July 13, 2007

Options for Funding SCHIP Expansion: Cigarette Taxes Least Defensible Alternative

Download Fiscal Fact No. 92

Fiscal Fact No. 92

This past week, Senate negotiators agreed on a bill that would increase the federal cigarette tax by 156 percent (from 39 cents to $1.00) in order to raise $35 billion for the popular SCHIP program that gives federal money to states for children’s health insurance. SCHIP is set to expire at the end of fiscal year 2007 (Sept. 30).

Unfortunately, this proposal is an abuse of sound tax and fiscal policy. A politically popular, expensive program should never be funded by a small, low-income minority like cigarette smokers, even though smokers are politically unpopular.

As Table 1 shows, no other federal tax hurts the poor more than the cigarette tax. Other taxes the federal government could use to raise $35 billion are displayed by income class.

Table 1
Cigarette Taxes Are the Most Anti-Poor Method of Funding S-CHIP

Household Income Quintile

Taxes that Could Be Used to Raise $35 Billion to Fund S-CHIP Expansion (Average Tax Increase per Household in Quintile)

Cigarette Tax Increase

Alcohol Tax Increase

Gas Tax Increase

Air Transport Tax Increase

Corporate Income Tax Increase

Payroll Tax Increase

Individual Income Tax Increase

All Households








Bottom 20 Percent








Second 20 Percent








Middle 20 Percent








Fourth 20 Percent








Top 20 Percent








Source: Andrew Chamberlain and Gerald Prante, “Who Pays Taxes and Who Receives Government Spending? An Analysis of Federal, State and Local Tax and Spending Distributions, 1991 – 2004,” Tax Foundation Working Paper, No 1.

Not only are the payers of cigarette taxes poorer as a group than the payers of these other taxes, but there are fewer of them. In fact, the burden of the proposed cigarette tax hike on the lowest-earning 20 percent of households is 37 times heavier than it would be if the government raised the money with the federal income tax. Put another way, the proposed cigarette tax hike would hit the poor with the same force as cutting the Earned Income Tax Credit (EITC) by one-fourth.

Why Are Smokers Taxed Again and Again?
Taxes on tobacco products have soared in recent years. As Table 2 shows, in just a five-year period from 2000 through 2005, tobacco tax collections rose 45 percent, according to the Department of Commerce. Not even property taxes have grown that fast, despite a housing bubble that pushed property taxes up at a historically rapid pace, starting a nationwide flurry of property tax relief measures. For more on how cigarette taxes have risen dramatically over the past five years, see Tax Foundation Fiscal Fact, No. 93, “State Tobacco Tax Rates Have Skyrocketed Since Last Federal Tax Increase.”

Table 2
Tobacco Taxes are a Fast-Growing Source of Government Revenue

Tax Category (BEA)

Percent Change in Collections from 2000 to 2005

Special Assessments


Severance Taxes


Taxes on Insurance Receipts


Taxes on Corporate Income


Tobacco Taxes


Property Taxes


Air Transport Taxes


Payroll Taxes


General Sales Taxes


Customs Duties


Motor Vehicle Licenses


Alcohol Taxes


Gasoline (and Diesel Fuel) Taxes


Personal Income Taxes

– 3.1%

Source: Tax Foundation calculations based on data from the Bureau of Economic Analysis, Dept. of Commerce

Taxes on tobacco products increased three times faster than alcohol taxes, the other major “sin tax,” from 2000 to 2005. The most likely reason for the disparity is that a majority of citizens enjoys alcohol while smokers are a minority, about 20 percent of the population nationwide.

Powerful special interest groups pushing “public health” have been able to bring the non-smoking majority along with their campaign to tax smokers. John Stuart Mill would call it a tyranny of the majority: politicians have identified an unpopular minority and forced punitive taxes on them.

These advocates of higher taxes on tobacco, regardless of the impact on the poor, are frequently accused of being modern-day temperance workers who busy themselves telling other people how to live.

In addition to campaigning for high tobacco taxes, they often advocate special taxes on other unhealthy products like soda, candy, alcohol, etc. What’s next, tanning beds? Extreme mountain climbing? Bacon cheeseburgers? Tony Blair has labeled such policies as representing a “nanny state.”

Perhaps growing government revenue is as important as health to these nanny-staters. If they really believed these products to be so deadly, they would advocate banning them, not just taxing them. However, taxes are rising on tobacco to the point that for low-income people, they are tantamount to a legal prohibition, and a huge underground economy filled with violent crime and smuggling has sprung up.

All this is not to say that cigarette taxes should be zero. Cigarettes do impose costs on society that are not borne by smokers, and so, despite the low-income profile of smokers, some tax per pack is justified. However, most empirical studies of these costs conclude that the current combined tax (federal and state/local) are already more than enough.1

Taxing only cigarettes to finance higher spending on SCHIP has absolutely no justification in sound tax policy. Excise taxes on cigarettes should be used to compensate for the costs they impose on society. Taxes levied above and beyond that point may be politically expedient because smokers are unpopular, but they only serve to make the federal tax system less principled and more regressive.


1. See, for example, Patrick Fleenor, “Who Bears the Ancillary Cost of Tobacco Use?,” Tax Foundation Background Paper, No. 36 (January 2001), available at http://www.taxfoundation.org/legacy/show/121.html.

A 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.

A gas tax is commonly used to describe the variety of taxes levied on gasoline at both the federal and state levels, to provide funds for highway repair and maintenance, as well as for other government infrastructure projects. These taxes are levied in a few ways, including per-gallon excise taxes, excise taxes imposed on wholesalers, and general sales taxes that apply to the purchase of gasoline.

A 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.

A 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.

A payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue.

An 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.

An 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.

A 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.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.