The Reverse Effect

Press enter to search
Close search
Open Menu

The Reverse Effect

By Renee M. Covino

It was Albert Einstein who classified insanity as "doing the same thing over and over again and expecting different results." That makes state lawmakers insane when it comes to tobacco taxes.

Year after year, they propose and pass hikes on tobacco state excise taxes on the promise that the taxes will bring in more state revenue. But for many, the tactic has gone past the point of diminishing returns. The strategy has burned out and is now having negative effects on not just c-stores and other tobacco retailers — but ironically, on the states themselves.

"A state may raise its cigarette tax to plug a budget hole, but when the tax doesn't raise the projected revenue, it creates another budget hole. When you have a gap in a budget, it needs to be made up elsewhere — another tax, cutting funding, etc.," said Bill Phelps, spokesman for Altria, the parent company of Philip Morris USA (PM USA). "Cigarette volumes are declining and have been for years. The programs linked to cigarette tax increases may have obvious merits, but this underscores that it doesn't make sense to fund an important program with a revenue source that continues to decline."

Tracking states' tobacco tax hikes, as well as the revenue collected as a percent of projections, R.J. Reynolds Tobacco Co. (RJRT) reported "49 inaccurate projections" since 2002, which equaled "over $1 billion in state-revenue shortfalls."

With a high state cigarette tax, second only to New York, New Jersey is a prime example.

In 2006, New Jersey Governor John Corzine convinced the state legislature to approve a 17.5 cents per pack cigarette excise tax increase — its fourth increase in five years — making it the highest state cigarette excise tax at the time. According to the RJRT report, the tax increase was expected to generate $30 million in additional revenue, but instead created a revenue gap of more than $52 million. Predictions are New Jersey's cigarette tax revenue will decline again in fiscal year 2008 by as much as another $4 million — stretching the gap to $56 million.

New Jersey fell short of projected revenues with all of the four tax increases since 2002. Revenue from the latest tax increase that led to the "tipping point" was 173 percent below the projected revenue the tax was intended to generate.

New Jersey is not alone. Arizona, Maine and South Dakota also recently reported significant budget shortfalls after raising their cigarette tax.

"We now refer to this phenomenon as 'the New Jersey experience' — when states raise their tobacco tax and watch their revenue go down," said Frank Lester, director of legislative policy and advocacy at Reynolds American Inc., parent to RJRT. "In reports where we pulled numbers from 2002-2006, there were 60 state tax increases, with 80 percent generating revenue less than the state projected. On average, the revenue shortfall was 70 percent."

Killing the Golden Goose
Legislators don't seem to comprehend "increasing the cigarette tax will probably result in killing the goose that lays the golden eggs," said Thomas A. Briant, executive director for the National Association of Tobacco Outlets (NATO).

Cigarette sales are no doubt going to continue to decline in states that keep raising tobacco taxes, but that doesn't mean smokers are quitting.

"When you have a tax increase, it creates an incentive for people to find other places to buy cigarettes that avoids the tax," Phelps said, listing the Internet, border states, black and gray market as such sources.

"The real losers will be the hard-working retailers, and ironically, the states as well, because potential tax revenue will evaporate," Briant stated.

For instance, tobacco tax increases in four states — Connecticut (49 cents), Iowa ($1), Tennessee (42 cents) and Texas ($1) — enacted in 2007 resulted in significant decreases in tax-paid sales volume during the 12 months pre- and post-hike, according to leading cigarette manufacturer Philip Morris USA. The smallest decrease was seen in Connecticut at 11.25 percent, followed by Texas at 20.97 percent, Tennessee at 35.02 percent and Iowa at 35.69 percent.

In the case of New Jersey, it handed a portion of its tobacco business to Delaware each time it raised taxes. Since 2000, New Jersey watched its cigarette volume decline by 7 percent, while Delaware saw its volume increase 6 percent during the same time period, according to Steve Kottak, director of communications at Reynolds American.

"Obviously, we could see that cross-border dynamic at work," he said. "States lose volume, revenue and jobs, and they gain higher crime with more cigarette theft throughout the distribution channel — from wholesalers to retailers — as cigarettes become more valuable."

In 2006, Willard Bishop Consulting in Barrington, Ill., was contracted, partly by c-store retailers in the Northeast, to show and evaluate revenue losses New Jersey experienced as a result of raising its tobacco taxes. From his work on that study, David Bishop, then-partner with Willard Bishop, and currently managing partner at Balvor LLC in Barrington, Ill., was amazed at how ignorant New Jersey lawmakers seemed to be.

"When we presented our case to the OLS [Office of Legislative Service], we heard the wildest metaphor, that in our minds, showed how disconnected legislators are from the real world," Bishop said. He explained they likened New Jersey to an island, essentially saying, "if New Jersey was an island and consumers couldn't leave, wouldn't this tax increase be a good thing for the state?"

"Our response was that in the hypothetical it has no merit, because New Jersey isn't an island and consumers will leave and have already demonstrated a willingness to leave," Bishop maintained. "It revealed a naiveté on their part, or ignorance, or complete reluctance to accept the fact that this consumer demand is shifting."

New York City legislators have shown a similar ignorance. With an added city tax on top of its exorbitant state tax, the Big Apple has the pleasure of knowing 75 percent of the tobacco used in New York City was purchased outside of it.

The real injustice of the state/tobacco tax situation, according to Bishop, Briant and many others closely following the issue, is how it is hurting retailers — particularly those who find themselves on the "wrong" side of a state border once a tax gets passed.

"Our big concern is it creates an unbalanced playing field for the retailers," stated Jeff Lenard, media relations representative with NACS: the Association for Convenience and Petroleum Retailing. "In places like New York State, there's a huge incentive for consumers to drive a few minutes to an Indian reservation and save almost 70 percent on a carton of cigarettes — it's almost a no-brainer. That's why we're seeing so many retailers, especially a select group of grocery stores, not selling cigarettes anymore. It's extremely difficult to compete with a no-tax alternative. It also increases bootlegging."

"It is an extremely disruptive tax to us as retailers," agreed a Northeastern c-store retailer who has been on top of the issue for years now. "We've watched it create illegal activity from a small to large scale, including organized crime."

Local Involvement
The retailer encouraged c-stores to stay on top of their local situation and get involved. "The biggest point is: how do you change this?" he stated. "You prepare diligently and ahead of time with indisputable facts and you present a strong case to your lawmakers. I've personally done that — gone into the bowels of their offices where accountants and economic advisors sit — and bring in experts to show them with facts what is the right course of action. You can't go in with hot air, you have to go in with facts, and grass-roots programs can be very helpful."

Retailers and wholesalers in Cook County, Ill., are very familiar with what can happen when you don't get involved in local issues. Four years ago, a "home-grown" tobacco tax was instituted by lawmakers and it blindsided many retail businesses, including Bill McCloskey, vice president and general manager of Texor Petroleum, a jobber that also runs nine retail stores called Minute Man Convenience stores.

"We lost close to 40 percent of cigarette volume in our Cook County locations — we had four at the time, and we sold one for that reason," McCloskey said. "They averaged 1,000 cartons a week, but after the tax it fell to 500 cartons."

The good news was McCloskey's stores just outside of Cook County made up for the loss. "We're very lucky, but if we didn't have those locations, we don't know where we'd be — probably out of business."

Getting a handle on the states' revenue situation should be a concern to even those outside of the tobacco world, Bishop said.

"Clearly, tobacco is not an unending fountain of revenue for the states," he said. "Other 'sin' products will be the next target — beer, alcohol and wine. Then they'll make their way to products with high trans-fats or high degrees of sodium and sugar. These are all provocative points of view, but one thing is clear — it doesn't stop here, and anyone who thinks it does is misguided."