Cigarette paradox: Raise taxes, lower revenue

An odd thing happened the last time New Jersey raised its cigarette tax: It lost money.

According to advocates for lower taxes, that's because New Jersey smokers have cheaper purchase options nearby in Pennsylvania and Delaware, or online.

Pennsylvania also saw revenues fall when it last raised cigarette taxes.

Still, with both states facing mounting budget gaps, Gov. Rendell has proposed a cigarette tax increase and Gov. Corzine is considering one for the spending plan he will introduce Tuesday.

Anti-tax groups are warning that if the levies on smokes go up again, states could see less bang per pack.

"When you're in a high-tax state, smokers, like anybody else, are price-sensitive, so they're going to go looking for cigarettes where they're cheaper," said Gregg Edwards, president of the Center for Policy Research of New Jersey. "There is a small number of folks who just wouldn't absorb the price increase and just decided to quit, but most of those folks just go to other places."

Edwards said the problem would be more acute in New Jersey because both Pennsylvania and Delaware are less expensive places to buy cigarettes.

To back up his argument, Edwards pointed to New Jersey's recent revenue and cigarette sales. The state raised its cigarette taxes in fiscal years 2003, 2004, 2005 and 2007. In the first three instances, sales shrunk but revenue grew.

But after the last increase, which at the time gave New Jersey the highest cigarette tax in the nation, collections fell from $788.6 million to $770.5 million. Estimated revenues for fiscal year 2008 are $775 million, below the peak of fiscal year 2005.

The sale of cigarette tax stamps has fallen from 495,000 in 2001-02 to around 300,000 per year.

Pennsylvania, too, saw revenue slide as taxes rose. Rendell raised cigarette taxes 35 cents in 2004. At first the commonwealth saw a modest income bump, but in the first full fiscal year after the tax hike, cigarette tax revenue fell by $72 million, roughly 8 percent.

Revenue has never gotten back to fiscal 2004 levels, when the increase first hit.

Michael LaFaive of the Mackinac Center for Public Policy recently studied the impact of cigarette taxes in Michigan, California and New Jersey and warned that as levies rise, so does smuggling from both "casual" smugglers - say a New Jerseyan who goes to Delaware for some smokes - and organized crime.

LaFaive's study estimated that 40 percent of cigarettes smoked in New Jersey come from out-of-state or illegal lines of distribution. The figure was based on smoking rates, the number of adults in the state, and the number of legal sales per adult.

The study, citing New Jersey's $2.575 tax per pack and its proximity to low-tax states, called New Jersey "a premier destination" for smugglers.

"It's happening in states that impose high cigarette excise taxes," said LaFaive, the director of fiscal policy at the center, based in Michigan.

New Jersey now ranks second to New York's $2.75 cigarette tax rate. Corzine is considering raising the tax as he tries to close a multi-billion dollar budget deficit.

Rendell has proposed a 10-cent cigarette tax hike to bring the rate to $1.45, which would be 19th highest in the nation. Delaware, which shares borders with both states, charges $1.15 per pack, less than Pennsylvania and less than half of the tax in New Jersey.

To anti-smoking groups, the tax rate is about more than just money.

"For us, it's sort of like one of the Ten Commandments of cancer prevention," said Peter Slocum, vice president of advocacy for the American Cancer Society of New York and New Jersey. "Any time you increase the price, it's a good thing, because it discourages people from smoking."

Slocum's organization estimates that for every 10 percent price increase, smoking drops by 4 percent. With the federal tax set to rise to $1.01 in April from 39 cents, Slocum said, New Jersey should aim even higher to make up for the expected consumption falloff.

"We would like to see them raise it more boldly," Slocum said. "Push it up to three bucks, then you would get some public health benefit."

Losses in revenue, he argued, are made up by having a healthier public. The cancer society estimates that $3 billion of private and public health care costs in New Jersey come from smoking-related health issues. The figure is based on population and national rates of health problems.

New Jersey Treasury spokesman Tom Vincz said the falloff in revenues after the 2006 tax increase does not account for cases the state is pursuing where people buy cigarettes online and have not paid taxes. He said the state works to get payments from those smokers.

Historically, cigarette tax increases take into account predicted changes in consumption, Vincz wrote in an e-mail. Over time, people who start buying in other states may tire of it and return to purchasing, and paying taxes, at home. Others who quit may return to smoking, he wrote, creating an "ebb and flow" of revenue over a long period of time.

"You know you won't get the dollar-for-dollar return, and you calibrate the change in the level of the tax accordingly," Vincz wrote.