As mentioned in one of my previous posts (see Taxes and Fairness – A Recent Study (March 3, 2005)), cigarette taxes are viewed as one of the fairest taxes imposed on Americans. Outcries against public health effects from smoking and its generally unfashionable status these days among the health-consious presumably contribute to this opinion.
In theory, raising taxes could help people decide to do the noble thing and quit their bad habit in exchange for other less-expensive guilty pleasures (or even healthy ones). However, people might alternatively choose to get their smokes from somewhere else where taxes (and thus total costs) are lower. In this case, state tax revenues don’t necessarily increase on account of a change in the tax rate. Buying habits, rather than smoking habits, end up changing.
There are considerable variations in tax rates applied to cigarettes. The Federation of Tax Administrators has a website that lists the for all states. See http://www.taxadmin.org/fta/rate/cigarett.html . For example, in Nebraska, smokers pay 64 cents/ pack, while Iowans pay 32 cents. The highest rate is in Rhode Island, at $2.46. Kentuckians win the award as the lowest tax state with only 3 cents. (I once rented a car in Louisville, where I asked for a smoke free car. The car I received had lots of burn marks in it – and when I returned to the rental agency for an exchange the agent apologetically stated that smoke-free meant something different in Kentucky. Nice people there, but many of them apparently do love those cigarettes!)
Tribal smoke shops have been a popular destination for tax-avoidance, as tribal members are exempt from state taxes imposed on their smokes. Although the Supreme Court has held that nontribal members are not exempt from taxes on their on-reservation purchases (see Department of Revenue v. Milhelm Attea & Bros., 512 U.S. 61 (1994)), enforcing those taxes can be another matter.
The rise of the Internet has raised still other options for those who want to circumvent state taxes in the purchase of various goods. Every online purchase potentially avoids state sales and use taxes, but these taxes are likely to be small in relation to an individual item. A six or seven percent tax is also offset by shipping costs, which makes it uneconomical to buy online in many cases if the only reason is to circumvent the sales tax. However, as tax rates rise significantly, this practice starts to make economic sense. Cigarette smokers apparently think so.
Last week the Federal government (Bureau of Alcohol, Tobacco, and Firearms), state attorneys general, and the credit card industry reached an agreement to prohibit the use of credit cards for online purchases of tobacco. (See Omaha World-Herald, Friday March 18, 2005). This will undoubtedly slow the path for circumventing state tax policies through the Internet, though it possibly may also affect some legitimate business transactions that do not directly involve tobacco. I have not yet looked into this agreement, but it will be interesting to see what induced the credit card industry to cooperate in this venture when it results in lower profits for them.