Federal Tobacco Tax Hike Turns Up in Obama's Proposed Budget

WASHINGTON, D.C. -- As expected, President Barack Obama included a hike in the federal tobacco tax in his proposed 2014 federal budget.

As CSNews Online reported earlier this week, the 94-cent levy increase will help fund pre-kindergarten programs for 4-year-olds. The tax currently stands at $1.01 per pack of cigarettes. If approved, the new rate will reach $1.95 per pack. The proposed tax hike is projected to raise approximately $78 billion over 10 years.

This marks the second time Obama has looked to raise the tobacco tax. In 2009, his signature ushered in a 62-cent-per-pack increase, hiking the levy from 39 cents to $1.01 per pack. At the time, the move was the single largest increase in the federal cigarette and tobacco tax rates in U.S. history. This latest hike would top that.

THUMBS DOWN
Not everyone is pleased with  proposal.

"For the president to target a minority of adult Americans with this massive tax increase to pay for the extension of preschool programs nationwide is unfair and ironic," said Tom Briant, executive director of the National Association of Tobacco Outlets (NATO). "With the Centers for Disease Control reporting that 29 percent of all smokers have incomes below the poverty level, it is ironic the president's proposal would seek to nearly double cigarette and tobacco taxes that fall more heavily on lower-income Americans to fund expanded access to pre-kindergarten programs for all 4-year-old children from families with low to moderate incomes."

The proposal also increases taxes on other tobacco products, such as cigars, pipe tobacco and smokeless tobacco, by about the same proportion and indexes the taxes for inflation after 2014, NATO noted.

"With cigarette sales declining year to year, the stability of this funding source is unreliable and therefore will likely not produce the $78 billion the president needs to fund the preschool education program over the next decade," Briant added. "If preschool education is important to the president, a better, more stable source of funding should be identified because the country can no longer depend on tobacco taxes to solve the country's problems."

If approved, this increase could also negatively impact tobacco retailers -- including convenience stores.

"For specialty tobacco stores that sell primarily tobacco and tobacco-related products, a sales decline greater than what occurred in 2009 to 2010 would be destructive to their businesses and result in store closures and employees losing their jobs," Briant said. "For convenience stores that rely on 35 [percent] to 40 percent of their in-store sales from tobacco products, these higher taxes would also spell sales losses and job curtailment."

TOBACCO INDUSTRY IMPACT
It is still too early to tell if the proposal, released today, is a done deal. Bonnie Herzog, senior managing director of tobacco, beverage and consumer research at Wells Fargo Securities LLC, explained that her firm believes the proposal has a low chance of passing in its current form. The U.S. House of Representatives has more Republican members than it did in 2009 -- and Republicans tend to oppose tax increases. In addition, this tax would unfavorably impact some of the more vulnerable income populations.

However, tobacco companies could see accelerated cigarette operating profit growth if the taxes rise, according to Herzog. She pointed out that following the 2009 increase, The Altria Group Inc. and Lorillard Inc. took cigarette list price increases of 71 cents per pack, while Winston-Salem, N.C.-based Reynolds American Inc. took increases of 44 cents per pack for brands such as Camel and 41 cents per pack for brands such as Pall Mall.

Richmond, Va.-based Altria is the parent of Philip Morris USA, which manufactures the Marlboro brand. Greensboro, N.C.-based Lorillard's brands include Newport and Newport Red.

"These list price increases resulted in accelerated cigarette operating profit growth in 2009 with an even greater positive impact in 2010. This favorable operating profit impact would occur, given [that] manufacturers realize three times the leverage from a point of pricing vs. a point of volume," Herzog said.

She noted that although there was some volume disruption in the market during the 2009 tax and price increases, volumes ultimately recovered and have remained at the long-term volume decline rate of approximately 3 percent to 4 percent a year. "If this tax were to ultimately come to fruition in some form, we would expect to see a similar trend of some short-term volume volatility but ultimately accelerated cigarette operating profit growth," she added.

Any increase in the federal tobacco tax could also benefit the electronic cigarette industry.

"A federal tax hike on traditional cigarettes would likely be followed by list prices increases from the manufacturers in excess of the federal increase, as well a likely uptick in state tax increases. These could, in aggregate, raise cigarette prices upwards of $2 per pack," Herzog said. "Since e-cigarettes are not currently federally taxed, this would widen the price gap of e-cigs vs. traditional cigs. Since smokers in general tend to be lower income and we believe were disproportionally affected by the payroll tax increase, this could spur greater interest and trial in e-cigarettes."