Brief Analysis
No. 123

The good news is that higher cigarette taxes really do cause people to quit smoking. The bad news is that if fewer people smoke, the Democratic health bills now before Congress will be underfunded. They will get far less revenue from their proposed cigarette tax hikes than the bills' sponsors allege. And, to the extent that higher cigarette taxes do help fund health care reform, they will take most of the money from the families that can least afford it.

The case for higher cigarette taxes.

President Clinton and the Democratic leadership hope to pay for health care reform, in large part, by increasing taxes on tobacco products. The original Clinton bill would have added a 99-cent tax on every pack of cigarettes to the current federal tax of 24 cents and state and local taxes of about 28 cents. The versions of the Clinton plan introduced by Senator George Mitchell (D-ME) and Representative Richard Gephardt (D-MO) would increase the federal cigarette tax to 69 cents a pack, while the Senate Finance Committee health bill would raise the tax to $2.24 a pack.

In addition to helping pay for the new health care bill, proponents argue that an increase in federal tobacco taxes would offset some of the burdens smokers place on the economy. The tax increase would also, they say, deter people from smoking.

Do these arguments make sense? Let's take a closer look.

Do smokers impose costs on the rest of society?

Apparently some, but less than most people think. The Centers for Disease Control contends that smokers incur $50 billion in health care expenses - an amount equal to $2.06 per pack at current smoking levels. However, smokers mainly pay their own way. Of the $2.06, only 89 cents represents costs for nonsmokers - primarily borne in the form of taxes to support Medicare and Medicaid. [See Figure I].

Moreover, smokers create a positive (if ghoulish) benefit for nonsmokers. Because they die earlier, smokers avoid health care expenses that might have otherwise been incurred over a longer life. They also save society money in Social Security payments and private pension benefits. When that element is factored in, a Rand Corporation study found that the net cost smokers create for nonsmokers equals about 28 cents a pack at 1993 prices.

Is an increase in the tobacco tax needed to make smokers pay their own way?

No. Since current federal and state taxes total 52 cents a pack, smokers are paying more than their fair share.

Granted, there is some dispute about whether 28 cents is the right estimate. That number does not include the effects of secondhand smoke, which the Environmental Protection Agency (EPA) says causes 3,000 lung cancer deaths a year. Yet the EPA conclusion is based on a controversial, rather sloppy review of other studies and is not taken seriously by most scholars.

A more profound problem is that the Rand estimate omits the extra costs of miscarriages and neonatal intensive care attributed to pregnant women who smoke. Yet all things considered, the Congressional Research Service is probably correct to conclude that the external cost argument does not justify any increase in tobacco taxes.

Who pays tobacco taxes?

Primarily, lower-income families. Other things equal, the lower a person's income, the more likely that person is to smoke. For that reason, a tax on tobacco is perhaps the most regressive of taxes - even more regressive than taxes on beer, wine or gasoline. A study by KPMG Peat Marwick found that:

• Families making less than $30,000 per year pay more than half of all the taxes paid on cigarettes.

• By contrast, families making more than $60,000 pay only 14 percent.

• As a percent of income, lower-income families bear almost five times the burden of high-income families.

Do higher cigarette taxes cause people to quit smoking?

Yes. And that might be a justification for a higher tax. But you can't have your cake and eat it too. The more people quit, the less revenue would be collected.

Nobel prize winner Gary Becker and his colleague Michael Grossman estimate that if the federal cigarette tax were increased to 95 cents, smoking would be cut in half. At a tax of $2.24, cigarette consumption would go down by 73 percent. It would take several years to get the full effect of the drop-off, as some people smoked less, some quit smoking altogether and teenagers, who are especially sensitive to price, decided not to become smokers.

Despite the fact that tobacco may be addictive, the U.S. evidence is that smokers respond to economic incentives. There is evidence from other countries as well. Since 1982, Canada has doubled its cigarette tax to $6 a pack and cigarette consumption has dropped by 40 percent.

How much additional money can be raised from higher tobacco taxes?

Only a fraction of what the Democratic leadership in Congress expects.

Economists Becker and Grossman estimate that a 10 percent increase in cigarette taxes eventually leads to an 8 percent decrease in cigarette consumption. Above a tax rate of about 95 cents, further increases in the tax rate would lead to lower tax revenue. [See Figure II.] The most additional revenue that can be raised with cigarette taxes is about $6.5 billion, say the economists, not the $30 billion that the antismoking lobby claims.

Even if very little revenue is to be raised, should we increase cigarette taxes to discourage smoking? Not if we want to be consistent in our social policies.

There is no question that we could begin to change people's behavior with taxes on saturated fat, unsafe sex and such risky activities as hot air ballooning, scuba diving, hang gliding and motorcycle riding. But we do not.

Part of what living in a free society means is having the right to take risks without asking others' permission and without paying others a fee for the privilege of exercising that right.

Recommended Reading: Gary S. Becker and Michael Grossman, "And Cigarette Revenues Up in Smoke," Wall Street Journal, August 9, 1994.

Note: Nothing written here should be construed as necessarily reflecting the views of the National Center for Policy Analysis or as an attempt to aid or hinder the passage of any legislation.