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Indexing Cigarette Taxes is Smart Public Policy

by | Jun 1, 2016 | Economy, Health Care, Taxes

The per pack cigarette tax in Minnesota is indexed (or adjusted annually) based on the change in the average cigarette retail price. As a result of indexing, the tax on a pack of cigarettes has risen from $2.83 in 2014 to $3.00 per pack in 2016 and will likely increase again next year. Opponents of indexing argue that it is unfair, since it pushes the Minnesota’s tax per pack—which is already above the national average—even higher. However, a strong case can be made that indexing cigarette taxes is a smart policy that advances the public good.

Nominal household income typically increases from year to year—and so too does the amount of dollars available for consumer purchases. Hence, any good that is frozen in price effectively becomes more affordable over time, since the amount of nominal purchasing power increases while the price of the good stays the same. The same logic applies to a tax that is frozen at a particular level per unit of purchase—such as the cigarette tax. A cigarette tax that is frozen at a particular level per pack actually decreases in real terms over time, as the level of nominal household income increases.

The cigarette tax increase enacted in 2013 is credited with a sharp decline in smoking among teens and a significant decline among adults, based on a 2015 MinnPost article. The reduction in smoking is particularly notable among low-income households, which are more price-sensitive and where smoking is more prevalent. By freezing the per pack tax, the level of the tax in real (i.e., inflation-adjusted) dollars will gradually decrease and the effect of the tax in deterring consumption among price-sensitive consumers will gradually diminish. The net result is likely to be increased smoking.

Increased smoking will result in an increase in the well-documented costs that cigarette smoking imposes on society. A 2010 Penn State study found that “the combined medical costs and productivity losses attributable to each pack of cigarettes sold [in Minnesota] are approximately $20.83 per pack [in 2009 dollars].” The use of a tax to discourage harmful activities and to generate revenue to offset the damage resulting from those activities has long been recognized as a legitimate and effective policy practice. The $3.00 per pack cigarette tax is certainly not excessive in comparison to the far greater cost per pack that cigarette smoking imposes on Minnesota’s healthcare system and overall economy.

Cigarette graph

Since 2009, the medical costs and productivity losses per cigarette pack have almost certainly increased, as healthcare and other costs have grown. Thus, the above chart likely understates the current gap between the cigarette tax per pack and the societal costs per pack associated with cigarette smoking. In the absence of indexing, the gap between the cigarette tax and the costs imposed on the state as a result of cigarette smoking will grow even larger over time. A strong case can be made that as the costs associated with cigarette smoking increase, so too should the cigarette tax.

Opponents of cigarette tax indexing argue that Minnesota’s high cigarette tax relative to other states leads to increased tax evasion, as smokers take illegal measures to circumvent the tax. Regarding this argument, two points should be made. First, the repeal of indexing will have only a marginal impact on the level of tax evasion, since the bulk of the tax increase resulting from the 2013 tax act (which is responsible for increasing the tax per pack from $1.60 to its current $3.00) will remain in effect. Second, the response to tax evasion should not be to repeal good tax policy, but to increase enforcement of that policy to make evasion more difficult.

It is undeniable that cigarette taxes are regressive, falling more heavily on lower income taxpayers than upper income taxpayers, and that the repeal of indexing will reduce the level of this regressive tax over time. While a reduction in tax regressivity is generally a good outcome, other policy goals must also be considered. By increasing the price of cigarettes, indexing results in reduced smoking, which in turn results in improved health, saved lives, and avoidance of medical costs and productivity losses associated with smoking—benefits which easily outweigh the slight impact that indexing has on overall Minnesota tax regressivity. As a state, there are many things we can do for low-income residents; increasing the affordability of addictive carcinogens should not be one of them.

The additional revenue generated by cigarette tax indexing is one—but certainly not the only or the most important—reason for continuing this policy. Indexing helps to ensure that the value of the cigarette tax as a deterrent to smoking among teens and other price-sensitive consumers does not erode over time. In doing so, indexing helps to improve health, prolong life, and reduce the steep medical and economic costs associated with cigarette smoking.

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