An April 2012 Government Accountability Office (GAO) report found that excise tax increases on certain tobacco products have resulted in dramatic shifts by manufacturers and consumers toward lower tax products. Specifically, the implementation of taxes on roll your own tobacco and small cigars have led to increases in production and consumption of pipe tobacco and large cigars. While the government has historically used tobacco taxes to raise revenue, GAO’s study revealed that these disparities in taxation instead decreased federal revenues.
In 2009, Congress passed the Children’s Health Insurance Reauthorization Act (CHIPRA), which increased federal excise taxes on cigarettes, roll your own tobacco, pipe tobacco and cigars. However, the taxes that were implemented on pipe tobacco and large cigars were much lower than those placed on other tobacco products, creating large disparities in tobacco taxation. According to the GAO, monthly sales of pipe tobacco increased from approximately 240,000 pounds in January 2009 to more than 3 million pounds in September 2011, while roll your own tobacco sales dropped from about 2 million pounds to 315,000 pounds. During the same period, large cigar sales increased from 411 million to more than 1 billion, while sales of small cigars dropped from 430 million to 60 million.
Adjusting to the tax changes was particularly easy for manufacturers because of the lack of distinction among tobacco products in the tax code. Producers of these products could shift their goods because the tax code differentiates between roll your own and pipe tobacco only by their appearance, their packaging, and their labeling. This allows manufacturers to simply re-label their products without having to make any substantive changes.
The categorization of cigars in the tax code is even less distinguishable. Small cigars are defined as weighing 3 pounds or less per thousand sticks, while every other part of the definition of large cigars is the same. Accordingly, a manufacturer can modestly change the weight of a cigar to adapt to the tax structure, while maintaining a nearly identical product. Because the only difference is a moderate size change, consumers are presented with a cheaper, essentially indistinguishable substitute.
The GAO found that as a result of these market shifts, the excise taxes produced far less revenue than was projected. Since CHIPRA was enacted in April 2009 through the end of fiscal year 2011, the Department of the Treasury brought in $40 billion in revenue. However, during the same period, the GAO estimates that the Treasury lost between $615 million and $1.1 billion in federal revenue due to manufacturer and consumer transitions from roll your own tobacco to pipe tobacco.
The findings of the GAO’s study further corroborate CAGW’s position on this issue: excise taxes almost never produce the projected revenue since they both change behavior and distort the free market by driving purchases to untaxed or lower-tax venues, such as Native American territories and the internet. Additionally, the Congressional Budget Office has reported that cigarette excise taxes are the most regressive type of excise tax and disproportionately impact the poor and those living on fixed incomes. In order to address budget shortfalls, state and federal lawmakers should avoid raising excise taxes and instead focus on eliminating wasteful spending and cutting taxes to spur economic growth.
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