Cigarette Tax Would Triple Under $35 Billion SCHIP Plan

Published March 1, 2009

Higher federal taxes on tobacco products could be in the offing to pay for a planned expansion of the State Children’s Health Insurance Program (SCHIP), which subsidizes health insurance for children in families whose income is below a certain level, depending on their state of residence.

The proposed $35 billion spending increase over five years—the program now costs about $5 billion a year—passed the House and Senate with bipartisan support in 2007 but was vetoed by President George W. Bush. A veto override vote in the House came up nine votes short of the necessary two-thirds majority.

Democratic Party leaders plan another try and are expecting success with fellow Democrat Barack Obama as president.

SCHIP has been funded largely through federal cigarette taxes. Critics of the expansion proposal point to the irony of imposing sharply higher taxes on cigarettes, whose buyers tend to come from lower- and middle-income families, because the very people SCHIP aims to help would be disproportionately hurt by the taxes.

They also point out smoking rates are declining and cigarette smuggling is growing, thus shrinking the tax’s revenue base.

Tax Would Nearly Triple

The proposal would take the federal excise tax on cigarettes from 39 cents to $1 a pack, on top of existing state and local taxes. Families earning up to four times the poverty level—about $83,000 for a family of four—could qualify for SCHIP coverage.

Critics of the expansion proposal point out SCHIP was designed for children of low-income families not eligible for Medicaid. This originally meant children in families earning less than twice the poverty level.

Critics also note more than a dozen states allow adults to be insured in the program even though it is ostensibly aimed at children. They expect more money will bring more such abuses.

Concerned for Small Businesses

In a December letter to Congress, a coalition of more than 40 state and national organizations, including the American Legislative Exchange Council, Americans for Tax Reform, Competitive Enterprise Institute, National Center for Public Policy Research, and Small Business and Entrepreneurship Council, asked lawmakers to “stand strong against all efforts to raise the tobacco tax as a funding mechanism.

“Taxpayers in many states are already struggling to make ends meet, and are already saddled with higher taxes to fund state health care program expansions,” the letter continued. “Congress should lead the way toward consumer-driven health care rather than replicating misguided tax increase strategies to expand misguided spending priorities.

“A higher tax rate will not only scapegoat a segment of the American population for using a legal product, but will also hurt small businesses which often lean on tobacco sales to stay in business,” the letter continued. “As small businesses continue to be the engine of job creation in the U.S., raising the tax on tobacco would throw a wrench into the gears of economic growth, at a time when this is the last thing America needs.”

Additional Tax Hikes Likely

Kristina Rasmussen, director of government affairs for the National Taxpayers Union, said, “We are absolutely opposed to this massive tax increase, which would come along with a massive increase in government spending. The planned increase in the tobacco tax would be expected to pay for a huge increase in government spending. But the use of tobacco products is going down, so smokers and nonsmokers alike will pay for those spending increases through other increased taxes.”

A recent study by the Mackinac Center for Public Policy supports Rasmussen’s point. “Cigarette Taxes and Smuggling: A Statistical Analysis and Historical Review” reported high cigarette taxes are leading to an increase in cigarette smuggling. That problem, combined with reduced levels of smoking as smokers try to cut costs, consistently results in less cigarette tax revenue than projected.

In New Jersey (where the smuggling rate exceeds 40 percent), cigarette revenue has not merely fallen short of projections. The amount of revenue collected has fallen, after four tax hikes in the past seven years have taken the tax to $2.58 per pack.

Popular with Lawmakers

With a national smoking rate of just under 20 percent, it is no wonder that raising cigarette taxes is popular with lawmakers, says John Nothdurft, a legislative specialist at The Heartland Institute. The “tax thee, but not me” approach makes raising cigarette and other “sin” taxes appealing to politicians who want more revenue without angering most taxpayers.

However, “This concentrates the tax on a minority of people who can least afford it and who already pay more than their fair share,” Nothdurft said.

“Cigarette taxes are highly regressive and place an undue burden on the poor,” Nothdurft continued. “Studies have shown that tobacco use is more common among low-income Americans than among those with higher incomes. Cigarette taxes take a bigger share of the income of a low-income person than of a high-income person, and the low-income person pays more in cigarette taxes in absolute terms, as well.”

Analysts note state and local taxes on tobacco products are already past the point on the Laffer Curve where raising rates reduces revenues. Named for economist Arthur Laffer, the curve shows at a certain point a high tax rate will actually decrease revenue because the tax becomes so punishing that people avoid the taxed item or activity.

Phil Britt ([email protected]) writes from South Holland, Illinois.

For more information …

“Cigarette Taxes and Smuggling: A Statistical Analysis and Historical Review,” by the Mackinac Center for Public Policy: