State Cigarette Excise Taxes: Implications for Revenue and Tax Evasion
State cigarette excise taxes have long been used to raise revenue,
curb smoking, and fund tobacco prevention and smoking cessation
programs. Recently, there has been a dramatic increase in the
average level of taxes and the number of states increasing their tax
rates. To better inform the debate over excise tax increases and
their impact on revenue and tax evasion, we examine the impact of
tax increases on cigarette sales and revenue from recent state
experiences. The following is a summary of the key findings:
Increasing state cigarette tax rates reduces smoking levels, especially among youth.
States that do not increase their tobacco tax rates lose tobacco tax revenue over time because of inflation and ongoing smoking declines.
States that significantly increase their tobacco tax rates gain tobacco tax revenue, despite related consumption declines, tax avoidance, and smuggling.
Although cigarette tax avoidance and smuggling increase somewhat after cigarette tax increases, they do not cause state revenues to decline but only reduce the size of the states' revenue gains from the tax increases.
Cigarette sales typically decline sharply immediately after a cigarette tax increase and then rise again to settle on a new sales level lower than the sales level before the increase. This pattern likely reflects a surge in tax avoidance efforts around the date of the tax increase, which subsequently subsides.
Organized smuggling accounts for the largest share of evaded state cigarette taxes, with Internet sales a growing threat. Cross-border purchases by state smokers account for only a relatively small portion of all state cigarette tax revenue reductions caused by tax evasion.
Curbing tobacco tax evasion offers states an opportunity to increase the additional revenues they receive from tobacco tax increases.
Since the beginning of 2002, 26 new state cigarette tax increases have been implemented and five more have been passed into law to go into effect on July 1, 2003. The average state cigarette tax rate as of July 1, 2003 is 68.3 cents per pack.