How high do taxes have to climb before people simply stop paying them — legally, at least?
Economist Todd Nesbit of Ball State University and Mike LaFaive, senior director at the Mackinac Center’s Morey Fiscal Policy Initiative challenge this question on the Overton Window Podcast. Their conversation centers on their recent study examining the scale and impact of cigarette smuggling driven by varying state excise taxes.
“There are two major issues going on with vice taxes. One is to thwart a purported sin, and the other is to raise revenue,” LaFaive says.
Cigarette taxes are one of the oldest tools used by states for this purpose. “Iowa imposed the first excise tax on cigarettes,” LaFaive notes, “but it first had to make them legal.”
Cigarette taxes today vary significantly from state to state. Part of this difference can be attributed to differing population preferences. “Maybe the more dense populations, there’s more secondhand smoke—and so you may see a tendency to try to discourage consumption more” Nesbit explains. These local attitudes have helped shape policy, often leading to sharp tax disparities between neighboring states.
Over time, cultural shifts have also played a major role. “In the 1970s, something like 42% of America smoked cigarettes,” LaFaive says. “It’s down to 12% or less today.” That decline in consumption, he argues, is at least as much a result of changing attitudes as it is of tax policy.
But with steep taxes come consequences. LaFaive warns that in high-tax states — like one with a $4 per pack excise tax — additional increases tend to backfire.
“You’re only taxing people who have such a strong preference for the product that they’re likely to turn to an illicit market,” he says. This includes not only smuggling from lower-tax states, but also unsuspecting consumers buying what they believe are legal cigarettes from retailers engaged in illicit trade.
California, long known for its aggressive anti-smoking stance, now leads the nation in cigarette smuggling. Nesbit reports that “California just recently took over number one — right around 53% of all consumption” is smuggled. According to LaFaive, if smuggling were eliminated, California would collect $1.4 billion more annually in cigarette excise tax revenue.
But lost revenue isn’t the only concern.
“There’s so much extra crime that does come along with it. A lot of state officials and even those in the police departments and correctional facilities are actually involved in this criminal activity,” Nesbit says. That raises troubling questions about the legitimacy and effectiveness of continually raising vice taxes.
LaFaive adds that enforcement challenges are immense. “We’ve repeatedly noted that state officials cannot keep tobacco and drugs and cell phones out of their prisons and jails, so it’s unlikely they’ll be able to stop a tidal wave of cigarettes from finding their way into a state.”
“The fact that smuggling is so high is really a solid indication that consumers have determined on average that these taxes are too high,” Nesbit concludes. “And maybe our politicians should take that more into account than they actually are.”
Listen to the full conversation on the Overton Window Podcast.
