Every two years, lawmakers gather in St. Paul to solve a budget crisis. This year, Minnesota is facing a $627 million two-year deficit. If lawmakers want a sustainable solution to their state’s budget woes, they’d be wise to avoid rehashing the same failed policies of the past decade.
The Minnesota House of Representatives passed a bill in April raising a number of taxes in order to combat the state budget deficit and funnel more money to schools and other state services. Among other things, the bill would raise cigarette excise taxes by $1.60 per pack, bringing the state’s total excise tax on cigarettes to $2.83 per pack (that doesn’t include the state’s $0.36-per-pack sales tax). Optimistic estimates say the bill, which would also increase the excise rate on other tobacco products from 70 percent to 95 percent of their wholesale price, will collect an additional $220 million annually from smokers — enough to cover about 70 percent of Minnesota’s budget deficit.
The proposal is strikingly similar to then-Governor Tim Pawlenty’s 2005 increase in cigarette excise taxes — a $1.00-per-pack hike he called a “health impact fee.” That tax hike caused tobacco tax revenues to jump the next year, but since then they’ve declined 11 percent. Meanwhile, the state’s deficits have persisted.
Raising taxes on smokers hasn’t solved Minnesota’s budget woes because tobacco taxes are inefficient and ineffective. After the Pawlenty “fee” went into effect in 2005, the excise tax on a pack of smokes went up to $1.23 (plus sales tax), an increase of more than fivefold and a notch above neighboring North Dakota’s $0.44-per-pack excise tax.
With cigarettes cheaper just across the state line, a new business opportunity opened up for anyone with a van, good road trip tunes and distaste for the law: smuggling. In fact, a recent Mackinac Center study on cigarette smuggling found that almost 20 percent of all cigarettes consumed in Minnesota in 2011 were smuggled across the state line (through either casual or commercial operations).
If the legislature raises the cigarette excise tax to $2.83 a pack, Minnesota’s cigarette excise tax will be higher than those of all four neighboring states (Wisconsin’s tax is $2.52 a pack, South Dakota’s is $1.53 and Iowa’s is $1.36). Mackinac analysts estimate that a $0.94 tobacco tax increase, as Gov. Dayton has proposed — which is lower than the $1.60-per-pack hike the legislature is considering — would increase the smuggling rate to 30.3 percent.
Not only does this smuggling reduce state tax revenues, it also hurts Minnesota businesses, especially convenience stores that depend on cigarette sales for a large percentage of their income.
“When you lose those tobacco customers … we’re all of a sudden looking at running our business on 75 percent-60 percent of our customer base,” convenience store owner Frank Orton recently complained to Gov. Dayton at a town hall. The governor acknowledged that smuggling is “undermining the intent” of the tax hike.
Taxes on smokers are not just ineffective, though, they are also inequitable. Tax hikes on cigarettes target a minority of the population, particularly the poor. When the cost of something rises, that price increase disproportionately affects the poor, since it represents a relatively large share of their income. This means all excise taxes — taxes on a targeted good such as cigarettes — are regressive. According to a recent study by the Minnesota Revenue Department, excise taxes like taxes on cigarettes affect the state’s poor 25 times more than they affect the state’s wealthy.
In May 2012, the academic journal Minnesota Medicine published research showing, “Minnesotans living at or below poverty are far more likely to smoke than those who have higher incomes.” In fact, nearly half of all adults in the Gopher State making under $35,000 a year are smokers.
The Minnesota Senate is expected to release its tax overhaul bill on Tuesday. That bill will likely include similar tax hikes on cigarettes. However, lawmakers would do well to learn the lessons of Gov. Pawlenty’s failed 2005 strategy, which just papered over the state’s long-run budget problems with short-term solutions that hurt the poor, made Minnesota businesses less competitive and shirked the obligation of public servants to manage the state’s budget responsibly. Minnesota should know by now that trying to balance a budget on the backs of smokers won’t work and is poor public policy.
Katie Furtick is a policy analyst at the Reason Foundation. Anthony Randazzo is the director of economic research at the Reason Foundation.