Trevor R. Martin
Director of Government Relations
The Heartland Institute
Testimony to the Texas House Committee
on Ways and Means
Wednesday, March 7, 2007
Why Taxing Like Products Differently Is Bad
for Commerce and Bad for the Consumer
Mr. Chairman, thank you for allowing me the opportunity to appear before you today. The Heartland Institute is a 23-year-old nonprofit research and education organization, based in Chicago but national in scope. My testimony is based on research conducted by The Heartland Institute in its mission to discover, develop, and disseminate free-market solutions for social and economic problems. The opinions in this testimony are my own.
In 40 states, taxes on smokeless tobacco products are causing double taxation, distorting consumer behavior, and hurting retailer profits. Texas currently is one of those states.
Arguably, there is no other product category that has such widespread discriminatory tax treatment as does smokeless tobacco.
From our nation’s founding, national and state tax policy has been to tax like items alike. So, in the eyes of tax collectors, beer is beer, whether a person buys a pricey micro-brew or a less expensive mass-produced product. The excise tax rate is based on the same amount of beer, not the price of the beer.
Likewise with gasoline, which is taxed on a per-gallon basis. It doesn’t matter if the gallon is a low-octane non-detergent no-name brand, or a more expensive high-octane name brand.
Even cigarettes are taxed per unit, not on whether each unit is a low-priced generic or a higher-priced name brand.
At the national level, the tax on smokeless tobacco is based on the amount of tobacco rather than the price, as is the standard practice with other items that are subject to excise tax. A per-unit tax is the proper approach to excise taxation, because it reduces market distortions and unintended consequences.
Regarding excise taxes: if you accept the argument that certain products can harm individuals and impose costs on society, and that those products therefore should be taxed to defray those costs—what is called imposing a “sin tax”—there is no justification for taxing similar items differently, solely on the basis of their price.
The harm caused by a unit of tobacco has no relation to its price. This is why every state and the national government impose taxes based on the number of cigarettes, not on the price of the cigarettes. This is why the states and national government impose taxes on beer, wine, and liquor based on unit, not on price. An expensive bottle of French Bordeaux wine causes no more harm to individuals who drink it, and imposes no more costs on society, than does a bottle of inexpensive Romanian wine produced from the same variety of grapes.
And, a $2 container of smokeless tobacco imposes no more harm to the user or cost to society than does the same size container selling for $5.
One effect of price-based—or, ad valorem—taxes is to shift consumption to less expensive brands. There is little or no impact on how much tobacco is consumed.
And, with over one hundred products and numerous everyday price points, not to mention discounts, incentives, and promotions, the tax rate charged on these products can vary wildly. The bottom line is that a weight-based tax would level the playing field for all products and customers, while at the same time preserving retail profits.
Defenders of the current ad valorem system sometimes present an interesting analogy: under a per-unit system of taxation, they say, an entry-level Ford or Chevy would be taxed the same as a high-end Mercedes or Lexus. This, they say, would be patently unfair.
The mistake in this analogy is the apparent confusion between sales taxes and excise taxes. The purchaser of a container of premium chewing tobacco would pay more in sales tax under a per-unit excise tax than someone who buys discount chewing tobacco, just as the purchaser of a new Mercedes would pay more in sales tax than someone who buys a 10-year-old Chevy.
With the ad valorem excise tax system, we have the national unit-based tax and then, in 40 states, an excise tax based on price, which drives up the final purchase price, to which sales tax is applied. This gives the effect of a double sales tax and hides the true tax burden.
While consumer price inflation might be a temptation to keep ad valorem taxes in place—as prices go up, so would tax receipts—this thinking ignores the changes in consumer behavior we have already noted. As consumers switch from high-taxed premium-priced products to lower-priced and lesser-taxed discount brands, tax receipts go down.
And rising prices are no guarantee. Imagine the volatility in fuel tax receipts if gasoline were taxed on a price basis instead of on a per-gallon basis. No one knows what prices tobacco products may fetch five or 10 years from now.
I conclude that states should not support a tax policy that creates a preference for one product over another. Texas has an opportunity to change a tax system that distorts commerce and the free market, hurts business, and changes consumer preference.
Thank you again for giving me the opportunity to appear before you today. I would be happy to answer any questions Members of the committee may have.