Do Cigarette Taxes Really Work?

The federal government has taxed tobacco products since 1794, although the first state tax wasn't implemented until Iowa passed a bill in 1921. Today, every state in the union as well as the District of Columbia, Puerto Rico, Guam, and Northern Marianas institute a tax on cigarettes. This is likely no surprise. If you have tried to buy a pack of cigarettes lately, then you know it is a pricey purchase. Unfortunately for smokers, cigarettes don't appear to be getting cheaper anytime soon.

Since 2002, states and territories have increased cigarette tax rates at least 105 times. Here's where they stand for summer 2013.

Source: Campaign for Tobacco-Free Kids.  

These are in addition to the $1.01 federal tax tacked on per pack -- up from just $0.39 in 2009 -- not to mention city taxes in several metropolitan areas. New York City and Chicago residents will be paying $5.85 and $5.66, respectively, per pack in state and local taxes this summer. You may be wondering if all of these measures actually amount to a reduction in smoking or enhanced public health -- presumably the targeted end result -- or are just an easy revenue source for Uncle Sam. Before we question the effectiveness of cigarette taxes, let's take a look at what is at stake.

Health effects of smoking
There is really nothing novel here. We are taught from an early age that smoking cigarettes can cause serious health problems. The Center for Disease Control hits home with these six statistics.

  1. Smoking accounts for approximately 443,000 deaths in the United States each year. That amounts to 20% of all deaths and more than HIV, illegal drug use, alcohol use, motor vehicle accidents, suicide, and murders combined.  
  2. About 90% of lung cancer deaths in men and 80% in women can be attributed to smoking.
  3. Smoking increases your risk of developing coronary heart disease by two to four times, stroke by two to four times, lung cancer (men) by 23 times, and lung cancer (women) by 13 times.
  4. The following cancers have been linked to smoking: acute myeloid leukemia, bladder, cervix, esophagus, kidney, larynx, lung, oral cavity, pancreatic, pharynx, and stomach.
  5. In the five years from 2000-2004, smoking added an estimated $193 billion to health-related economic losses in the United States.  
  6. Each year, Americans lose a cumulative 5.1 million years of life from cigarettes.

Given the health and economic consequences of smoking, it is easy to see why federal, state, and local governments would set out to curb tobacco consumption. But do cigarette taxes really work?

Survey says...
The surgeon general releases annual reports on tobacco use every few years. In the 2000 report, the office maintained that a 10% increase in cigarette prices results in a 3%-5% reduction in consumption. This was backed up by an overall decline in smoking from 2005-2011 across several groups, including a 22.5% fall among those ages 18 to 24 years old. A separate study conducted by the New York Department of Health in 2011 determined that smoking rates in the state -- where consumers face the stiffest taxes in the nation -- fell 20% from 2003-2004 to 2009-2010.

The evidence suggests that cigarette taxes do in fact curb consumption.

However, you would be hard-pressed to find any connection between falling smoking prevalence and share performance at Reynolds American (NYSE: RAI  ) , Lorriland (NYSE: LO  ) , Phillip Morris (NYSE: PM  ) , and Altria (NYSE: MO  ) . These companies are some of the best performers in the past decade. In fact, Altria is the best-performing stock of the last half-century!

^SPX Chart

^SPX data by YCharts.

How is that possible? Tobacco consumption is rising rapidly in low- and middle-income countries, as noted by the World Bank. Each company has increased its presence internationally and diversified into products such as nicotine gum, electronic cigarettes, and even wine. The group has also spent billions on advertising and millions more on lobbying. I still find it interesting that, at the end of the day, no one can blame higher cigarette taxes for hampering growth.

Can cigarettes be taxed out of existence?
If high taxes are effective, then even higher taxes should be even more effective, right? Not quite. The same New York Department of Health study quoted above questions the effectiveness of increasing taxes further. While overall consumption has fallen in the state since 2004, researchers found that households with less than $25,000 of annual income saw consumption rates decline less than 10%. More worrisome is the fact that households with $30,000 of annual income that smoked spent 23.6% of earnings on cigarettes in 2011 -- more than double the 11.6% spent in 2004.

In other words, lower-income smokers are less likely to quit because of higher taxes but feel a much bigger economic pinch as a result. Consider that similar economic studies have shown that low-income households spend less than 20% of their income on food. Keep in mind that the study included the state -- and city -- with the highest tax rates. Nonetheless, policymakers may need to realize that increasing cigarette taxes from here may do more harm than good. Perhaps allocating more tax revenue toward a smoking awareness campaign geared toward low-income households would be more effective.    

Foolish bottom line
Even if cigarette taxes are nearing a wall in terms of effectiveness, there is no debating that they have done a great job of curtailing tobacco consumption in the United States. Ironically, tobacco companies have thrived in the same time period that smoking rates have dropped by 20%. I am aware that differences persist, but perhaps this is proof that taxing other negative externalities -- carbon emissions, sugary foods, and the like -- won't result in the doomsday economic scenarios often hypothesized by critics. Heck, investors in energy companies may welcome a carbon tax after seeing the performance of the tobacco industry.

Altria has been the best-performing stock of the past 50 years, but as the number of smokers in the U.S. continues to steadily decline, is Altria still a buy today? To find out whether everyone's love-to-hate dividend stock is a savvy investment choice or a hazard to your portfolio, simply click here now for access to The Motley Fool's premium research report on the company.

 


Read/Post Comments (9) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 12, 2013, at 12:40 PM, mdk0611 wrote:

    Let's not go totally altruistic here. Cigarette taxes are also a great way to raise revenue with a minimum of protest.

  • Report this Comment On June 12, 2013, at 12:43 PM, doggiesstocks wrote:

    "Each company has increased its presence internationally"

    That is a patently false statement. As a tobacco investor, it is really important to understand which markets are served by specific companies. All 3 of the tobacco companies shown in the relative S&P 500 performance chart ONLY sell tobacco products in the domestic US market. Altria spun off international operations as PMI in 2008, Reynolds' international operations are handled by BAT (which owns 40% of RAI), and Lorillard ceded international marketing of Newport to Japan Tobacco in the 1970s.

    There are only 4 major international, publicly-traded tobacco comapnies: Imperial Tobacco (ITYBY), British American (BTI), and Japan Tobacco (JAPAF), and Swedish Match (SWMAY).

  • Report this Comment On June 13, 2013, at 6:20 PM, JadedFoolalex wrote:

    Canada tried high taxes for tobacco products only to drive the industry underground. The higher the tax rate charged, the greater the smuggling became. The Federal Government eventually lost so much revenue that they were forced to cut back the tax rate!

    The same phenomenon happened when Sweden tried to tax high-fat products sold in the market. The taxes forced people to shop for their products in Denmark, thus causing the Government to cut back on the tax as they, too, were losing too much revenue!

    Which just goes to show you that you cannot legislate human behavior!

  • Report this Comment On June 13, 2013, at 10:12 PM, wjcoffman wrote:

    DC is a state?

  • Report this Comment On June 13, 2013, at 10:17 PM, TMFBlacknGold wrote:

    @JadedFoolalex

    Imagine going to the black market for a bag of potato chips, haha.

    --Maxxwell

  • Report this Comment On June 13, 2013, at 10:18 PM, wjcoffman wrote:

    Do cigarette taxes work? Depends upon what work you're wanting them to do. Curtail smoking? Probably not. Raise revenue? Heck yea! If your implied response is do they curtail smoking then are gas taxes supposed to cut down on driving? Food taxes reduce eating? Sales tax reduce purchases? Payroll taxes reduce working?

    Silly headline and really what's the point at an investment site?

  • Report this Comment On June 14, 2013, at 6:35 AM, r2d23333 wrote:

    The bottomline here is that studies clearly show higher taxes to have much less effect in terms of getting people to drop the smoking habit, though higher taxes are highly effective at deterring young people from starting the habit. Keep taxes high - - it's important that the next generation not get hooked.

  • Report this Comment On June 14, 2013, at 11:31 PM, wjcoffman wrote:

    "higher taxes are highly effective at deterring young people from starting the habit. Keep taxes high - - it's important that the next generation not get hooked."

    What study is that from? My 21 year old son comes home from a party. Of the 20 or so kids there he says maybe 6 of them are not smoking. Blows my mind. That's probably the first generation where we should see the effects of the Warnings and billboards and commercials and ban on smoking in public. I read somewhere that the percent of the smoking age population dropped to around 20% and has remained there. Ain't no taxes gonna stop kids from smoking.

  • Report this Comment On June 14, 2013, at 11:44 PM, TMFBlacknGold wrote:

    @wjcoffman

    A lot of those kids at the party may smoke, but most of them are the weasels who constantly bum cigarettes off of other kids. I had plenty of friends in college who "smoked" but wouldn't buy packs on a regular basis. Aside from my observation, the scientific data does in fact show a drop in smoking prevalence.

    Maxxwell

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2484451, ~/Articles/ArticleHandler.aspx, 11/21/2014 10:12:37 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement