“OF SALES & SIN” (PART 2) – TOBACCO TAX MARCH 25TH 2016 DESCRIPTION:

In the second episode of our series on consumption taxes, we take a look at California’s tobacco tax—where it came from, where its revenue goes, and how we might expect it to change in the future.

TRANSCRIPT:

Welcome to the Politi-Cal Podcast, policy in a golden state of mind. My name is Tony Mastria, and today we’re talking about California’s tobacco tax. This show marks the second installment of our series on consumption taxes—a series we’re calling “Of Sales and Sin.” If you tuned in to our last episode, you’ll recall we talked at length about California’s sales & use tax, which is added to nearly every tangible item we buy across the state. So, today we’ll be covering a slightly different type of tax, one that applies only to a very narrow band of these purchases. Excise taxes—or “sin” taxes, as they’re often called—include things like the tobacco tax, the gas tax, and the alcohol tax. Excise taxes are imposed intentionally on a very specific set of items, usually on top of the regular sales tax that we already pay for these goods. Typically, we create excise taxes to fulfill a particular purpose that the sales tax alone is unable to achieve. For example, we might impose an excise tax on something in order to discourage people from consuming too much of it— that is, by artificially raising its price to a point where customers aren’t willing to buy quite as much of it as they did before. We might also impose an excise tax to pay for the externalities of using a particular product—that is, the societal costs that are imposed by that product but aren’t taken into account in its original price—things like air pollution and healthcare costs. Finally, we might impose an excise tax on something simply to raise more revenue, either for a specific purpose or for government in general. Running an entire state is a costly enterprise—especially for a place like California, whose population and economy are larger than those of most countries on Earth. And due to the growing requirements and restrictions imposed by voters through direct democracy, lawmakers are increasingly constrained in the ways they’re able to fund the activities of government.

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“OF SALES & SIN” (PART 1) – SALES TAX

So, sometimes imposing a tax on something like tobacco is simply the most pragmatic and popular way to ensure that our state has the means to run itself properly. California’s tobacco tax is imposed on both cigarettes and other tobacco products, including cigars, snuff, pipe tobacco, and chewing tobacco. As of 2016, the tax imposed on a typical pack of twenty cigarettes is 87 cents, and for other tobacco products, it’s equal to 28% of the wholesale price. While that eighty-seven-cent cigarette tax has stayed the same since the 1990s, the tax on other tobacco products is periodically readjusted to match the rate on cigarettes. The exact percentage imposed is determined annually by the State Board of Equalization, which—among other things—collects tobacco taxes. Like the sales tax, the tobacco tax isn’t technically imposed on consumers themselves, but it is passed on to them in their final purchase. In order to sell cigarettes legally in California, distributors are required to purchase stamps—equal to eighty-seven cents apiece—directly from the State Board of Equalization. Each of those stamps is then affixed to a pack of cigarettes before sale and serves as verification that those tobacco taxes have been paid in full. California’s smoking rate is just under thirteen percent of its adult population, giving it the secondlowest prevalence of all fifty states. At the same time, because California also has the largest population overall, it also has the highest number of smokers overall, totaling about four million people or roughly the size of the City of L.A. As such, we collect around 800 million dollars in tobacco taxes per year. And while a portion of those proceeds goes into California General Fund— what we typically think of when we talk about the state budget—the vast majority goes into special funds that are legally committed to specific policy areas—things like anti-smoking campaigns, cancer research, early childhood development, and healthcare for the poor. In addition to the tobacco tax, California’s smokers also pay the sales & use tax, the federal tobacco tax, and the cost of a 1998 settlement between the states and tobacco companies. As a result, the total cost of a pack of cigarettes in California—that is, the retail price plus taxes—is about five dollars and fifty-three cents. Judging solely by its relatively low smoking rate, one may be lured into assuming that California places a greater burden on smokers than most other states do. It is true that California has invested a great deal of its resources on anti-tobacco efforts and is generally more restrictive with smoking laws in general. But to the extent that cost serves as the main deterrent, California’s tobacco tax actually ranks toward the bottom of the list. And notwithstanding its success in promoting public health, California has historically been a relative latecomer to adopting and increasing tobacco taxes. That history begins in the depths of the Civil War, when the federal government imposed its first tax on cigarettes in 1864. This was long before anyone recognized the risks of tobacco consumption, so the decision was driven less by concerns over public health than it was by concerns over public finance. Burdened with the enormous cost of funding the Union’s war efforts, the federal government initiated an unprecedented expansion in the types of taxes imposed on civilians, including—among other things—cigarettes. Most of these Civil War-era taxes were repealed after

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“OF SALES & SIN” (PART 1) – SALES TAX

the conflict ended, but the cigarette tax stayed in place, and it would remain the only major tobacco tax in the U.S. for the next fifty years. That changed in 1921, when Iowa instituted its own tax on cigarettes and sparked what would become a national trend. Soon after Iowa’s decision, South Carolina, South Dakota, Utah, and Tennessee all jumped on the tobacco tax bandwagon, and over the next three decades, they were followed by a cascade of forty more states and the District of Columbia. This policy shift was so widespread and so definitive that by the end of the 1950s, California was one of only five states that had yet to impose a tax on cigarettes, along with Virginia, Colorado, Oregon, and North Carolina. California finally took the plunge in 1959, and within the next decade, every state in the country had its own tobacco tax on the books. California’s tax on cigarettes began at a modest three cents per pack, which, by 1967, had grown to a comparatively hefty ten cents per pack. Shortly thereafter, tax collectors began to observe a troubling trend in California’s tobacco sales: people were still buying cigarettes but were somehow obtaining them without paying the tax. What lawmakers failed to anticipate was that, in raising the tax so suddenly and so substantially, California had unwittingly thrust itself into the middle of a black market. Californians who felt overburdened by the increase quickly became privy to the knowledge that the tax did not apply on either military bases or Indian reservations, both of which were abundant in California. As a result, anyone who had access to these areas—or knew someone who did—could purchase their cigarettes tax-free. While this experience didn’t dissuade lawmakers enough to lower the tax, it made them intensely apprehensive about raising it further—so much so that California’s ten-cent tax on cigarettes would stay in place for the next two decades, and it would require direct intervention by the people for that rate to increase. So, in 1988, voters approved Proposition 99, the Tobacco Tax and Health Protection Act. This initiative raised the tax on cigarettes for the first time in over twenty years, from ten cents per pack to thirty-five. In addition, the initiative imposed a new excise tax on other tobacco products as well, which, up to that point, had been inexplicably exempt. For products composed of at least fifty percent tobacco, this tax would be applied as a percentage of the item’s wholesale price at a rate equivalent to the tax on cigarettes. It would adjust automatically from year to year, in order to incorporate any changes in price and mirror any amendments to the tax on cigarettes. Another characteristic that made Prop 99 unique was that, for the first time, it ensured that a portion of California’s tobacco tax would be set aside for a dedicated purpose. Instead of depositing that extra twenty-five cents into the General Fund and leaving its fate in the hands of lawmakers, Prop 99 specified in advance what types of programs that additional revenue could support. In this case, at least forty-five percent of the proceeds would go toward healthcare for the poor, another twenty percent would fund educational programs on personal health and tobacco use, five percent would support research on tobacco-related disease, and another five percent would support outdoor initiatives like fire prevention and public parks. The remaining twenty-five percent could go toward any one of these purposes, depending on need in a given year.

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“OF SALES & SIN” (PART 1) – SALES TAX

Although California’s tobacco tax had languished for some time, Prop 99 instantly catapulted it to being the second-highest in the nation, just behind Minnesota’s. That sounds impressive, but it’s also worth noting that if the rate had simply kept pace with inflation, then a ten-cent tax in 1967 would have equaled almost forty cents by 1988. The rate we ended up with instead—thirty-five cents—isn’t far off that mark, so the real increase may not have been quite as dramatic as California’s jump in the rankings suggested. This abrupt leap forward started a trend that would play itself out at least one more time in California’s history. But perhaps the bigger pattern to emerge from Prop 99 was how the state would treat its tobacco tax revenue at all. Prop 99 convinced elected officials that Californians weren’t quite as averse to tobacco taxes as they once were. However, lawmakers also recognized that voters had agreed to that increase with the caveat that it be used for a particular purpose. Even when it came to tobacco taxes, which are relatively uncontroversial, voters weren’t prepared to give lawmakers a blank check. So, in 1993, the California legislature approved two bills—AB 478 and AB 2055—known together as the Breast Cancer Act. The Breast Cancer Act raised the tax on cigarettes by a humble two cents per pack, bringing the total to thirty-seven cents. That additional revenue would go toward the establishment of a grant system called the California Breast Cancer Research Program. As its name implies, the program distributes grants to California scientists to support research on breast cancer, including prevention, treatment, and—hopefully—a cure. Despite the popularity of these two components— tobacco taxes and research on breast cancer—it’s worth observing that California places a high hurdle on any statewide tax increase, requiring two-thirds approval from both houses of the legislature. So even under the most conducive of circumstances, getting this passed was no small feat. Emboldened by the passage of both Prop 99 and the Breast Cancer Act, California’s community of anti-smoking advocates sought to carry their victories even further. So, in 1998 they drafted and passed Proposition 10, which raised the tax on cigarettes by an additional fifty cents. Prop 10— known as the California Children and Families Act—increased the total tax on cigarettes to 87 cents per pack, instantly propelling it to the third-highest rate in the nation. This time, the initiative’s policy target would be early childhood development, resulting in the creation of state and county commissions designated with tackling this issue. These commissions—known as the First 5 Commissions, after the first five years of a child’s life—are tasked with fulfilling a variety of responsibilities around early childhood development, including creating educational materials, conducting outreach to parents, offering training and technical assistance, and evaluating the effectiveness of specific programs. As ordered by Prop 10, twenty percent of the measure’s funds would go to the state-level commission, while the remaining eighty percent would be divided amongst the county commissions. Around the same time as Prop 10, California joined forty-five other states in finalizing a massive settlement with the country’s five largest tobacco companies, including Philip Morris and R.J. Reynolds. The issue at hand was whether these manufacturers bore any financial responsibility for the impact of smoking on public health—specifically, whether they were liable for the added cost to

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“OF SALES & SIN” (PART 1) – SALES TAX

taxpayers on state Medicaid systems. While the debate was unsurprisingly contentious, the two sides ultimately reached an accord that would become the largest civil litigation settlement in U.S. history. The Master Settlement Agreement, or MSA, obligated these companies to pay the states roughly ten billion dollars per year indefinitely—meaning those payments are still coming to this day. While the MSA isn’t technically a tax, manufacturers nonetheless needed a way to pay for it. So, in 1998, they opted to raise the price of cigarettes by an average of forty-five cents per pack, or about sixty-four cents today. And that’s where we stand right now. The one-two punch delivered by both Prop 10 and the MSA almost eighteen years ago represent the last time California succeeded in raising the cost of tobacco—though not necessarily for lack of trying. Raising the state’s tobacco tax has become a perennial subject of public debate, and it seems that every election year features at least one attempt to do so, even if only a handful of these proposals actually make it to the ballot. For example, ten years ago, in 2006, one proposition sought to raise the tax by an ambitious two dollars and sixty cents per pack. And despite 2006 being a relatively receptive year for progressive candidates and causes—what’s often been called a Democratic “wave” election—California left-leaning electorate still shot down the idea by several points. Even a more modest one-dollar increase was rejected by voters as recently as 2012, though that was admittedly a much narrower defeat. While no outcome is certain, the landscape may be more favorable to change today than it was in the past. In recent years, public support for raising the tax on tobacco has registered anywhere between sixty and eighty percent—a degree of consensus that few other tax increases can match. Meanwhile, the real impact of the tax has diminished substantially as two decades of inflation have gradually chipped away at its value. If this rate had simply kept pace with inflation, then California’s eighty-seven-cent tax in 1998 would be worth over $1.20 today. And over the past eighteen years, most other states have gone far beyond the rate of inflation to determine the proper tax on tobacco. Today, a total of twenty-six states have cigarette taxes of at least a dollar-fifty per pack, including fifteen states that charge at least two dollars, and eight states that charge at least three. The fact that California’s still sits comfortably under a buck places ever greater pressure on the state to catch up. Bearing that in mind, advocates are confident they can finally ride these factors to victory at the polls, including a two-dollar increase that may appear on the ballot this year. That would raise California’s tax on cigarettes to two dollars and eighty-seven cents per pack, increasing the state’s ranking from number thirty-five to number eight—not outlandishly high but still firmly in the top tier. The proposal, which is currently gathering signatures for qualification, draws on the model of its successful predecessors by directing the bulk of its revenue to things like healthcare, research, and education. In addition—and for the first time—it reclassifies new nicotine products like e-cigarettes and vaporizers as subject to the state’s tobacco tax, though it remains to be seen how this might affect the initiative’s change of passage. So, now that we understand how California’s tobacco tax arrived at where it is, let’s explore some of the broader implications of this tax more generally. Over the past few decades, the prevalence of smoking in California has undergone a massive decline. Since 1988, the state’s proportion of

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“OF SALES & SIN” (PART 1) – SALES TAX

smokers has decreased from about one in four people to just one in eight today, giving California the second-lowest smoking rate of any state in the country, behind Utah. While this shift is undoubtedly part of a national trend, it’s also safe to assume that at least part of California’s drop is attributable to both high taxes and strong public health programs. Simultaneously—and perhaps unfortunately—this means that revenue from the tobacco tax has been steadily dropping, as well. The combined impact of both lower tobacco use and higher inflation means that this once-potent source of revenue has been essentially decimated. In the decade after the passage of Prop 10, California’s tobacco tax generated over a billion dollars per year. But it hasn’t crossed that threshold since 2008 and has instead been drifting consistently downward. Today, it’s approaching just eight hundred million dollars per year and isn’t projected to reverse course anytime soon. While eight hundred million doesn’t sound so small, the reality is starker when you place this amount in context. The dominant source of revenue in California today is the personal income tax, which, in 1970, generated only about five times more revenue than the tobacco tax did. By comparison, today the personal income tax generates about a hundred times more revenue. So, while the programs that the tobacco tax supports are as important now as they’ve always been, the tax itself has shrunk to a sliver of its former self. And to that point, it’s worth asking how long policy areas like cancer research and early childhood development should rely on what is evidently a dying source of funding. Obviously, the state could—and, to some extent, does—support these things outside the amount that tobacco users pay in taxes for them. But these are things that we all value— collectively and universally—and it’s for that reason that we may someday be forced to reevaluate why the burden of ensuring their success is placed in the hands of such a small, and shrinking, portion of our population. Similarly, it’s worth recognizing the types of people who are affected most by the tobacco tax in the first place. In California and elsewhere, smokers tend to be lower-income, less educated, more concentrated in rural areas, and disproportionately African American or American Indian. Those below the federal poverty line are seventy-five percent more likely to smoke than those earning the median income. And someone with only a high school education is twice as likely to smoke as someone with a Bachelor’s degree—not to mention three times as likely as someone with a graduate degree. On top of that, nicotine is a viciously addictive drug, and most of the people who consume it are probably, by definition, addicted to it. They’re compelled less by personal choice than by the mandates of a deep, aggressive physiological need. Outside the merits of the tax itself, any one of these metrics would suggest an enormous degree of regressivity. Like the sales tax, it imposes a heavier burder on those with the fewest means to afford it. The tobacco tax fits every one of these adverse criteria, so any debate over increasing or amending it should include a conversation about who would be impacted and how. We embrace it, after all, as a powerful tool for helping our fellow citizens, and it’s in that spirit of compassion that we ought to acknowledge its consequences in sum. Finally, we should observe—as we’ve alluded to already—that California’s tobacco tax does not encompass emerging markets like e-cigarettes and vaporizers. While these relatively recent

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“OF SALES & SIN” (PART 1) – SALES TAX

inventions don’t contain tobacco, they do contain nicotine, as well as a few other questionable ingredients. So, the debate over whether they’re truly a safe alternative to smoking will probably remain an open question for the foreseeable future, at least until researchers have taken more time to examine them. What we can say for certain is that these products are growing in popularity, even as conventional tobacco use continues to decline. In the year between 2012 and 2013, the percentage of adults in California who used e-cigarettes regularly more than doubled, and for Californians between the ages of 18 and 24, that number quadrupled over the same time period, from just one in forty-five to about one in twelve. Considering there’s still some ambiguity on the exact risks of e-cigarettes, this might not necessarily represent a troubling trend—were it not for the fact that these habits are also seeping down to children and teenagers. According to a national study by the CDC, the proportion of high school students using these products ballooned from about four-and-a-half percent in 2013 to over thirteen percent just one year later. Among middle school students, the increase has been even more dramatic, from about one in ninety to one in twenty-five. And considering all these numbers are now several years old, it’s likely they’ve expanded even further since then. The reality we now face is that these products are coming whether we like it or not. And however we decide to tax or regulate them, ultimately they will require a definitive answer from our public policy. If California’s anti-tobacco crowd has anything to say about it, that answer may arrive before the year is out. … That’s our show. Thank you for joining me on part two of our consumption tax series. If you haven’t subscribed to the show already, you can do so through iTunes, TuneIn, Soundcloud, Stitcher, or wherever you get your podcast fix. If you want to learn even more about California’s tobacco tax, you can browse through notes, sources, and infographics from today’s show by visiting our website, politicalpod.org. And be sure to add us on Facebook, Twitter, and Instagram at @politicalpod to stay in touch with news, politics, and policy every day. Thanks for tuning in, and I’ll see you next time.

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