(Please do not cite. An updated version of this study is available at: http://www.taxfoundation.org/legacy/show/1858.html.)
Fiscal Fact No. 65
While there exist a large literature and extensive policy discussion on the issue of cigarette taxation, smokeless tobacco has received comparatively little attention. In recent years, controversy in many state legislatures has erupted over the proper way of taxing smokeless tobacco. The goal of this Fiscal Fact is to clarify the rationale for excise taxation in general, and specifically to explain the proper method of taxation of smokeless tobacco products and how it compares to cigarette taxation.
The Fallacies of Current 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.
Policy on Smokeless Tobacco Products
Even though the federal government taxes smokeless tobacco at a per unit rate based upon weight, most states tax it based upon the sale price. This can be seen in the following table of the tax rates on smokeless tobacco across the country.
Table 1
Smokeless Tobacco Tax Policy Is Highly Inconsistent Across States
|
State |
Tax Rate on Moist Snuff Tobacco (MST) |
Type of Tax |
|
Alabama |
2 cents per typical can1 |
Per Unit |
|
Alaska |
75% of wholesale price |
Ad Valorem |
|
Arizona |
13.3 cents per ounce |
Per Unit |
|
Arkansas |
32% of manufacturer’s price |
Ad Valorem |
|
California |
46.76 percent of wholesale price2 |
Ad Valorem |
|
Colorado |
40% of manufacturer’s price |
Ad Valorem |
|
Connecticut |
40 cents per ounce3 |
Per Unit |
|
Delaware |
15% of wholesale price |
Ad Valorem |
|
Florida |
25% of wholesale price |
Ad Valorem |
|
Georgia |
10% of wholesale price |
Ad Valorem |
|
Hawaii |
40% of wholesale price |
Ad Valorem |
|
Idaho |
40% of wholesale price |
Ad Valorem |
|
Illinois |
18% of wholesale price |
Ad Valorem |
|
Indiana |
18% of wholesale price |
Ad Valorem |
|
Iowa |
22% of wholesale price |
Ad Valorem |
|
Kansas |
10% of wholesale price |
Ad Valorem |
|
Kentucky |
9.5 cents per unit4 |
Per Unit |
|
Louisiana |
20% of manufacturer’s price |
Ad Valorem |
|
Maine |
78% of wholesale price |
Ad Valorem |
|
Maryland |
15% of wholesale price |
Ad Valorem |
|
Massachusetts |
90% of wholesale price |
Ad Valorem |
|
Michigan |
32% of wholesale price |
Ad Valorem |
|
Minnesota |
70% of wholesale price |
Ad Valorem |
|
Mississippi |
15% of manufacturer’s price |
Ad Valorem |
|
Missouri |
10% of manufacturer’s price |
Ad Valorem |
|
Montana |
85 cents per ounce |
Per Unit |
|
Nebraska |
20% of wholesale price |
Ad Valorem |
|
Nevada |
30% of wholesale price |
Ad Valorem |
|
New Hampshire |
19% of wholesale price |
Ad Valorem |
|
New Jersey |
75 cents per ounce |
Per Unit |
|
New Mexico |
25% of product value |
Ad Valorem |
|
New York |
37% of wholesale price |
Ad Valorem |
|
North Carolina |
3% of wholesale price |
Ad Valorem |
|
North Dakota |
60 cents per ounce |
Per Unit |
|
Ohio |
17% of wholesale price |
Ad Valorem |
|
Oklahoma |
60% of wholesale price |
Ad Valorem |
|
Oregon |
65% of wholesale price |
Ad Valorem |
|
Pennsylvania |
No tax |
na |
|
Rhode Island |
$1.00 per ounce |
Per Unit |
|
South Carolina |
5% of manufacturer’s price |
Ad Valorem |
|
South Dakota |
10% of wholesale price |
Ad Valorem |
|
Tennessee |
6.6% of wholesale price |
Ad Valorem |
|
Texas |
35.213% of manufacturer’s price |
Ad Valorem |
|
Utah |
35% of manufacturer’s price |
Ad Valorem |
|
Vermont |
$1.49 per ounce |
Per Unit |
|
Virginia |
10% of wholesale price |
Ad Valorem |
|
Washington |
75% of wholesale price |
Ad Valorem |
|
West Virginia |
7% of wholesale price |
Ad Valorem |
|
Wisconsin |
25% of manufacturer’s price |
Ad Valorem |
|
Wyoming |
20% of wholesale price (or 10% of retail) |
Ad Valorem |
1 Alabama charges 1.5 cents per ounce of chew tobacco, and a varying rate on snuff tobacco per can, depending upon the size.
2 Adjusted annually by the California Board of Equalization
3 Connecticut charges a tax of 20 percent on other tobacco products besides snuff.
4 Kentucky charges a tax of 7.5 percent on other tobacco products besides snuff.
Source: Federation of Tax Administrators; various updates compiled by Tax Foundation
As Table 1 shows, the lowest tax burdens on smokeless tobacco are found in the tobacco-producing South, which also imposes the lowest tax rates on cigarettes. But outside of the South, why do some states tax smokeless tobacco so heavily and some so lightly? Why do some base their tax on the weight and others on the price of the product?
To answer these questions and determine which states, if any, are practicing proper tax policy, we must develop a framework for explaining proper tax policy with regard to smokeless tobacco. Tobacco taxation policy should follow the framework of three crucial questions:
(1) Should products like smokeless tobacco have a special tax imposed?
(2) By what method should they be taxed, i.e. based on the sale price (ad valorem) or per unit?
(3) What is the proper level of taxation?
Should Tobacco Products Have a Special Tax?
Assuming that the role of government is to prevent individuals from harming one another, and not to prevent individuals from harming themselves, then special taxes on tobacco products should exist only if those products impose significant costs on third parties. A frequently cited example is the healthcare costs to other taxpayers associated with tobacco consumption.1 Another often cited external cost of tobacco products, cigarettes in particular, is second-hand smoke—both in public places and in homes where children reside. Smokeless tobacco, however, imposes no such harm. Other costs unfairly imposed on society from tobacco consumption have been cited, such as the unattractiveness of witnessing certain behavior associated with chew tobacco, and the message children receive as a result of viewing adult tobacco consumption.
To the extent that tobacco imposes undue costs on society, specific taxation of the product may be warranted. But a government official who merely desires to influence individual consumption decisions because of his own anti-tobacco sentiment cannot be justified by an appeal to principles of sound tax policy.
By What Method Should Tobacco Products Be Taxed?
There are two methods of levying an 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.
on any product. The first and most common type of excise tax is a per-unit tax. In this case, the tax is independent of the price of the product. The other type of excise tax is an ad valorem tax, which is akin to a typical general 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.
where the tax is a percentage of the sale price.
Regardless of the rationale for the government’s attempt to limit tobacco consumption via taxation—whether it is through the proper framework of controlling for negative costs imposed on others or through the authoritarian method of trying to control individual decisions—tobacco products should be taxed via a per-unit tax. The harm caused by a unit of tobacco is essentially unrelated to its price. A $5 pack of cigarettes would not impose any cost to society or harm any individual more than a $2 pack of cigarettes would. With respect to cigarettes, most tax-levying officials have properly understood this because every state imposes the tax based on the number of cigarettes, not based upon the sale price.
However, with respect to smokeless tobacco, most states have gone in the opposite direction of sound tax policy, and have imposed ad valorem taxes, which are based upon the sale price of the smokeless tobacco. Only nine states impose the tax on a per-unit basis even though the federal government taxes moist smokeless tobacco based on weight, which is essentially a tax on quantity, and is the proper way of taxing the product.
It is not logical to base the tax on the value of the product. A $6 can of premium smokeless tobacco does no greater harm to the user or to society than a $2 brand of generic smokeless tobacco, but under the current system in most states, the premium brand is charged a tax three times that of the generic brand. Much of the effect of this ad valorem tax is merely to encourage more consumption of the inexpensive brand, thereby making irrelevant much of the government policy designed to limit the quantity of tobacco consumed.
What is the Proper Level of Taxation?
Now that we have defined the conditions under which a government is justified in imposing a special tax on tobacco and explained how that tax should be levied, the obvious question is what the level of taxation should be. In standard economic theory, a tax designed to compensate for a negative externality imposed on society should be levied on a per unit basis and should equal the difference between the social cost of the good (the cost to society at large) and the private cost (the cost to individual consumers). Therefore, if the social cost of tobacco consumption is greater than the total private cost, then the tax should be set at a level that will make the two costs equal, thereby improving overall societal well-being. The problem that governments face is calculating the social cost of tobacco and comparing it to the private cost. Often, those with certain agendas try to overstate the difference between the private cost and the social cost of tobacco in order to impose their principles of morality on everyone else. What constitutes a true cost to society is therefore always a subject of disagreement and should be carefully calculated. Policymakers should be clear about the factors involved in their calculations when they recommend a level of taxation.
Summary
Even if the goal of policymakers is to reduce tobacco consumption, in a free society this should be done solely for the purposes of correcting for social costs unfairly imposed on others, not to impose some individuals’ moral agenda on everyone else. Taxes should not be used to impose morality; social engineering through the tax code is never sound tax policy. Because the proper purpose of tobacco taxes is to correct for market imperfections, taxes should be levied only up to the point at which the tax per unit equals the difference between the social cost of a unit of tobacco and the private cost of a unit of tobacco. This can only be accomplished with per-unit excise taxes because the dollar value of the tobacco consumed is irrelevant with respect to reducing overall consumption of tobacco.
Footnote
1 Some economists will note that any healthcare cost imposed on society is technically a transfer that has been created by government through a quasi-socialized healthcare system. Moreover, while it is commonly assumed that individuals’ unhealthful habits must necessarily impose healthcare costs on society, this is not at all the case. A field of economics known as social cost accounting attempts to discern the aggregate fiscal effects of different types of behavior, and its findings are often counterintuitive. Smoking, for example, has been found to not impose healthcare costs on nonsmokers. To the contrary, current federal, state, and local fiscal regimes have been found to transfer tens of billions of dollars from smokers to nonsmokers. See, for example, Patrick Fleenor, “Who Bears the Ancillary Cost of Tobacco Use?,” Tax Foundation Background Paper, No. 36 (January 2001).