Attacking Consumer Choices through the Tax Code

Last week, a bill was introduced but never heard in the Washington State Senate that considered a proposal to tax electronic cigarettes at 95 percent of their cost; the same as other tobacco or tobacco substitute products. A similar proposal is currently working its way through the Washington House as part of the House budget bill package. Whatever the intentions of policymakers, singling out a specific product or group of products for extra severe tax assessment is contrary to the principles of sound tax policy and will harm the state’s economy overall.

First and foremost, the tax code is the mechanism by which government collects the necessary revenue to fund essential government services and programs. Trying to manipulate consumer choices by penalizing and incentivizing certain products over others has no place in the tax code. ALEC’s Principles of Taxation provides a succinct explanation:

“Economic Neutrality – The purpose of the tax system is to raise needed revenue for core functions of government, not control the lives of citizens or micromanage the economy. The tax system should exert minimal impact on the spending and decisions of individuals and businesses. An effective tax system should be broad-based, utilize a low overall tax rate with few loopholes, and avoid multiple layers of taxation through tax pyramiding.”

Next, small businesses that rely on the revenue that tobacco and tobacco substitutes bring in would feel the most damaging effect of this type of specific tax penalty. For the plan currently being considered in Washington, revenue estimates put resulting tax revenue gains at $40 million for the state. This doesn’t account for revenue lost from fewer electronic cigarette sales—a likely result from artificially doubling their price. In the end, convenience store owners will be hit the hardest.

Additionally, taxing electronic cigarettes at 95 percent (as opposed to treating them like any other product in the sales tax base) is not just bad tax policy, but also bad public health policy. Study after study shows that using electronic cigarettes is far less harmful than using traditional cigarettes. If the goal is to reduce harm to consumers’ health, then there is certainly a case to be made that electronic cigarettes should not be penalized at the same high tax rate as traditional cigarettes.  The price of these electronic products provides an economic incentive to current smokers in the state, which will be lost if they are taxed at the same rate as tobacco.

Finally, if the goal is to raise tax revenue, taxing electronic cigarettes at 95 percent of cost will not help the state reach this goal. Tobacco taxes and similar taxes on tobacco substitutes are an extremely volatile source of state revenue. Washington is not the only state in the Pacific Northwest to sell electronic cigarettes; if the state imposes taxes that effectively double their price, it is likely that the state will see sales of electronic cigarettes dramatically reduced. For example, in 2012 Illinois significantly raised taxes on traditional cigarettes. The state projected the measure would net an additional $325 million in new revenue. Consumers reacted to the excessive tax by traveling across state lines to purchase cigarettes, resulting in only $212 million in revenue—over one third less than the state was expecting to take in.

Whether the goal is to raise revenue or to improve consumer health, taxing electronic cigarettes at 95 percent is simply ineffective public policy. The tax code should be used for the purpose of raising necessary government funds, rather than attempting to puppeteer choices people are free to make for themselves.