Will tobacco tax estimate go up in smoke?

Revenue Commissioner Myron Frans notes that one objective of a higher cigarette tax is to discourage smoking, which makes state reliance on the new revenue tricky. Frans also notes that reducing cigarette use was the main reason Gov. Mark Dayton, who generally dislikes regressive taxes, eventually supported the increase. (Staff photo: Peter Bartz-Gallagher)

The consequences of raising the tax on a pack of cigarettes, as the Minnesota Legislature and Gov. Mark Dayton have now agreed to do, are no simple matter to sort out. This much is acknowledged by all.
As part of the tax bill passed in the final minutes of the 2013 session, the cigarette tax will be raised by $1.60 a pack. The resulting increase in revenue is expected to contribute more than $430 million in new general fund money.

If history is any guide, what follows such an action is a complex set of social, economic and behavioral reactions that bear heavily on a state’s budget, both in terms of health cost savings and increased revenue collections. The issue arises in dozens of states each year, and has been the subject of countless research projects, which often arrive at drastically different results.

“It is complicated,” admitted Revenue Commissioner Myron Frans, whose team of analysts and number-crunchers spent many hours calculating revenue estimates this year.

The department addresses cigarette revenues differently from virtually all other categories, given the dynamic nature of consumer behavior and the complicating factors. To name a few:

• An increase in the price of cigarettes will undoubtedly lead to a drop in the number of smokers.

• Others who continue to smoke will cut back to varying degrees, therefore making fewer purchases.

• Some smokers who live near neighboring states with cheaper prices will choose to cross the border and stock up on cartons to avoid the new tax.

• Still others will seek out black market cigarettes, which have in the past been transferred across state lines and resold in shops and under-the-table settings.

On top of these possible outcomes, there is also the underlying impetus behind the price increase: Namely, to get current smokers to quit, and prevent young people from ever picking up the habit. Indeed, Frans said this thinking was the main reason Dayton, who generally dislikes “sin” taxes for the regressive impact they have in hitting the poorest Minnesotans harder than others, eventually came around on the higher excise on cigarettes.

“The ultimate thing,” Frans said, “is that we do want these revenues to go down over time. But from a budgetary standpoint, we don’t want them to go down too quickly.”

Many states’ revenues short of projections

On numerous occasions this year, lobbyist Ward Einess, himself a former head of the revenue department, argued against the proposed cigarette tax hike on behalf of his client Altria Group, which most people know better by its former name, Phillip Morris Companies. In studying 28 recent cases of state-level increases, Altria found that revenues fell short of their projected levels 18 different times; on nine occasions, the tobacco revenues failed to hit 50 percent of estimated levels.

The case studies Altria puts forth include Iowa, which raised its per-pack price in 2008, and Wisconsin, which did so in 2008 and again in 2009. Combined, according to Altria’s figures, the two Wisconsin tax increases fell short by a total of $191 million.

For his part, Frans said he was “surprised” to find Einess warning of potential miscalculations in Minnesota’s revenue estimate.

“I’m surprised he’s not assuming we’re looking at those other states,” Frans said “We have one of the best research teams in the country.”

Revenue analysts’ calculations focused heavily on the impact that boosting the excise would have on consumer behavior, and Frans said he found legislators were appropriately curious about how sure the state could be in its numbers. On one issue likely to affect western Minnesota more than the eastern half, Sen. Ann Rest, DFL-New Hope, seemed resigned to dealing with some level of lost revenue. North Dakota’s $0.44 per-pack tariff is among the lowest in the country, and has not changed in the last decade.

“It’s not against the law to cross the border into North Dakota,” Rest said. On other concerns, such as possible black market sales the decrease in consumption, Rest said legislators were well aware of the risks.
In fact, in the case of less smoking, Rest said it was a major selling point in convincing the Senate, which had passed a $0.94 cent increase, to agree to the $1.60 spike approved on the House side.

“The advocates for it said that at the $1.60 per pack level, that is when you have the most impact on persuading people not to start,” Rest said. “They came in with research that indicated that.”

Estimates vary widely

Precisely how much usage will be curtailed depends on who is challenged with making an estimate. Frans said the state had calculated that the new price, which will raise the cost of cigarettes by about 30 percent, will lead to a 28.5 percent drop in consumption.

That’s significantly higher than the number put forth by University of Michigan School of Public Health Professor Kenneth Warner, who has studied the subject of price sensitivity on cigarette sales extensively. Warner predicted that a 30 percent increase in cost would, through a combination of youth smokers who never start and adults who quit or cut back, result in a drop in consumption between 9 percent and 12 percent.
As it turns out, Warner’s figure is quite a bit higher than the one offered by National Conference of State Legislatures (NCSL) health policy analyst Karmen Hanson. Hanson pointed to a projection from the Washington, D.C.-based Campaign for Tobacco Free Kids, which welcomed the passage of Minnesota’s tax bill by estimating that it would cut overall consumption by “about 4 percent.”

Both Hanson and Warner, whose approach to the topic has centered on smoking cessation and resulting health savings, said Minnesota’s new tax level should produce a short-term impact in alleviating state spending for tobacco-related illnesses.

“You will see systemic savings with a reduction in smoking,” said Hanson, who said the state should quickly see a drop in the number of hospital visits for asthma and other lung ailments.

Warner said children, and even low-income and destitute smokers, will react to a change in price by avoiding tobacco altogether or shrinking their current usage rates. He said the regressive effect of cigarette taxes is “a real [issue],” but argued that raising the tax is probably the single largest decision state lawmakers can make in cutting mortality rates among the poor.

“I always refer to cigarette taxes as an opportunity for legislatures to do good while they’re doing well,” said Warner, who has advised other states on their tobacco tariffs. “They do some public health good at the same time they’re doing well by the treasury.”

As for the local treasury, Frans said he will be eager to begin examining results after the tax level kicks in on July 1. But he admits that it’s probably best to withhold even preliminary judgment until the November economic forecast is compiled. “That,” he said, “might be the first time we feel like we’ve got a handle on both the consumption changes and the economic changes, and how they interact together.”