Proposition 29 is an initiative sponsored by “Californians for a Cure,” a coalition of health associations and cancer survivors. Their goal is to increase the amount of excise tax on cigarettes and other tobacco products to fund research on cancer and other tobacco-related diseases in California and to reduce tobacco use in the state.

Background

The excise and sales taxes on tobacco products are directly responsible for hundreds of millions of dollars in revenue to the state. Tobacco products have also been indirectly responsible for nearly $10 billion of revenue to California from a 1998 settlement with the major tobacco companies (MSA – Master Settlement Agreement).

Along with these increases in revenue came other effects: higher prices for tobacco products, decreases in smoking, and fewer deaths related to smoking. There were other unintended consequences: increases in cigarette bootlegging, tax-avoidance, and ancillary crimes.

California Tobacco Tax Laws

All cigarettes sold in California by retailers such as grocery, convenience, and specialty stores as well as Indian reservations (for sales to non-Native Americans), must bear a tax stamp showing payment of the state excise tax. Tax stamps are purchased by licensed distributors, wholesalers, importers, and manufacturers of cigarette and tobacco products, who file monthly tax returns with the state Board of Equalization (BOE) and affix tax stamps to each pack before distribution. The cost of the tax stamps (the excise tax) is passed along to consumers in the price of the product. Sales taxes are applied to the price of the product, including all excise taxes.

Consumers who purchase more than 400 cigarettes or tobacco products for their own use from outside of California are required to pay the excise tax directly to the BOE. This includes purchases through the mail, by telephone, or the Internet, which are also subject to use taxes.

In California, there are restrictions on Internet purchases, requiring distributors to verify the purchaser is at least 18 years old and restricting common carriers such as UPS or Fed Ex from delivering cigarettes to individuals.

Tobacco Tax Consequences

Rising Prices / Lower Demand

A key policy issue regarding these taxes is their future revenue potential given declining tobacco consumption caused by higher excise taxes and health concerns. In 2009, the BOE reported tobacco tax revenue declined 8.1 percent. Whether this decline was due to a decrease in the number of smokers or from non-taxed tobacco purchases is not known.

According to the Centers for Disease Control, a 10 percent increase in the real price of cigarettes is estimated to reduce consumption by nearly 4 percent. If this projection were applied to the $1/per cigarette pack excise tax increase proposed in Prop 29, it would represent a 20 percent increase in the cost of a pack of cigarettes and would reduce consumption by 8 percent.

Currently, the average retail price of a pack of cigarettes in California is roughly $5, including all taxes.

According to the California Department of Public Health, California’s excise tax of 87 cents per pack places it 33rd among other states, with New York State as the highest at $4.85 and Missouri the lowest at 17 cents.

Whether the result of higher taxes or the success of anti-smoking campaigns, smoking in California has declined. According to the Centers for Disease Control and Prevention, in 2010 California’s smoking rate for individuals over age 18 was 14 percent. Among all states, Utah had the lowest smoking rate at 9 percent while West Virginia had the highest at 26 percent.

Increased Tax Evasion

As cigarette taxes (and prices) have increased, the incentives to evade the tax have increased, leading to three types of crime: border shopping (including unreported Internet purchases), smuggling, and “ancillary crime” (armed robbery, kidnapping and even murder committed because of cigarette smuggling). (Tax Foundation special report in October 2006.) Such crimes deprive the state of tax revenue and can fund organized crime.

In 2010 Congress passed the Prevent All Cigarette Trafficking Act (PACT Act), in recognition that the range of state cigarette and smokeless tobacco taxes creates a potential for interstate trafficking to avoid state tax. The law requires Internet tobacco product sellers to register, report and record sales with the Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF), information which is shared with state taxing authorities. This law generally bans the mailing of cigarettes through the U.S. Postal Service.

A 2003 BOE survey of 1,300 retailers found untaxed cigarettes in inventory. Their report concluded that 274 million packs of untaxed cigarettes were being sold annually in California. In the fiscal year 2005-06, the BOE estimated 209 million of the 1.4 billion packs sold were sold tax free, a 15 percent evasion rate, representing a $182 million loss of revenue for the state. The BOE’s enforcement efforts result in a minimal amount of collections. In 2008-09 BOE’s investigative efforts assessed taxes of $14.8 million for evasion of cigarette and tobacco product taxes. The BOE introduced new encrypted tax stamps in January 2011, but still estimates that tax evasion will cost the state $182 million in 2011.

About $10 million was included in the 2011-12 proposed state budget for the BOE’s investigative efforts. This represents about 1 percent of the approximately $900 million in anticipated tobacco tax revenue.