Maryland’s Doubled Cigarette Tax Brings in Just 50% More Revenue

January 14, 2009

Last month, the Maryland Board of Revenue Estimates released updated tax collection statistics. As the only state to raise every major tax in 2008 to fund new spending programs, it is a good case study to follow, particularly since it’s turning out to be a study of what not to do.

For instance, Maryland doubled its cigarette tax from $1 to $2, notwithstanding the smuggling induced by large disparities in tax rates between states. Maryland’s $2 tax is now significantly higher than neighboring Virginia (30 cents), West Virginia (55 cents), Delaware ($1.15), and even Pennsylvania ($1.35). At some point, cigarette taxes meet the Laffer Curve, and at the time, we warned that Maryland should expect a sharp rise in bootlegging.

In FY 2007, Maryland’s $1 cigarette tax brought in $269.1 million in revenue. In proposing the increase, Governor Martin O’Malley estimated that the increase would bring in $255 million a year. In other words, he estimated that the 100% tax increase would result in a 95% revenue increase.

The increase, which occurred on January 1, 2008, was half-way through FY 2008. For the full fiscal year, Maryland collected $366.3 million in cigarette tax revenue, about $100 million of which is attributed to the increase. For the first few months of 2008, Maryland’s 100% tax increase had resulted in a 75% revenue increase.

The newly revised estimate for FY 2009, the first full fiscal year with the tax increase, shows cigarette tax revenue at $408.7 million. Maryland’s 100% tax increase is now resulting in just a 51% revenue increase. Put another way, Maryland is getting just half the revenue it expected. Further, the Comptroller estimates revenue to fall again in 2010 to $403.0 million. Since Maryland ramped up spending assuming the full doubling of tax revenue, it is a big contributor to the state’s current shortfall.

The Comptroller dryly notes:

Demand for cigarettes did prove to be highly elastic, as tobacco stamp sales have declined by over 25% since the rate increase took effect…. [T]obacco stamp sales are down 26% year to date, which can be attributed to a number of factors including a decline in smoking, a possible increase in cross-border and Internet sales, as well as a possible increase in smuggling.

Revenues from non-cigarette tobacco products are up 7.6%, suggesting a wave of smokers quitting isn’t the culprit. If a person fills up a car trunk of cartons of cigarettes in Virginia, and illegally sells them in Maryland, the profit from the tax arbitrage could be over $5,000. Quite lucrative. States should be wary of thinking that cigarette tax revenue is an endless source to be exploited.


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