Among my colleagues in the public health and addiction fields, I am nearly alone in disliking President Obama's proposed doubling of federal cigarette taxes. My reservations stem from the hard lessons of America's policy towards illegal drugs.
As recently noted by drug policy expert Dr. Peter Reuter, anti-tobacco advocates see the smoking rate as the only index of public policy success. When it goes down -- as it virtually always will in response to higher taxes -- they cheer unreservedly. I passionately want more Americans to kick the smoking habit. But I worry about how extremely high tobacco taxes expand black markets, which in turn can trigger draconian law enforcement responses.
In New York City, a legal, fully taxed pack of cigarettes costs $10-15; Chicago prices are only slightly less. Working class and poor addicted smokers (i.e., most smokers) thus face great temptation to enter into the black market. Columbia University Professor Donna Shelley documented that "the $5 man" -- a street seller of untaxed black market cigarettes -- is now a pervasive feature of life in low-income New York City neighborhoods.
Extremely high cigarette taxes are widely evaded. Professor David Merriman of the University of Illinois at Chicago organized teams of apparently non-squeamish research assistants to gather discarded cigarette packs from garbage cans and sidewalks in 100 Chicago neighborhoods. He discovered that 75 percent had no tax stamp, indicating a black market or grey market provenance.
An across-the-board increase in federal tobacco taxes would not only expand black markets in high-tax areas, it would also do nothing to address the widespread smuggling of cigarettes to high tax states from states where cigarette taxes are ridiculously low. Such smuggling is not driven by cash-strapped college kids with a few cartons in their backpacks. Organized crime groups, and even terrorist organizations, are the big players in the lucrative trade.
The most common political reaction to the exploding illegal cigarette trade is a familiar one for experts in illegal drug policy: Crack down with law enforcement. Arrests sweeps and stiff prison sentences are the current proposed policy of the government in Canada, where an estimated 15 percent of all cigarette sales are illicit. Get tough proposals are also being mooted in U.S. cities such as New York City and Philadelphia. Of course the New York City police are capable of rounding up hordes of $5 men (most of whom are low-income people of color) and sending them to already-overcrowded prisons, but the experience of illegal drug policy reveals that to be a lose-lose proposition.
The challenge for federal tax policy on cigarettes therefore is to avoid feeding black markets in high-tax states, to shrink cross-state tobacco smuggling operations, and, to increase tobacco taxes in those states where taxes have room to grow without creating black markets. A flat increase in the tobacco tax cannot serve all three goals, but a more creative tax policy could.
States adapt quickly to federal tax policy incentives. When the federal government allowed states to keep estate taxes up to a certain financial amount, almost every state set their estate taxes accordingly, creating rough parity throughout the country. The same approach could be applied with federal tobacco taxes. Specifically, the federal government could refund federal tobacco taxes to any state that keeps its own tobacco taxes within a particular range.
If one imagined for the sake of argument that $1.50-$2.50 a pack were the initial chosen range for receiving federal tax largesse, that would give the 28 states below that range an incentive to hike state taxes. Citizens in those states would smoke substantially less, improving public health and more fully reimbursing the public purse for the costs of smoking. And out-of-state gangs of tobacco smugglers would have far less incentive to maintain a presence in the state.
High-tax states (e.g., Washington, New York, New Jersey) would reap little net revenue from that part of their tax which was over $2.50 a pack because of the loss of the federal tax rebate. This would give them an incentive to stop further increases or even cut back. This could have the lamentable effect of reducing the frequency of price-driven smoking cessation, but those same states would benefit in terms of shrinking black markets. And as for state revenue, a state takes in far more money from a lower tax that people actually pay than a higher tax that is evaded 75 percent of the time.
In states at the top of the federally incentivized range, where further hikes in taxation may lower smoking only at the cost of producing black markets, the refunded federal taxes could be used as the state saw fit. This could and should include trying to reduce smoking in other ways (e.g., providing free smoking cessation treatment). In states below the federally incentivized range, legislatures would raise state taxes to get the federal dollars, thereby reducing their residents' smoking rate without creating a large black market. And across all states, the rough equalizing of price across the country would collapse the profits of cross-state tobacco smuggling rings.