State Excise Taxation: Horse-and-Buggy Taxes In an Electronic Age

May 31, 2005

Download State Excise Taxation: Horse-and-Buggy Taxes In an Electronic Age

Background Paper No. 48

Executive Summary Selective excise taxes are already obsolete, but because government is always slow to change, they will die a slow death. In the meantime they will cause a great deal of harm, both to taxpayers and to the state governments who use them most.

Because many states have raised the cigarette tax rate precipitously during the last 10 years, this particular excise tax is putting on a clinic, so to speak. It is demonstrating to any dispassionate observer that the greater mobility of people and goods, along with instant communication, have made excise taxes obsolete. This is especially true of the cigarette tax because the product is lightweight, compact and highly taxed.

Cigarette excise taxes only function as a predictable, untroublesome tax at a low tax rate. States that have raised their cigarette tax to the point that it is 50 cents per pack higher than a readily available, alternative source are discovering a host of problems:

  • Revenue estimates are rarely met, causing budget problems.
  • Bonds sold against future master settlement revenues are unattractive except at preposterously high interest rates, and even then they are downgraded by the rating agencies.
  • In a replay of Prohibition-era social decay, law-abiding citizens learn to break the law routinely, and states respond by adopting intrusive and sometimes abusive tactics to catch them.
  • Organized criminals and terrorist cells begin trafficking in smuggled cigarettes, and the states spend prodigiously to catch them, with almost no success.
  • Businesses and jobs, along with their tax revenue on income, sales and property, are lost to interstate competition.

The growth of these destructive consequences brings state governments to a crossroads. In one direction: state governments that use increasingly invasive, threatening, expensive and ultimately futile tactics to enforce high tax rates. In the other direction: innovative, service-oriented state governments that know they must compete with their neighboring jurisdictions, that they are evaluated by citizens according to their willingness to support the services that government offers with tax payments.

Tobacco taxation is a severe form of tax discrimination whose victims reside primarily among the working classes and not professional people. It is tax discrimination against people of modest means for the benefit of the well-to-do.

Revenues from the master settlement are declining because they are linked to taxable sales that are dropping precipitously because of high state cigarette tax rates. A vicious cycle is created where states react to lower-than-expected revenue with sharp tax increases which, in turn, drive down settlement revenue and make revenue estimates less reliable by pushing smokers to cross state borders for lower-taxed cigarettes or into the underground economy.

The inaccuracy of revenue estimates for tobacco tax hikes obviously creates difficulties for state fiscal planning. That inaccuracy, moreover, will surely grow as the tax rates climb, and the rate of taxed sales is further and further divorced from the rate of tobacco consumption.


Topics


About the Author


Related Research