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In the United States, tobacco is taxed by federal, state, and local governments. Tobacco products are taxed in two ways: the unit tax, which is based on a constant nominal rate per unit (that is, per pack of cigarettes), and the ad valorem tax, which is based on a constant fraction of either wholesale or retail price. Currently, federal taxes on cigarettes, small cigars, and smokeless tobacco products are unit taxes; federal taxes on large cigars are ad valorem taxes. In 1993, all states and most localities used a unit tax for taxing cigarettes and ad valorem taxes for non-cigarette tobacco products.  In 1993, consumer excise taxes on tobacco generated more than $12 billion in tax revenue, 98% of which was derived from taxes on cigarettes.1

Historically, governments have levied tobacco taxes to generate revenues. Increasingly, however, taxation of tobacco products is being recognized as an effective strategy to discourage tobacco use and enhance public health.2 This chapter of the report reviews the history of tobacco taxation in the United States, compares tobacco tax policy in the U.S. with policies in other industrialized countries, and reviews evidence regarding the impact of tobacco taxation on overall consumption and on tobacco use by adolescents specifically. The chapter concludes with a discussion of arguments for and against using tobacco taxes as a strategy to discourage adolescent tobacco use in the United States.

TOBACCO TAXES IN THE UNITED STATES

Federal Tobacco Taxes

Tobacco was one of the first consumer goods to be taxed in North America, first by the British and then by the newly independent republic in the early



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Page 177 In the United States, tobacco is taxed by federal, state, and local governments. Tobacco products are taxed in two ways: the unit tax, which is based on a constant nominal rate per unit (that is, per pack of cigarettes), and the ad valorem tax, which is based on a constant fraction of either wholesale or retail price. Currently, federal taxes on cigarettes, small cigars, and smokeless tobacco products are unit taxes; federal taxes on large cigars are ad valorem taxes. In 1993, all states and most localities used a unit tax for taxing cigarettes and ad valorem taxes for non-cigarette tobacco products.  In 1993, consumer excise taxes on tobacco generated more than $12 billion in tax revenue, 98% of which was derived from taxes on cigarettes.1 Historically, governments have levied tobacco taxes to generate revenues. Increasingly, however, taxation of tobacco products is being recognized as an effective strategy to discourage tobacco use and enhance public health.2 This chapter of the report reviews the history of tobacco taxation in the United States, compares tobacco tax policy in the U.S. with policies in other industrialized countries, and reviews evidence regarding the impact of tobacco taxation on overall consumption and on tobacco use by adolescents specifically. The chapter concludes with a discussion of arguments for and against using tobacco taxes as a strategy to discourage adolescent tobacco use in the United States. TOBACCO TAXES IN THE UNITED STATES Federal Tobacco Taxes Tobacco was one of the first consumer goods to be taxed in North America, first by the British and then by the newly independent republic in the early

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Page 178 1790s. Federal taxes on tobacco have been part of the federal tax system since the Civil War. Between 1864 and 1983, the federal tax on cigarettes has fluctuated in response to the revenue requirements of the government, corresponding mainly to alternating periods of war and peace.3 In 1951, the federal cigarette excise tax was increased from 7 cents to 8 cents per pack to help finance the Korean War. The federal cigarette tax was not increased again until 1983, when it was doubled to 16 cents per pack. In January 1992 the federal tax on cigarettes was increased from 16 to 20 cents per pack, with another 4 cents per pack added in January 1993. In 1985, the federal government levied a tax of 24 cents per pound on snuff, 8 cents per pound on chewing tobacco, and 45 cents per pound on pipe tobacco. As of 1993, federal taxes on snuff, chewing tobacco, and pipe tobacco are 36, 12, and 67.5 cents per pound, respectively.4 State and Local Tobacco Taxes All 50 states, the District of Columbia, and 440 cities, towns, and counties levy taxes on cigarettes.5 (See table 6-1.) In addition, 40 states impose taxes on tobacco products other than cigarettes. In 1921, Iowa became the first state to tax cigarettes; in 1969, North Carolina was the last state to enact a cigarette excise tax.6 In addition to the excise tax on cigarettes, 43 states have general sales taxes that apply to cigarettes. In all but 4 of these 43 states, the sales tax base includes the excise tax, adding between 6 cents and 14 cents to the price of a pack of cigarettes.7 With few exceptions, the imposition of, and increases in, state tobacco taxes are the result of the need to raise revenues. However, the level of tax imposed appears to be influenced by how dependent a state is on tobacco production. For example, in 1992, the average cigarette tax in non-tobacco-producing states was 19 cents higher than in large tobacco-producing states.8 Recently, public health advocates in several states have attempted to increase tobacco taxes through ballot initiatives. In November 1988, California voters passed Proposition 99, which increased the state cigarette excise tax from 10 cents to 35 cents per pack and earmarked 20% of the additional revenue raised for a statewide antismoking campaign.9 Similarly, in November 1992, voters in Massachusetts passed an initiative to increase the tax on cigarettes by 25 cents per pack and on chewing tobacco by 25%. In addition to state excise taxes, over 440 local jurisdictions in 9 states also levy taxes on tobacco products. In 1993, 440 cities and counties imposed taxes on cigarettes, while 82 cities and counties levied taxes on non-cigarette tobacco products. 10 Differences in cigarette tax rates among states and localities can create problems in the enforcement of tax laws. A 1977 report by the Advisory Commission on Intergovernmental Relations identified a variety of tax evasion strategies including casual smuggling (that is, individuals buying cigarettes in neighboring

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Page 179 TABLE 6-1  State cigarette excise tax rates (as of November 1993) State Tax per pack (cents)   State Tax per pack (cents) DC 65.0   NH 25.0 HI 60.0   KS 24.0 NY 56.0   DE 24.0 WA 54.0   OH 24.0 MA 51.0   OK 23.0 MN 48.0   SD 23.0 CT 47.0   NM 21.0 ND 44.0   LA 20.0 TX 41.0   CO 20.0 NJ 40.0   AZ 18.0 RI 37.0   MT 18.0 ME 37.0   MS 18.0 IA 36.0   VT 18.0 MD 36.0   ID 18.0 CA 35.0   WV 17.0 NV 35.0   AL 16.5 AR 34.5   IN 15.5 FL 33.9   MO 13.0 PA 31.0   TN 13.0 IL 30.0   WY 12.0 AK 29.0   GA 12.0 OR 28.0   SC 7.0 NE 27.0   NC 5.0 UT 26.5   KY 3.0 MI 25.0   VA 2.5 states with lower taxes), purchase of cigarettes through tax-free outlets such as military stores and American-Indian reservations, commercial smuggling for resale, and illegal diversion of cigarettes within the traditional distribution system by forging tax stamps and underreporting. During the late 1960s and early 1970s, as the differential between state cigarette tax rates increased, organized smuggling and illegal diversion of cigarettes from the legal distribution system also increased.11 In response to this problem, the Federal Cigarette Contraband Act was enacted. This law prohibits the transportation, receipt, shipment, possession, distribution, or purchase of more than 60,000 cigarettes not bearing the indicia of the state in which the cigarettes were found. A 1985 study by the Advisory Commission on Intergovernmental Relations concluded that the Cigarette Contraband Act had markedly reduced organized interstate smuggling of cigarettes. 12 However, the casual smuggling of cigarettes from neighboring states and the purchasing of cigarettes from tax-free outlets continues to be a problem for many states with high cigarette taxes. 13 A recent analysis of tobacco product sales at U.S. military stores found that sales are strongly influenced by the price gap between nonmilitary retail outlets and military stores.14

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Page 180 Trends in Cigarette Prices, Taxes, and Affordability Figure 6-1 shows the federal and state cigarette taxes (actual costs) and pack prices between 1955 and 1993 in the United States. This figure illustrates the growing discrepancy between taxes and pack price. In 1955, the average price of a pack of cigarettes was 23 cents, of which 11 cents (48%) was due to taxes. As of November 1, 1993, the average price per pack of cigarettes was $1.79, of which 53 cents was due to taxes (30%). Figure 6-1 also shows that the average state excise tax on cigarettes has increased by more (3 cents to 29 cents) than the federal tax (8 cents to 24 cents) since 1955. Because excise taxes on cigarettes in the United States are unit rather than ad valorem taxes, inflation reduces the real value of the tax relative to the price. Figure 6-2 shows trends in cigarette taxes and pack prices adjusted for inflation. FIGURE 6-1  Source: Tobacco Institute. The Tax Burden on Tobacco. Washington, D.C.: Tobacco Institute, 1994.

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Page 181 FIGURE 6-2  Source: Tobacco Institute. The Tax Burden on Tobacco. Washington, D.C.: Tobacco Institute, 1994. Overall, taxes today have failed to keep pace with inflation and therefore are less, in real value, than they were in 1955. As seen in figure 6-2, although the actual tax amount increased by 16 cents from 1955 to 1993, the real value of the federal tax on cigarettes in 1993 is only worth about 56% of what it was in 1955. Overall, the combined real value of federal and state taxes amounts to 88% of what they were in 1955. Interestingly, the real price of a pack of cigarettes is about 43% higher today than in 1955; thus, the higher price of cigarettes today is the result of price increases from tobacco manufacturers, not taxes. In order to appreciate economic incentives or disincentives to use tobacco products, one must consider not only price changes but also price affordability. Over the past half century, tobacco has become increasingly more affordable to consumers in the United States because of rising income. 15 Table 6-2 shows

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Page 182 changes in the affordability of cigarettes in the United States between 1955 and 1990, using 1955 as the base year. Until the 1980s, the affordability of cigarettes increased because of the declining real price of cigarettes. Between 1985 and 1990, tobacco manufacturers increased cigarette prices in excess of the rate of inflation and consumer income.  Thus, there was a sharp decline in the affordability of cigarettes, although prices remained more affordable than in 1955. The lower affordability of cigarettes in the 1980s corresponds with a decline in consumption.  As illustrated in table 6-2, the lower cigarette affordability since 1985 had little to do with government taxes; total taxes on a pack of cigarettes were no less affordable in 1990 than in 1980. More significantly, total taxes were 60% more affordable in 1990 than in 1955. In 1993, cigarette manufacturers, led by Philip Morris, Inc., implemented major price cuts on premium brand cigarettes, significantly increasing their affordability. Trends in Cigarette Tax Revenues and Sales The dollar amount of tobacco tax revenue (combined federal and state) increased from $2 billion in 1955 to $12 billion in 1993. However, when these figures are adjusted for inflation they show a decline: federal tobacco tax revenues have fallen dramatically, from a peak of $9.5 billion (expressed in 1993 dollars) in 1963 to $5.5 billion in 1993. The decline in revenues from tobacco taxes partly reflects a steady drop in per capita cigarette consumption since the mid-1970s. However, the primary reason for the declining revenues is the fail- TABLE 6-2 Changes in the affordability of a pack of cigarettes in the United States between 1955 and 1990, using 1955 as the base year   % Change in affordability relative to 1955   Year Federal taxes State and federal taxes Average pack price 1955 0% 0% 0% 1960 +14% -1% +4% 1965 +33% +2% +13% 1970 +51% +15% +17% 1975 +67% +43% +32% 1980 +80% +61% +45% 1985 +71% +57% +35% 1990 +78% +60% +23% Note: ''+" indicates an increase in affordability relative to 1955; "-" indicates a decrease in affordability relative to 1955. Source: Non-smoker's Rights Association of Canada, 1992.

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Page 183 FIGURE 6-3  Source: Tobacco Institute. The Tax Burden on Tobacco. Washington, D.C.: Tobacco Institute, 1994. ure of the federal government to adjust cigarette tax rates to keep pace with inflation. For example, figure 6-3 shows that the decline in federal tobacco tax revenues occurred despite the fact that total cigarette sales were nearly identical in 1993 and 1963. As a result of inflation, declining consumption, and identification of other revenue sources, tobacco taxes at both the federal and state levels now account for a significantly smaller share of total revenues compared to 40 years ago.16

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Page 184 TAX RATES IN OTHER INDUSTRIALIZED COUNTRIES Among industrialized countries of the world, the United States has one of the lowest tax rates on cigarettes (see table 6-3). In two countries, taxes are now above $3 per pack—Denmark ($3.48) and Norway ($3. 11). In the United States, the average combined federal and state tax on cigarettes in 1993 was 53 cents per pack. The combination of lower cigarette taxes and a higher standard of living (that is, more money to spend on goods) makes cigarettes much more affordable for Americans than for persons in nearly all other industrialized countries. TABLE 6-3  Average retail selling price, total taxes, and percentage tax of average retail price for a pack of 20 cigarettes in 24 selected countries as of December 1, 1993 Country Total taxes (U.S.$) Average retail price (U.S.$) Tax (% of retail price) Denmark $3.48 $4.11 85 Norway $3.11 $4.55 68 Canada $2.90 $4.22 69 United Kingdom $2.85 $3.68 77 Ireland $2.68 $3.55 75 Sweden $2.43 $3.33 73 Finland $2.28 $3.08 74 Germany $2.04 $2.86 71 New Zealand $1.93 $2.85 68 France $1.70 $2.33 75 Belgium $1.70 $2.31 73 Netherlands $1.65 $2.28 72 Hong Kong $1.50 $2.78 54 Japan $1.21 $2.02 60 Luxemburg $1.19 $1.76 68 Portugal $1.17 $1.48 79 Italy $1.16 $1.60 73 Switzerland $1.04 $2.07 50 Argentina $0.96 $1.37 70 Greece $0.78 $1.13 69 Taiwan $0.62 $1.31 47 United States $0.56 $1.89 30 Korea $0.45 $0.74 60 Spain $0.42 $0.63 66 Source: Non-Smokers' Rights Association of Canada, 1993.    

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Page 185 EFFECT OF EXCISE TAXES ON CONSUMPTION It is well recognized in economic theory, as well as in everyday life, that purchasing decisions are influenced by price.17 Economists use a particular measure, termed "price elasticity," to judge the degree to which the demand for a product is responsive to its price. The price elasticity of demand is defined as the percentage change in consumption that results from a 1% change in price; for example, a price elasticity of -0.5 implies that a 10% increase in price would reduce consumption by 5%. Because of the addictive qualities of tobacco, some researchers have speculated that consumption of cigarettes will be insensitive to price changes at least in the short run.l8 However, numerous studies, using a variety of methodologies, have shown that overall consumption of cigarettes is responsive to price changes.19 Estimates of the price effect vary, but generally speaking a 10% increase in the real price reduces consumption by around 4%.20 Decreases in consumption occur both because some people choose not to smoke and because some smokers choose to smoke fewer cigarettes. Studies estimate that approximately two-thirds of the decreased consumption is the result of people choosing not to smoke at all.21 Conversely, a decline in the real price of tobacco leads to increased consumption. An analysis of Finland's cigarette consumption between 1960 and 1987 found that the demand for cigarettes was twice as sensitive to falling prices as to rising prices.22 An estimate of the impact of tax increases on consumption must account for the extent to which taxes are incorporated into the price of cigarettes, since cigarette taxes account for only a share of the total retail price of cigarettes. Increases in excise taxes are usually passed on to consumers.23 Thus, to determine the effect of a tax change, the price elasticity of demand must be multiplied by the percent change in price resulting from the tax change. In addition to taxes, the retail price of tobacco products is determined by the manufacturer's costs and profits and wholesale and retail markups. For example, Harris argues that most of the decline in U.S. cigarette consumption during the mid-1980s resulted from increases in the wholesale prices of cigarettes because of markups from manufacturers, not from increases in federal and state taxes.24 While numerous studies have investigated the impact of cigarette taxes on consumption, only a few studies have attempted to estimate the impact of increased cigarette taxes on the consumption of non-cigarette tobacco products. In Finland, Pekurinen found that the most important factor influencing demand for pipe tobacco was the price of cigarettes.25 Similarly, in Canada consumption of fine-cut tobacco (used to make roll-your-own cigarettes) increased in relationship to the widening price gap between cigarettes and fine-cut tobacco.26 It is possible that the increased popularity of smokeless tobacco seen among male adolescents in the United States during early 1980s may have resulted in part from higher cigarette prices. In other words, at least for male adolescents, there

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Page 186 may be a significant degree of substitutability between cigarettes and smokeless tobacco; however, no studies have actually tested this hypothesis. The Canadian Experience The Canadian experience with raising tobacco taxes during the past decade provides a useful model for predicting the impact of tobacco tax increases in the United States.27 Canada, like the United States, has a federal system of government; in both countries the national and state/provincial governments levy taxes on tobacco products. In the early 1980s, federal taxes on tobacco products in Canada were modest, not unlike the current tax rate in the United States. Since 1985, there have been three significant increases in the federal cigarette tax in Canada, raising the tax from 32 cents (U.S. dollars) in 1984 to $1.45 (U.S. dollars) per 20 cigarettes in 1992. During the same period, provincial governments also dramatically increased taxes on tobacco, raising the combined average federal and provincial tax to close to $3 ($2.91 in U.S. dollars as of December 1993) and the average price of 20 cigarettes to over $4 ($4.22 in U.S. dollars as of December 1993).28 In addition to increases in cigarette taxes, federal and provincial governments implemented other measures to limit smoking, including banning smoking in public buildings and prohibiting tobacco advertising on billboards, at the point of purchase, and at sporting events.29 Between 1982 and 1992, total per capita cigarette consumption in Canada, adjusted for estimates of tobacco smuggling, fell by 38%.30 An analysis comparing the slope of the decline in per capita tobacco consumption in the United States and Canada reveals that during the 1980s consumption dropped 30% faster in Canada than in the United States.31 A 1991 independent investment research report on Imperial Tobacco, the largest of the three Canadian tobacco manufacturers, concluded that a large share of the reduction in cigarette consumption in Canada between 1982 and 1990 could be attributed to price increases in cigarettes, primarily from higher federal and provincial taxes.32 The report also concluded that prices still are a major determinant of levels of smoking and that there is no indication that consumption was less responsive to price increases in 1991 than in 1980. Declines in cigarette smoking prevalence have mirrored trends in per capita sales. Between 1979 and 1991, prevalence of regular smoking among Canadians over age 14 decreased from 38% to 26%.33 The most recent analysis of Canadian price sensitivity for tobacco, prepared by the Canadian Department of Finance, reports an increasing elasticity as prices have increased. The findings from this study are of interest for several reasons. First, the price elasticity of demand for tax-paid cigarettes was significantly higher than found in most other studies. In 1991, it was estimated that a 10% increase in the real price of cigarettes would lead to a short-term 9% decline in consumption.34 Second, contrary to the findings of other economic studies,35 the

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Page 187 price elasticity of demand for cigarettes tended to be more inelastic in the long run (-0.7) than in the short run (-0.9), although the level is still higher than found in most other studies (range -0.2 to -0.5). The report speculates that Canadian smokers may have initially reacted to price increases either by reducing the amount smoked or by quitting. However, over time, the addictive nature of tobacco leads some of these individuals to return to their past consumption levels. Third, the study found a significant degree of substitutability between cigarettes and fine-cut tobacco. Since 1980, both price and tax increases have widened the price differential between cigarettes and fine-cut tobacco. As a result, some smokers have switched from cigarettes to cheaper, fine-cut (roll-your-own) tobacco products. The analysis estimates that a 10% increase in the price of cigarettes led to a 13% increase in the sales of tax-paid fine-cut tobacco. Fourth, exports and smuggling of cigarettes increased as a result of tax hikes. Between 1985 and 1991 there was a large increase in the number of seizures of illicitly imported tobacco products, indicating that smuggling had become a problem in Canada. In February 1994, the Canadian government announced plans to cut the tax on tailor-made cigarettes by 30% and increase the export tax as a way of reducing illegal smuggling of cigarettes from the United States into Canada. Finally, the study found that tobacco taxes were particularly important in discouraging younger Canadians from smoking. A comparison of the smoking habits of teenagers and adults showed that younger Canadians were more sensitive to price changes than adults. Overall, the study concluded that "On balance, federal tax increases since 1985 have resulted in a net decline in overall tobacco consumption in Canada."36 Adolescents' Sensitivity to Price The issue of whether adolescents respond differently than adults to changes in tobacco prices is of interest for several reasons. First, as noted in chapter 1, the vast majority of adult smokers began their smoking careers before they turned 21; therefore, there is a good chance that persons who have not started smoking by age 20 will never smoke. Second, preventing people from starting to smoke is likely to be the most effective approach in the long term for reducing the health problems associated with tobacco use. Finally, there is good reason to expect that adolescents are more price sensitive than adults because they are less addicted to smoking (that is, they smoke fewer cigarettes per day) and have less disposable income (that is, cigarettes are less affordable for them).37 A teenager in a focus group conducted under the auspices of the Committee illustrated the effect of a tax increase on cigarettes as follows: "Major . . . Sure, they'll buy them every once in a while, and they start thinking: running out of money. No money to go to the movies, no money for gas or whatever." Only a few studies have examined the question of whether cigarette price increases affect teenagers differently than adults.38 In the United States, three

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Page 188 studies have investigated adolescents' sensitivity to cigarette prices. The largest of these studies utilized data from Cycle III of the Health Examination Survey conducted between 1966 and 1970 to study the effects of cigarette prices, advertising restrictions, and sociodemographic factors on the cigarette smoking behavior of 5,308 teenagers between the ages of 12 and 17. The study found that cigarette prices had a significant effect on the smoking behavior of teenagers.39 Moreover, the estimated price elasticity of demand observed among teenagers of -1.4 was roughly three times higher than that estimated for adults in a separate study conducted by Lewit and Coate.40 Results from a study41 utilizing national surveys on drug abuse conducted between 1974 and 1979 to estimate the effects of cigarette price on adolescent smoking behavior confirmed the 1981 finding by Lewit and colleagues42 that the smoking behavior of teenagers is negatively related to the price of cigarettes. The summary price elasticity of demand of -0.76 observed for teenagers in this study is also higher than that usually found for adults, implying that teenagers are more responsive to price than adults. However, a more recent study, utilizing data collected in the Second National Health and Nutrition Examination Survey (1976-1980), failed to find a statistically significant effect of cigarette prices on cigarette smoking by youths aged 12 through 17.43 The authors speculate that one reason for the lack of association between price and consumption was the inclusion in their cigarette demand model of an index that captured state regulations limiting smoking in public locations; this regulation index highly correlated with price. The index measuring state antismoking regulations was found to have a significant effect on cigarette consumption by teenagers, leading the authors to conclude that restrictions on indoor smoking may have a greater impact on preventing youths from initiating smoking than do increases in cigarette prices. However, critics of this study point out that antismoking regulations are not likely to have any direct impact on youths because youths spend most of their time in school; instead, the regulation may merely reflect the level of antismoking sentiment in a region.44 Other critics point out that the study did not take into account the rapid market growth of discount cigarettes in the United States during the late 1970s and 1980s, which offered price-sensitive consumers a range of very cheap products.45 Because of the wide differential in price between discount and premium brands, average retail price (used in the study to measure price) may not be an accurate indicator of actual price, since price-sensitive consumers would presumably gravitate toward lower-priced products.46 However, while this argument may be valid for adults, it is not likely to hold true for teenagers in the United States, 90% of whom report smoking one of three premium cigarette brands: Marlboro, Newport, or Camel.47 The conflicting results of the few U.S. studies that have examined the impact of cigarette prices on consumption by adolescents, including possible substitution of smokeless tobacco products in response to higher cigarette prices, reinforce the need for new research to

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Page 189 assess the potential for using higher tobacco taxes to deter adolescent tobacco use. The Canadian experience in raising tobacco taxes during the 1980s provides useful data for comparing the price sensitivity of teenagers and adults. An analysis comparing the cigarette smoking prevalence and average daily consumption of Canadian teenagers (ages 15-19) and the total population (over age 15) between 1980 and 1989 found that the decline in smoking prevalence among teenagers was steeper than for the total population.48 Teenage smoking declined by 52%, from 45% to 22% between 1980 and 1989, while smoking in the total population age 15 and older declined by only 23% (from 41% to 31%). Figure 6-4 illustrates the price sensitivity of Canadian teenagers by juxtaposing teenage smoking trends between 1979 and 1991 with changes in the average retail price for 20 cigarettes. FIGURE 6-4  Source: Sweanor, David T., L. R. Martial, and J. B. Dossetor. The Canadian Tobacco Tax Experience: A Case Study. Ottawa, Ontario: The Non-Smokers' Rights Association of Canada and the Smoking and Health Foundation of Canada, 1993.

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Page 190 In addition to changes in the proportion of teenagers smoking, there has been a dramatic change in the pattern of smoking by Canadian teens. From 1979 to 1991, there has been a 62% decline (from 42% to 16%) in the percentage of 15- to 19-year-olds who report daily (or regular) smoking. Conversely, there has been an increase in the percentage of young Canadians who report smoking occasionally.49 It appears that many of Canada's young people have reduced tobacco use in response to the comprehensive set of tobacco control measures, which have included large increases in cigarette taxes. However, Sweanor and colleagues caution that reductions in tobacco prices or increases in personal income may result in many occasional smokers becoming regular smokers in the future, and argue that ". . . the trend toward occasional smoking makes a strong case for continued tax increases and ancillary tobacco control strategies."50 A 1992 study attempted to evaluate teenagers' perceptions of the impact that cigarette price increases would have on their smoking behavior.51 Approximately 8,000 14- and 15-year-olds located in Erie County, New York, were asked to indicate what impact increases of 10 cents and of $1 in the price of cigarettes would have on their decision to smoke. Not surprisingly, a 10-cent increase in the price of a pack of cigarettes was perceived not to be a large deterrent to smoking, especially among current daily smokers. However, over one-third of the teenagers reported that a $1 increase in the price of a pack of cigarettes would make them less likely to smoke. Interestingly, those most at risk of becoming regular smokers (that is, nonsmokers who said they expect to smoke in the next year and those who already report smoking occasionally) were most likely to report that a $1 price increase would make it less likely that they would smoke. The findings from this study suggest that teenagers themselves perceive sizable price increases on tobacco products to be an important deterrent to tobacco use. This perception was also confirmed in focus groups conducted under the Committee's auspices. The following statement by one teen represents the opinion expressed by many of the teens: "A $2 increase in the price would definitely stop a lot of teens from smoking. Kids have better ways to spend $5 than on cigarettes. A 50-cent increase wouldn't make any difference. " ARGUMENTS FOR AND AGAINST HIGHER TOBACCO TAXES The data from research on the relationship between cigarette prices and cigarette consumption support the conclusion that substantial increases in cigarette excise taxes will reduce cigarette smoking.52 The higher price of tobacco products would encourage individuals to stop smoking or to smoke less, and would discourage children and youths from initiating smoking. Despite the fact that only a few studies have actually examined the relationship between

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Page 191 cigarette prices and smoking by youths, most health economists conclude that the price responsiveness of adolescents is likely to be at least as high as for adults, if not higher.53 Therefore, it is reasonable to suppose that raising tobacco taxes in the United States to the levels current in areas such as Canada, Scandinavia, and the United Kingdom could significantly reduce tobacco consumption and related disease in future generations. For example, it has been estimated that if Congress were to raise the federal cigarette tax by $2 per pack and maintain this tax in real terms, tobacco use would decrease by 23% (approximately 7 million fewer smokers).54 In addition to the health benefit, other potential benefits support the argument for large increases in tobacco taxes in the United States. Because tobacco taxes are relatively low, higher taxes would generate large increases in revenue even while smoking rates decline. The United States could raise an additional $35 billion annually from tobacco taxes before consumption rates would drop to a point where tax revenues would begin to decline.55 Obviously, while no tax is desirable, the simple fact is that governments need money to operate, and they acquire that money through taxation. Some taxes can have undesirable effects; for example, income taxes might discourage working, and investment taxes might discourage savings. However, high taxes on tobacco products are desirable because they would discourage use of the nation's leading cause of preventable death.56 Opinion polls and the recent successful ballot initiatives in California and Massachusetts indicate that the public is willing to support substantial increases in tobacco taxes.57 The level of public support for higher tobacco taxes tends to increase when revenues from those taxes are earmarked for specific purposes such as deficit reduction or health care financing.58 In 1992, seven states were using cigarette tax revenues to finance tobacco-related public health programs.59 Opponents of tobacco taxes argue that these taxes are undesirable because they unfairly affect the poor. A 1990 report by the Congressional Budget Office supports the widely held belief that tobacco taxes are regressive. Data from the 1984-1985 Consumer Expenditure Survey were used to relate expenditures for tobacco products with income. Results showed that families in the lowest income quintile spend 4% of their post-tax income on tobacco, whereas families in the highest quintile spend only 0.5% of their post-tax income on tobacco.60 Only a few studies have attempted to evaluate differences in price elasticity of demand for tobacco between income groups. A study in the United Kingdom found a greater sensitivity to cigarette prices among people with lower incomes.61 A recent study in the United States, however, failed to find a significant relationship between price elasticity and income, but did show that the estimated income elasticities have changed in this country over time from positive to negative; that is, cigarette consumption tends to be lower at higher income levels.62 The growth of discount cigarette brands in the United States during the past decade, mentioned above, may be masking differences between income groups in response to

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Page 192 price changes.63 The regressiveness of tobacco taxes is a valid concern. On the other hand, the burden of illness and death caused by tobacco is borne to a greater extent by the poor.64 For the poor as a class, the hardship imposed by steep increases in tobacco prices produced by higher tobacco taxes is arguably outweighed by the reduction in suffering and premature death resulting from lower consumption of tobacco. Moreover, revenues generated through higher tobacco taxes could be earmarked for health care for the indigent, thus offsetting the regressivity of tobacco taxes.65 Loss of tobacco-related jobs and the potential economic consequences of such job loss on the economy is another argument used to oppose increases in tobacco taxes.66 However, of the 2.3 million jobs claimed by the Tobacco Institute to be dependent on tobacco,67 only 11% are directly involved in growing, warehousing, manufacturing, or wholesaling tobacco products. The remaining 2 million jobs are in sectors of the economy (retailing, supplier jobs) that have no relation at all to tobacco.68 Money not spent on tobacco products because of a tax increase would not disappear from the economy, but would be redirected to non-tobacco goods and services, creating employment and tax benefits in other sectors of the economy.69 Even in tobacco-growing states, such as North Carolina, the economic impact of a tobacco tax increase is likely to be fairly small as a share of total economic activity.70 CONCLUSIONS AND RECOMMENDATIONS The consumption of tobacco products is strongly related to their affordability. If tobacco is made less affordable by higher prices resulting from higher taxes or other reasons, consumption will tend to decline, especially among children and youths, whose smoking habits are not firmly established. Therefore, policymakers have an effective means available to them—increasing the real price of tobacco by increasing excise taxes—to reduce the consumption of tobacco by youths and thereby to reduce the health toll of tobacco use in future years. Despite the rather obvious relationship between consumption and affordability, the federal government and most state governments have given little attention to the role of pricing in controlling tobacco consumption. Evidence from Canada,71 New Zealand,72 and the United Kingdom73 lead the Committee to the conclusion that pricing policy is perhaps the single most important element of an overall comprehensive strategy to reduce tobacco use, and particularly to reduce use among children and youths. This evidence leads the Committee to make the following five recommendations for changing how tobacco products are taxed in the United States: 1. Tobacco tax policies at the federal and state levels should be linked to the national objectives for reducing tobacco use. In other words, government policymakers should use tobacco taxes as an intervention to accomplish these health goals.

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Page 193 2. The excise tax on cigarettes should be increased to a level comparable with that in other major industrialized countries. A reasonable target would be to increase the federal cigarette tax by $2 by 1995. Accomplishing this objective would also have the added benefit of reducing illegal smuggling of tobacco products between Canada and the United States. 3. All tobacco products should be taxed on an equivalent basis. For example, when cigarette taxes are increased, taxes on non-cigarette tobacco products should also be increased on an equivalent basis to discourage substitution of one harmful form of tobacco for another (such as smokeless tobacco). 4. The real value of tobacco taxes should be maintained to account for inflation over time. Optimally, tobacco tax policy should take into consideration the affordability of tobacco products to prevent tobacco from becoming more affordable. 5. Tobacco products in U.S. military stores should be priced at the same rate that exists in the surrounding community. This policy change would have an effect on the smoking behavior of military personnel, many of whom are young adults. Also by eliminating the price differential between military and nonmilitary retail outlets, the incentive for illegal smuggling of tobacco products out of military bases would be eliminated. While the Committee feels that the empirical evidence is sufficiently developed to make these five recommendations, at the same time the Committee acknowledges the need for additional research to understand better the impact of tobacco pricing on consumption by youths and the benefits of various taxation policies. For this reason, the Committee recommends that the National Institutes of Health should allocate resources to support research on tobacco tax questions. A summary discussion of research issues on tobacco taxation policy, and of priority areas for future research, is presented in a 1992 report by a study group formed as a result of meetings convened on the topic of tobacco policy research.74 REFERENCES 1. Tobacco Institute. The Tax Burden on Tobacco. Washington, DC: Tobacco Institute. 1993. 2. Lewit, Eugene M., and Douglas Coate. ''The Potential for Using Excise Taxes to Reduce Smoking." Journal of Health Economics 1 (1982): 121-145: Warner, K. E. "Cigarette Taxation: Doing Good by Doing Well." Journal of Public Health Policy 5 (1984): 312-319: National Cancer Institute. Cancer Control Science Program, Division of Cancer Prevention and Control. The Impact of Cigarette Excise Taxes on Smoking Among Children and Adults. Summary Report of a National Cancer Institute Expert Panel. 1993; and Sweanor, David, and K. E. Warner. "The Role of the Federal and State Excise Taxes." In Houston, T.P., ed. Tobacco Use: An American Crisis. Final Conference Report. Chicago: American Medical Association, 1993. 59-62. 3. Lewit, Eugene M. "U.S. Tobacco Taxes: Behavioral Effects and Policy Implications." British Journal of Addiction 84 (1989): 1217-1234. 4. Centers for Disease Control and Prevention. Preventing Tobacco Use Among Young People.

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Page 194 A Report of the Surgeon General. S/N 017-001-00491-0. Washington, DC: U.S. Government Printing Office, 1994. 265. 5. Tobacco Institute, 1993. 6. Centers for Disease Control and Prevention. Preventing Tobacco Use. 265. 7. Tobacco Institute, 1993. 8. Centers for Disease Control and Prevention. Preventing Tobacco Use. 265. 9. Breslow, Lester, and Michael Johnson. "California's Proposition 99 on Tobacco, and its Impact." Annual Reviw of Public Health 14 (1993): 585-604. 10. Tobacco Institute, 1993. 11. Advisory Commission on Intergovernmental Relations. Cigarette Bootlegging. A State and Federal Responsibility. Washington, DC: ACIR, 1977. 12. Advisory Commission on Intergovernmental Relations. Cigarette Tax Evasion. A Second Look. Washington, DC: ACIR, 1985. 13. Lewit. 14. Office of the Surgeon General, U.S. Navy. "Tobacco and the Military." Internal document. 1993. 15. Non-Smokers' Rights Association of Canada. The Tax Burden on Tobacco? An Analysis of Tobacco Taxation Policy in the United States. Ottawa, Ontario: Non-Smokers' Rights Association of Canada, 1992. 16. Lewit. 17. Watson, Donald S. Price Theory and Its Uses. Boston, MA: Houghton Mifflin Co., 1972. 18. Becker, Gary S.. and K. M. Murphy. "A Theory of Rational Addiction." Journal of Political Economy 96 (1988): 675-699. 19. Lewit, Eugene M., Douglas Coate, and Michael Grossman. "The Effects of Government Regulation on Teenage Smoking." Journal of Law and Economics 24 (1981): 545-569; Lewit and Coate; Grossman, M. "The Demand for Cigarettes." (Editorial.) Journal of Health Economics 10 (1991): 101-103; Bishop, John A., and J. H. Yoo. "Health Scare: Excise Taxes and Advertising Ban in the Cigarette Demand and Supply." Southern Economic Journal 52 (1985): 402-411; Baltagi, Badi H.. and D. Levin. "Estimating Dynamic Demand for Cigarette Using Panel Data: The Effects of Bootlegging, Taxation and Advertising Reconsidered." Review of Economics and Statistics 68 (1986): 147-155; Pekurinen, Markuu "The Demand for Tobacco Products in Finland.'' British Journal of Addiction 84 (1989): 1183-1192; Simonich, William L. Government Antismoking Policies. New York: Peter Lang, 1991; Wasserman, J., W. G. Manning, J. P. Newhouse, and J. D. Winkler. "The Effects of Excise Taxes and Regulations on Cigarette Smoking." Journal of Health Economics 10 (1991): 43-64: Peterson, Dan E., S. Zeger, P. L. Remington, and H. A. Anderson. "The Effects of State Cigarette Tax Increases on Cigarette Sales, 1955 to 1988." American Journal of Public Health 82:1 (1992): 94-96; Department of Finance Canada. Tobacco Taxes and Consumption. Ottawa, Ontario: Department of Finance Canada, 1993; Emont, Seth L., Won S. Choi, Thomas E. Novotny, and Gary A. Giovino. "Clean Indoor Air Legislation, Taxation, and Smoking Behaviour in the United States: An Ecological Analysis." Tobacco Control 2:1 (1993): 13-17; and Keeler, Theodore E., Teh-Wei Hu, Paul G. Barnett, and Willard G. Manning. "Taxation, Regulation, and Addiction: A Demand Function for Cigarettes Based on Time-Series Evidence." Journal of Health Economics 12 (1993): 1-18. 20. See for example: Lewit; Centers for Disease Control. Reducing the Health Consequences of Smoking: 25 Years of Progress. A Report of the Surgeon General. DHHS Publication No. (CDC) 898411, 1989. 533-540; and Centers for Disease Control. Smoking in the Americas. A 1992 Report of the Surgeon General, in Collaboration With the Pan American Health Organization. DHHS Publication No. (CDC) 92-8419, 1992. 21. Lewit and Coate. 22. Pekurinen. 23. Harris, J. E. The 1983 Increase in the Federal Cigarette Tax. In Summers, L. H. ed. Tax Policy and the Economy. Vol. I. Cambridge, MA: MIT Press, 1987.

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Page 195 24. Ibid. 25. Pekurinen. 26. Department of Finance Canada. 27. Ferrence, Roberta G., J. M. Garcia, K. Sykora, N. E. Collishaw, and L. Farinan. Effects of Pricing on Cigarette Use Among Teenagers and Adults in Canada, 1980-1989. Toronto, Ontario: Addiction Research Foundation, 1991; Kaiserman, Murray J., and Byron Rogers. "Tobacco Consumption Declining Faster in Canada Than in the US." American Journal of Public Health 81:7 (July 1991): 902-904; Department of Finance Canada; Sweanor, David T., L. R. Martial, and J. B. Dossetor. The Canadian Tobacco Tax Experience: A Case Study. Ottawa, Ontario: The Non-Smokers' Rights Association of Canada and the Smoking and Health Foundation of Canada. 1993: and Sweanor and Warner. 28. Sweanor et al., 1993. 29. Ibid. 30. Ibid. 31. Kaiserman and Rogers. 32. Burns and Fry, Ltd. Imasco Limited—Investment Highlights. Burns Fry Limited Investment Research. Toronto, Ontario: 26 Sept. 1991. 33. Sweanor et al., 1993. 34. Department of Finance Canada. 35. Becker, Gary S., M. Grossman, and K. M. Murphy. Working Paper No. 3322. An Empirical Analysis of Cigarette Addiction. Cambridge, MA: National Bureau of Economic Research, 1990: and Chaloupka, Frank "Rational Addictive Behavior and Cigarette Smoking." Journal of Political Economy 99:4 (1991): 722-742. 36. Department of Finance Canada. 37. U.S. General Accounting Office. Teenage Smoking. Higher Excise Tax Should Significantly Reduce the Number of Smokers. GAO Publication No. GAO/HRD 89-119, 1989: and Non-Smokers' Rights Association of Canada. Average Retail Selling Price and Total Tax Incidence for a Pack of 20 Cigarettes in Various Countries as of December 1, 1993. Ottawa, Ontario: Non-Smokers' Rights Association of Canada, 1993. 38. Lewit et al.; Ferrence et al.; Wasserman et al.; Department of Finance Canada; and Grossman. M., D. Coate, E. M. Lewit, and R. A. Shakotko, Economic and Other Factors in Youth Smoking. Final Report. Washington, DC: National Science Foundation, 1983. Grant No. SES-8014951. 39. Lewit et al. 40. Lewit and Coate. 41. Grossman et al. 42. Lewit et al. 43. Wasserman et al. 44. Grossman et al. 45. Sweanor et al., 1993. 46. Maxwell, John C. "Maxwell Report: U.S.A: Philip Morris Takes Stronger Lead," Tobacco Reporter (April 1992):12-22. Cited in Federal Trade Commission. Report to Congress for 1991 Pursuant to the Federal Cigarette Labeling and Advertising Act. 1994. 14-15. 47. Centers for Disease Control. "Comparison of the Cigarette Brand Preference of Adult and Teenage Smokers—United States 1989, and 10 U.S. Communities, 1988 and 1990." Morbidity and Mortality Weekly Report 41 (1992): 169-173, 179-181. 48. Ferrence et al., and Department of Finance Canada. 49. Sweanor et al., 1993. 50. Ibid. 51. Roswell Park Cancer Institute. Department of Cancer Control and Epidemiology. Survey of Alcohol, Tobacco and Drug Use Among Ninth Grade Students in Erie County, 1992. Buffalo, NY: Roswell Park Cancer Institute, 1993. 52. Lewit; National Cancer Institute; Sweanor and Warner; Centers for Disease Control, Reduc-

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Page 196 ing the Health Consequences, 1989. 533-540; and Centers for Disease Control and Prevention, Preventing Tobacco Use. 269-274 53. Lewit; Department of Finance Canada; National Cancer Institute; Sweanor and Warner; and Centers for Disease Control and Prevention, Preventing Tobacco Use. 271-272 54. Coalition on Smoking OR Health. Saving Lives and Raising Revenue: The Case for Major Increases in State and Federal Tobacco Taxes. Washington, DC: Coalition on Smoking OR Health, 1993. 55. Sweanor and Warner. 56. Ibid. 57. Gallup Organization. The Public's Attitudes Toward Cigarette Advertising and Cigarette Tax Increases. Princeton, NJ: The Gallup Organization, Inc., April 1993; and Marttila & Kiley, Inc. Survey Highlights from an American Cancer Society Survey of U.S. Voter Attitudes Toward Cigarette Smoking. Boston, MA: Marttila & Kiley, Inc., 9 Sept. 1993. 58. Centers for Disease Control and Prevention. Preventing Tobacco Use. 214. 59. Association of State and Territorial Health Officials. State Tobacco Prevention and Control Activities: Progress Report 1990 to 1992. Washington, DC: ASTHO. May 1994. 69. 60. Congressional Budget Office. Federal Taxation of Tobacco, Alcoholic Beverages, and Motor Fuels. Washington, DC: U.S. Government Printing Office, August 1990. 25-37. 61. Townsend, Joy L. "Cigarette Tax, Economic Welfare and Social Class Patterns of Smoking." Applied Economics 19 (1987): 355-365. 62. Wasserman et al. 63. Federal Trade Commission. Report to Congress for 1991 Pursuant to the Federal Cigarette Labeling and Advertising Act. 1994. 14-15. 64. Herdman, Roger, Maria Hewitt, and Mary Laschober. Office of Technology Assessment. Smoking-Related Deaths and Financial Costs: Office of Technology Assessment Estimates for 1990. Before the Senate Special Committee on Aging. Preventive Health: An Ounce of Prevention Saves a Pound of Cure. 6 May 1993. 65. Sweanor and Warner. 66. Price Waterhouse. The Economic Impact of the Tobacco Industry in the U.S. Economy. Price Waterhouse, 1992. 67. Tobacco Institute. Economic Losses from Increasing the Federal Excise Tax. Washington, DC: Tobacco Institute, 1993. 68. Andersen, Arthur and Co.. S.C. Tobacco Industry Employment: A Review of the Price Waterhouse Economic Impact Report and Tobacco Institute Estimates of Economic Losses from Increasing the Federal Excise Tax. Los Angeles, CA: Arthur Andersen Economic Consulting, 6 Oct. 1993. 69. Chase Econometrics. The Impactof the Tobacco Industry on the United States Economy in 1983. Balacynwood, PA: Chase Econometrics, 1985; and Warner, Kenneth E., and G. A. Fulton. "The Economic Implications of Tobacco Product Sales in a Nontobacco State." Journal of the American Medical Association 271:10(1994): 771-776. 70. Andersen. 71. Sweanor et al., 1993; Perkurinen; and Laugesen, Murray. "Tobacco Advertising Restrictions, Price. Income, and Tobacco Consumption in OECD Countries." British Journal of Addiction 86 (1991): 1343-1354. 72. Toxic Substances Board. Health or Tobacco: An End to Tobacco Advertising and Promotion. Wellington, New Zealand: Department of Health, 1989. 73. Royal College of Physicians. Smoking and the Young. London: Royal College of Physicians, 1992. 74. Sweanor, David, S. Ballin, R. D. Corcoran, A. Davis, K. Deasy, R. G. Ferrence, R. Lahey, Lucido S., W. J. Nethery, and J. Wasserman. "Report of the Tobacco Policy Research Study Group on Tobacco Pricing and Taxation in the United States." Tobacco Control I (Suppl. 1992): S31-S36.