for each pack sold, above and beyond any cigarette tax revenue. State taxes average about $1.91 a pack, but the all-in revenue is more like $2.66 due to MSA payments.
According to our estimates, based on changed purchasing patterns under menthol bans abroad, state governments stand to lose a combined $4.7 billion a year under a menthol ban. Much of this revenue is earmarked for dedicated health care, education, and infrastructure expenditures, and some states have even securitized their MSA payments and sold bonds, using MSA proceeds to make their bond payments. In New York, for instance, MSA money helps fund Medicaid. In New Hampshire, some of it goes to public education. In North Carolina, a portion of the revenue is dedicated to community colleges. Generally, at least a portion of tobacco tax (and often MSA) revenues are used to counter the negative health effects of smoking.
Prohibition comes at a cost to states. No one ever doubted that. But that cost is more than many realized, and it comes with little public health benefit to show for it. A menthol ban won’t stop people from smoking. It simply boosts the illicit trade while leaving states with even less revenue to deal with the health consequences of smoking.
Stay informed on the tax policies impacting you.
Subscribe to get insights from our trusted experts delivered straight to your inbox.Subscribe