Smokers Change Habits to Avoid Higher Taxes

May 4, 2012

In 2009, Children's Health Insurance Program Reauthorization Act (CHIPRA) increased and equalized federal excise tax rates for cigarettes, roll-your-own tobacco and small cigars.  Though CHIPRA also increased federal excise tax rates for pipe tobacco and large cigars, the effective tax burden of consuming these products was significantly lower.

As a study by the Government Accountability Office (GAO) confirmed, this created opportunities for tax avoidance and led to significant market shifts by manufacturers and price sensitive consumers toward the lower-taxed products.

  • Monthly sales of pipe tobacco increased from approximately 240,000 pounds in January 2009 to over 3 million pounds in September 2011.
  • Simultaneously, roll-your-own tobacco dropped from about 2 million pounds to 315,000 pounds.
  • The same behavior can be seen for large and small cigars (which have low and high tax rates, respectively): large cigar sales increased from 411 million to over 1 billion cigars in those months, while small cigars dropped from about 430 million to 60 million cigars.

The study demonstrates that producers and consumers alike respond to taxes by changing their behavior, favoring lower-taxed products.  This change has significant effects on government revenue from the taxes it places on tobacco products.

  • Revenue collected for all smoking tobacco products from April 2009 through fiscal year 2011 amounted to $40 billion.
  • The GAO estimates, however, that federal revenue losses due to market shifts from roll-your-own to pipe tobacco and from small to large cigars range from about $615 million to $1.1 billion for the same period.

Problems with levying the taxes equally are caused by inherent difficulties in differentiating between the products.  The definitions of the two products in the Internal Revenue Code of 1986 do not specify distinguishing physical characteristics.  Furthermore, pipe tobacco and cigars are not currently regulated by the Food and Drug Administration and thus are not subject to the same restrictions on characterizing flavors, sales or distribution.

Source: "Large Disparities in Rates for Smoking Products Trigger Significant Market Shifts to Avoid Higher Taxes," Government Accountability Office, April 18, 2012.

For text:

http://www.gao.gov/products/GAO-12-475

 

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