It was a good two months late, but yesterday both political parties and the American people got to read the fine print of President Barack Obama's proposed 2014 federal budget.
As you might expect, quite a few Democrats supported the main points of the budget, and House Republicans in almost every respect shunned the president's outlined measures, which included higher taxes for upper-income earners and some spending cuts as well. Ultimately, there wasn't much new and the bipartisan bickering that ensued has become a norm on Wall Street for the past couple of years.
82 billion reasons to quit
However, what did stick out like a sore thumb was Obama's budget proposal that entailed raising the federal tax on cigarettes from $1.01 per pack to $1.95 – a $0.94 increase! According to calculations associated with the president's budget proposal, the increase would raise $78 billion over the next decade, which would be enough to fund a universal preschool program for children.
Source: White House.
In addition, it's estimated that $1 billion in long-term health care costs would be saved from a reduction in smoking caused by the increase in prices, and $3 billion would be added to the economy thanks to a healthier labor force. Added together, Obama's plan to smoke the tobacco industry -- the irony here is that the president was once a smoker himself -- could result in an $82 billion favorable swing over the next decade.
While the magnitude of the tax provision astounded me, I'm not actually surprised to see a cigarette tax hike included in the president's budget proposal with the implementation of the Patient Protection and Affordable Care Act, known as Obamacare, right around the corner. The president understands the costs associated with implementing a wave of health reform, and also understands that minimizing as many long-term health problems as possible (i.e., getting young people to stop smoking) will help his health care reform bill achieve success.
No ifs, ands, or butts about it!
Big tobacco companies, on the other hand, definitely didn't take kindly to the president's proposal, which represents the latest threat in a series of events meant to increase the public's awareness of the dangers of smoking.
Last year, the Centers for Disease Control and Prevention took aim at the tobacco industry with a $54 million, three-month long marketing blitz advertising the dangers of cigarette smoking, while the Food and Drug Administration exerted its force on the industry by requiring tobacco producers to disclose the quantities of 20 known harmful chemicals found in cigarettes.
Before even the CDC and FDA got involved, individual cities and locales, such as New York, got involved by banning cigarette smoking inside restaurants and in largely public places like plazas and beaches.
The weight of these measures on domestic tobacco companies is really going to start taking its toll. Even if Obama's budget proposal fails to pass through Congress -- and every political think tank will assure you it's dead on arrival -- a higher tax on cigarettes might be one of the very few tax increases that would receive bipartisan support and could work its way into a compromised budget package.
Big tobacco's response
We've already seen a swift reaction from domestic tobacco companies over the past couple of years in light of weak tobacco sales. The U.S.' largest tobacco producer, Altria (MO 0.12%), announced in October 2011 that it'd be laying off 15% of its workforce in response to declining cigarette sale volume. Reynolds American (RAI), the second-largest U.S. tobacco producer, followed suit with a 10% workforce cut of its own just a few months later.
As I've stated before and I'll state again, the safest way to invest in the tobacco sector is to look overseas. Philip Morris International (PM 1.39%) and British American Tobacco (BTI -0.24%) are two tobacco producers that operate outside the confines of the United States' strict regulations. Having operations spread throughout the world, these two companies can take advantage of a burgeoning middle-class market in China and India, while also catering to more established markets where smoking regulations are considerably more relaxed. This type of geographical diversification is what makes these stocks attractive, and what makes U.S. big tobacco an easy sector to avoid.
