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. competition is the bane of governments worldwide seeking higher levels of tax receipts. On the other hand, tax competition is an effective force protecting taxpayers from higher taxes.
At state and local levels, governments must compete for private sector investment in much the same way that companies compete for customers. State where taxes are low consistently lure private investment away from states where taxes are high. Similarly, if a state imposes a beer or cigarette excise that is lower than in surrounding states, the low-tax state will gain sales from the residents of surrounding states who live near the border.
Cigarette and beer excise taxes have been many politicians, favorite revenue raisers for years. Even in the boom year of 1998, when no state raised its sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. rate, its individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. rate or its corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. rate, and many excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. es were down, five states raised their cigarette taxes, and one state its beer tax.
During 2002, it has been hard to even keep track of all the efforts by state governments to raise excise taxes. Tobacco has been the main target. At last count, nine state legislatures had raised their cigarette tax rates this year, though not all had been signed into law: Connecticut went from 50¢ to $1.11 per pack, Hawaii from $1.00 to $1.40, Illinois from 58¢ to 98¢, Kansas from 24¢ to 79, Maryland from 66¢ to $1.00, Ohio from 24¢ to 55¢, Nebraska from 34¢ to 64¢, New York from $1.11 to $1.50, and Utah from 51.5¢ to 69.5¢. In Kansas and Hawaii, the tax hikes are phased in.
Proposals to raise these excise taxes rarely mention that most of the people who will pay them have low incomes. Nor do advocates of these “sin” taxes talk much about the higher prices that these low-income consumers will pay. Instead, they make claims about deterring smoking and drinking. That so-called deterrence is often “confirmed” by data that takes no account of cross-border shopping. To improve their understanding of these important public policy issues, legislators and the public need to understand how the cigarette and beer markets react to high and low excise taxes.
Two recent Tax Foundation studies have explored the many different avenues that consumers take to save money on these highly taxed items. By using sophisticated economic models of the cigarette market and the beer market, we can follow the trends in taxation up to 1997, all the while examining the ways that excise taxes in each state changed smokers, and beer drinkers, purchasing habits.
Cross-Border Shopping for Beer The sale of beer in the United States is an interesting case study of this cross-border shopping phenomenon, and it is the subject of the Tax Foundation senior economist Patrick Fleenor’s most recent Background Paper, No. 31 in the series and titled, “How Excise Tax Differentials Affect Cross-Border Sales of Beer in the United States“.
While the study measures cross-border shopping in every state, the results are naturally most dramatic along borders where the tax differential is high. For example, Washington state, which levies a statewide 6.5 percent sales tax, additional local sales taxes and a $7.172 per barrel beer excise tax, shares a border with Oregon, which levies no state or local sales taxes and has a state beer excise of just $2.60 per barrel.
Huge quantities of beer cross the border in these circumstances, but this migration of economic activity affects more than just sales and product-specific excise tax collections. Cross-border shopping affects income and property taxA property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services. collections, license fees, and a host of other sources of government revenue.
Policymakers are frequently surprised by the magnitude of the revenue effects, and such surprises can be particularly unnerving when the government in question is required to maintain a balanced budget.
Smokers Tax Avoidance Published in late 1998 as No. 26 in the Tax Foundation’s Background Paper series, “How Excise Tax Differentials Affect Interstate Smuggling and Cross-Border Sales of Cigarettes in the United States,” also by senior economist Patrick Fleenor, examines all the methods smokers have used over the years to avoid highly taxed cigarettes.
They all involve crossing borders of some sort, either state borders, international borders, or the “borders” of such low-tax jurisdictions as military bases and Native American tribal reservations. In the case of cigarettes, not all cross-border activity is innocent bargain shopping. The extensive organized smuggling of cigarettes that occurs between high- and low-tax jurisdictions is a major focus of this study, and the results should be of interest to federal and state law enforcement officials as well as policy makers.
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