Washington cigarette tax hike results in decreased revenues as smokers buy outside city limits

The District of Columbia’s Chief Financial Officer Natwar Gandhi learned a hard lesson this week after assessing the fiscal forecast for 2010: D.C. smokers weren’t happy with the city council after it upped the cost of cigarettes, and responded by depriving the District of millions in tax revenue.

Any nicotine fiend who’s dodged puddles of upchuck in Adams Morgan on a Friday night or maintained a distance of 30 feet from downtown office buildings on a weekday could have predicted that smokers would flee to Maryland and Virginia. And according to a report released Wednesday by Gandhi, that’s exactly what happened after the D.C. Council raised taxes on cigarettes from $2.00 to $2.50 a pack in mid 2009.

In a report addressed to D.C. Council Chairman Vincent Gray and Mayor Adrian Fenty, Gandhi wrote, “The 50-cent increase in the cigarette tax rate was projected to increase revenue but also decrease volume. Collections year-to-date point to a more severe drop in volume than projected.”

How severe?

“The estimate for cigarette tax revenue is revised downwards by $15.4 million in [fiscal year] 2010 and $15.2 million in [fiscal year] 2011.”

Annie Chen, the owner of North Sea China Restaurant on 18th St. NW, noticed the drop almost immediately: Since the tax increase was put into effect, Chen has sold smokes to her customers in Adams Morgan at a pre-increase price. “Some places sell for $8,” she slyly reminded me Wednesday night. “But we sell for $7.30. Otherwise you all go to Virginia and Maryland.”

North Sea doesn’t rely on cigarette sales — that’s what the food is for — but the extra revenue is significant enough that Chen would rather reduce her profit margin than lose customers. “I just want to make customers happy,” she said.

Smoking commuters have always fallen into two distinct camps: those who are willing to buy their cigarettes in D.C. despite the high costs, and those who religiously wait until they’re back home in Maryland or Virginia to stock up. Washington City Paper reporter Mike DeBonis suspects that Gandhi and the council failed to take this possibility seriously during a closed-door meeting in July 2009.

“The cigarette tax was literally a no-brainer. I don’t remember much debate at all,” DeBonis, who also covered the tax, wrote in an e-mail. “Part of the blame, if not most of the blame, is on the CFO people who made the cig-tax revenue estimate. Somehow they forgot to consider that Maryland smokers would defect.”

In Wednesday’s report, the CFO’s office expressed frustration that the tax hike hadn’t gone as planned, and suggested that all it had in the way of an explanation was “anecdotal evidence” that Maryland residents, who paid more for cigarettes in their home state prior to the hike in D.C., “have shifted purchases back to Maryland now that District taxes are higher.”

A staffer at the CFO’s office spoke to the Daily Caller on background about the agency’s attempt to find a sweet spot between taxing too little and driving people to other purchase in other states. “The anticipation was that we’d lose some smokers and we’ll collect more money from the people who keep buying,” the staffer said, citing Virginia as an example of a state that has dealt well with increasing excise taxes. “When the federal excise tax went up, Virginia assumed a 12 percent decline. They’ve seen about  7 percent decline.” The staffer also said that the CFO’s office is aware that “Buyers will go where the price is cheapest.”

In the conclusion to his section on the cigarette tax hike, Gandhi seemed to acknowledge this economic reality as well, writing, “Future increases in the tax rate will likely generate less revenue rather than more.”