Daily Tax Report: State provides authoritative coverage of state and local tax developments across the 50 U.S. states and the District of Columbia, tracking legislative and regulatory updates,...
Bloomberg BNA regularly spotlights the insights of state and local tax professionals at Grant Thornton. In this installment of Grant Thornton Insights, Jamie Yesnowitz and Emily Fiore discuss sin taxes.
By Jamie Yesnowitz and Emily Fiore
Jamie Yesnowitz, J.D., LL.M., is a principal and the SALT—National Tax Office leader in Grant Thornton LLP's Washington D.C. office. He can be reached at email@example.com. Emily Fiore, J.D., is a state and local tax manager in Grant Thornton LLP's Chicago office. She can be reached at firstname.lastname@example.org.
Sin taxes have recently enjoyed a renaissance of sorts as a means to supplement state and local tax revenues and balance budgets. Traditionally, sin taxes were designed to control or curb perceived vices such as tobacco, alcohol, and gambling that were deemed to be undesirable to society. As our economy has evolved, so have our vices, and states and localities have begun to specifically target marijuana, sugary beverages, plastic bags and other items from a tax perspective. In this article, we examine the history and modern efficacy of sin taxes, provide thoughts on why these taxes have been proposed, and discuss what the future may bring in this burgeoning field.
We seem to hear about changes to existing and proposed sin taxes nearly every week. These range from increased tobacco taxes in California, to a proposed sugary drink tax in Santa Fe, New Mexico, to a bag tax in Chicago, Illinois. [Voters rejected the Santa Fe sugary drink tax on May 3, 2017.] Many state and local jurisdictions are considering these taxes for a variety of reasons, including generating additional tax revenue. Sin taxes have a long and varied history both worldwide and in the United States. For example, one of the earliest examples of a sin tax is Britain's excise tax on distilled spirits, which was enacted in 1643. A look at this history can inform us as to how jurisdictions may handle similar taxes in the future.
The United States has had a long and complicated history with alcohol that is reflected in the tax policies undertaken with respect to this substance. One of the first sin taxes to be enacted at a federal level in the United States was a tax on distilled spirits in 1791. From this point forward, alcohol taxes were intermittently used to generate revenue for the next 26 years to fund the growing country and the many wars during that period. These taxes were eventually repealed in 1817.
With the start of the Civil War in the early 1860s, the federal government again needed additional funds, and so a liquor tax was levied in 1862. It was heavily relied upon for revenue during the Civil War, and that dependency continued into the 20th century. Historians estimate that between 30-40 percent of the country's revenue was generated from alcohol or liquor taxes in the late nineteenth and early twentieth century. [Due to the federal government's reliance on alcohol taxes, many historians attribute the creation of the federal income tax under the 16th Amendment in 1913 to the Prohibitionists' desire to ban alcohol. Without a more progressive income tax imposed at the federal level, the federal government would not have had the revenue it needed if alcohol was banned. As such, Prohibitionists heavily supported the creation of the federal income tax. https://taxfoundation.org/how-taxes-enabled-alcohol-prohibition-and-also-led-its-repeal/.]
All alcohol and liquor taxes were halted with the enactment of Prohibition in 1919. After the repeal of Prohibition in 1933, liquor taxes once again became a source of revenue for the federal government. Since that time, alcohol and liquor taxes have played a part in the fabric of our federal and state and local tax structures, generating over $29.8 billion in revenue in 2013. [Distilled Spirits Council of the U.S., Inc., History of Beverage Alcohol Tax Changes, 2015 (July 2015).]
The United States first attempted to tax tobacco in 1794; the initial proposal by Alexander Hamilton passed, but was quickly repealed. The country did not consistently attempt to tax tobacco products again until the Civil War. In 1864, the United States implemented a national cigarette tax as a revenue measure to assist with the cost of the Civil War. The measure was successful and remained in place even after the war. Iowa was the first state to implement a state-wide cigarette tax in 1921. All 50 states eventually followed suit by 1969. Initially the tax was implemented largely for the purpose of revenue generation. However, as public recognition of the health hazards of smoking came to light, supporters of cigarette taxes encouraged their adoption both to generate revenue and to discourage behavior. Undoubtedly influential in this effort were statements from multiple Surgeon Generals and several prominent health organizations such as the American Cancer Society, American Heart Association, and the American Public Health Organization that came out in the late 1950s and early 1960s indicating that smoking leads to serious health issues.
The rate of the tobacco tax has continued to increase over the years, comprising a material part of some states' revenues. The rate ranges from less than 20 cents per pack to over $4 per pack. In 2014, state and local governments collected over $17.4 billion in tobacco taxes. At the federal level, tobacco taxes make up approximately 15 percent of all excise tax revenue, accounting for $14.5 billion of tax revenue in 2015.
Gambling income is generally considered taxable income both at the state and federal levels. Many states also tax casinos, riverboats, “racinos” (combined race track and casino), and lottery proceeds under a separate tax regime, in addition to income tax. These taxes often started as penalties for participating in games of chance. In 1861, three years prior to admission to the United States, Nevada became one of the first jurisdictions to regulate gaming, imposing penalties for running and participating in games of chance. By 1869, the Nevada State Legislature decriminalized games of chance. However, during the early years of the Progressive Movement starting in 1909, gaming was once again outlawed in Nevada. Over the next 10 years, the state began to license certain types of gambling and by 1930, gambling was legal once again. Gambling taxes were generally handled at the local level, but in 1945, the administration of taxes and licensing shifted to the Nevada State Tax Commission and a state-wide one percent tax went into effect the following year. The tax revenue generated in the first year totaled $670,000 statewide. Soon after World War II, Nevada developed the Las Vegas Strip and became the go-to destination for live gambling operations, resulting in dramatic increases in gambling revenue. By 2014, Nevada hotel-casino operators remitted over $2 billion in taxes and fees to the state, comprising one of Nevada's largest sources of revenue. [More than $2.0 billion in taxes and fees were paid by Nevada hotel-casino operators. This included major contributions to Nevada's three largest sources of revenue: sales tax, property tax and gaming tax. Nevada hotel casinos account for nearly $1.4 billion, or approximately 45 percent of State General Fund revenues – more than any other industry. This includes property, sales/use, live entertainment, and gambling taxes.] While this figure is not limited to gambling taxes, the industry as a whole is a significant draw to the state, increasing the overall revenue brought into the state. This revenue stream undoubtedly has made it possible for Nevada to maintain the ability not to impose a personal income tax on its residents. The same could be said for the lack of a corporate-level tax until the recent enactment of the Nevada Commerce Tax in 2015. [Enacted by NV S.B. 483, this tax is designed to supplement funding for Nevada's educational system and is a gross-receipts tax on businesses with substantial amounts of gross receipts earned in the state.]
After many years in which Nevada and Atlantic City, New Jersey essentially cornered the market in live gambling revenues at casinos, other states wanted in on the “monopoly.” Encouraged by growing popular support for live gambling, states developed elaborate casinos through partnerships with Native American tribes and independent efforts, with the proviso that a substantial amount of revenues generated by these ventures would be taxed. As a result, nearly half of all states have adopted excise taxes associated with gaming. Casino and racino revenues totaled approximately $8.6 billion in 2014. Some states rely on these revenues more than others. For instance, nearly a tenth of Rhode Island's total state tax collections come from gambling tax revenues. Similarly, both Nevada and West Virginia also rely on gambling revenues, collecting approximately $720 million and $500 million, respectively, in 2014 in gambling-related taxes.
In addition, state (and multistate) lotteries have grown in importance from a revenue perspective. Typically, states sponsor lotteries because it allows them to raise revenue without increasing taxes. The additional revenue brought in by lotteries allows states to balance budgets and often fund education and scholarships. States such as New Mexico and Georgia have even created scholarship programs funded primarily through lottery revenue. However, many policy analysts question the benefits of using lottery funds in this way because lottery profits are unstable and unpredictable. Both New Mexico and Georgia had to change the format of their scholarship programs due to the popularity of the programs and the inability of the lotteries to keep pace.
More generally, only about a third of the revenue generated by lotteries are used by states, as the rest of the funds are paid out in prize money and a small portion goes toward administration. For example, in 2015, over $66 billion was raised by lotteries, but only approximately $21 billion was actually returned to states. Generally, less than 5 percent of a state budget comes from lottery revenue. As mentioned, while these funds are typically earmarked for education, there is skepticism whether the funds are actually used for that purpose. Rather, many believe that the funds may be used as a gap-fill in other areas of the budget. Finally, lotteries can be considered regressive because everyone pays the same amount for a ticket and a disproportionate amount of lottery players are low-income individuals or families. Lotteries do generate revenue without raising traditional taxes, and this is an important feature to many lawmakers. However, at the end of the day, the question ultimately becomes whether the revenue they generate justifies the other costs.
Sin taxes are designed to discourage behavior and generate revenue. Taxes have long been used to serve societal purposes, encouraging behavior that the government favors with tax incentives and credits, while discouraging behavior it considered undesirable with increased or additional taxes. Sin taxes are used to discourage behavior because it is argued that certain behaviors generate negative externalities that cause a greater financial burden on society. Based on this theory, these behaviors “deserve” to be taxed more than other behaviors that have a neutral or positive effect on society. Health professionals in organizations like the American Heart Association, World Health Organization, and the Mayo Clinic argue that these taxes are critical in helping to change behavior and improve health. However, there is opposition to these views, on the basis that these taxes are regressive in nature and unfairly discriminate against lower classes. Further, the imposition of onerous sin taxes has been linked to the creation of black markets and smuggling rings, resulting in a situation where the state receives no revenue, the activity continues on unabated, and crime surrounding (and in some cases caused by) that activity grows. As such, there is a question as to how much these taxes actually benefit society, and in fact whether there is a benefit at all.
On the other hand, sin taxes have been fairly successful as a revenue generator. These taxes have funded wars and balanced budgets for centuries. While most states do not generate a significant amount of revenue from sin taxes, there are a few notable exceptions. In 2014, states collectively generated approximately $32 billion from tobacco, alcohol and gambling taxes. This represents nearly four percent of the total state tax revenue in 2014. However, other states raised significantly more than four percent of their tax revenue from sin taxes. For example, sin taxes accounted for nearly 16 percent of the state tax revenue in Rhode Island, nearly 15 percent in Nevada, 11.5 percent in West Virginia, and nearly 10 percent in both New Hampshire and Delaware in 2014. These states often lack other types of taxes and this may somewhat account for the disparity, though the fact remains that sin taxes are important to balancing the budget in these states. [In addition to Nevada's relative lack of an income tax, neither New Hampshire nor Delaware have statewide sales and use taxes.]
Numerous countries, states, and local jurisdictions have recently enacted new sin taxes, including marijuana taxes, sugary beverage taxes, and bag taxes.
Several states recently have legalized the use of recreational marijuana as social acceptance of the use of this drug has grown over time, and states have realized that with legalization comes the ability to generate tax revenue.
Colorado legalized the recreational use of marijuana in 2012 and the state began to regulate sales of marijuana on January 1, 2014. The tax is structured as an approximately 15 percent tax on the average market rate of wholesale marijuana, plus a 10 percent state tax on retail marijuana sales, a second state sales tax of 2.9 percent on retail and medical marijuana, local sales tax, plus local marijuana taxes (i.e., a 3.5 percent tax in Denver), creating an average overall tax rate of approximately 29 percent for retail purchases of marijuana. Colorado recently passed a rate increase for the state Retail Marijuana Sales Tax. Per Senate Bill 17-267, the Colorado Retail Marijuana Sales Tax rate increased from 10 percent to 15 percent as of July 1, 2017, increasing the overall state average rate for retail marijuana to approximately 34 percent. [ See Colorado Department of Revenue, Information for Cultivators; https://taxfoundation.org/taxing-marijuana-washington-and-colorado-experience/; https://www.colorado.gov/pacific/revenue/colorado-marijuana-tax-data; Jeremy P. Meyer, Denver Voters Backing 3.5 Percent Tax on Pot, Denver Post, Nov. 5, 2013]
In 2014, it was reported that there were nearly $700 million in total sales. That number increased to approximately $996 million in 2015. There were over $1 billion of marijuana sales in 2016, bringing in over $152 million in tax revenue for Colorado as of February 2017 for its year-to-date fiscal year. This is significantly more tax than the state's collections for other sin taxes. In comparison, Colorado collected approximately $70 million in liquor excise taxes in January through November 2016.
Massachusetts legalized marijuana in November 2016, and the state recently decided how it will tax the drug. Initially, the tax included in the legalization bill was a 6.25 percent state sales tax, 3.75 percent state excise tax and 2 percent municipal tax. [Adrianne Appel, Massachusetts Would See $64M From Marijuana Taxes, Bloomberg BNA Daily Tax Report: State, March 21, 2017] On July 28, 2017, the governor signed H. 3818, which increased the excise tax from 3.75 percent to 10.75 percent and allows municipalities to add an additional 3 percent tax to the sale of marijuana. While retailers cannot legally sell marijuana until July 1, 2018, early revenue estimates indicate that Massachusetts will collect $64 million in 2018 based on the marijuana tax alone. [ https://malegislature.gov/Bills/190/H3818] It is unclear how much the increased tax rate will affect the revenue estimates, though it is safe to assume that it will be a revenue generator for the state. [Similar to Massachusetts, Maine legalized marijuana in 2016. Also similar to Massachusetts, the initial tax that was voted on by residents was fairly low. The Maine legislature recently proposed an increased tax rate on July 25, 2017, similar to Massachusetts H. 3818. It is estimated that the increase would bring in up to $18 million in tax revenue annually. http://www.pressherald.com/2017/07/25/maine-recreational-pot-sales-would-be-taxed-at-20-percent-under-proposal/]
At a 12 percent aggregate tax rate, the Massachusetts tax would have been one of the lowest marijuana taxes in the country, significantly lower than the Colorado and Washington state marijuana taxes. Many Massachusetts legislators wanted to increase the tax rate before the tax went into effect to increase the potential revenue for the state. By raising the rate to 10.75 percent, the revenue is estimated to increase to approximately $70 million. If the rate is later increased to 23.25 percent, which was discussed prior to the passage of H 3818 and would be more consistent with the Colorado and Washington state taxes, the potential revenue increases to $511 million. [Appel, supra]
There are currently nineteen countries and several local jurisdictions that impose, or plan to impose, a tax on sugary drinks. The majority of these taxes were specifically enacted to address health concerns associated with the consumption of these drinks.
i. Philadelphia, Pennsylvania
Philadelphia passed a sweetened beverage tax, effective January 1, 2017. Distributors of sweetened beverages have an obligation to collect tax on any non-alcoholic beverage, syrup, or other concentrate used in a beverage with an ingredient list including any form of caloric sugar-based sweetener (including, but not limited to, sucrose, glucose, or high fructose corn syrup) and any form of artificial sugar substitute (including stevia, aspartame, sucralose, neotame, acesulfame potassium (Ace-K), saccharin, and advantame). The tax rate is $0.015 per ounce of sweetened beverage and the revenue generated primarily funds school and education initiatives.
Sales of these beverages in Philadelphia have decreased by as much as 50 percent during the first six weeks of the tax. This is a larger decrease than was expected based on the results in other jurisdictions that have implemented a similar tax. However, advocates argue that it is too soon to know the full impact of the tax. This tax was unsuccessfully challenged by, among others, the American Beverage Association and the Pennsylvania Food Merchants Association, on the basis that double taxation would result. On June 14, 2017, an appellate court in Pennsylvania held that the beverage tax was valid. The court stated that the tax did not duplicate the state sales tax and was not preempted by the Food Stamp Act. As such, the city has moved forward with full enforcement of the tax.
ii. Berkeley, California
Berkeley was the first city in the United States to adopt a sugary drink tax. The tax is one cent per fluid ounce and became effective in March 2015. The city stated that the purpose of the tax is to “diminish the human and economic costs of diseases associated with the consumption of sugary drinks by discouraging their distribution and consumption in Berkeley through a tax.” The tax is imposed on distributors and all funds collected are deposited into the City's general fund.
A 2016 UC Berkeley study indicated a 21 percent drop in soda and other sugary drink consumption in low-income neighborhoods after the implementation of the tax. Similarly, a recent study published in April 2017 concurred and indicated that sales of sugary beverages declined under the tax. [Lynn Silver, et. al., Changes in Prices, Sales, Consumer Spending, and Beverage Consumption One Year After a Tax on Sugar-Sweetened Beverages in Berkeley, California, US: A Before-and-After Study (April 18, 2017)] Specifically “[s]ales in ounces of taxed [sugary beverages] fell by 9.6% in relation to predicted sales in the absence of the tax, while sales of untaxed beverages rose 3.5% and total beverage sales rose in Berkeley.” As such, early signs indicate the tax is effective in reducing consumption, although reduced consumption by itself may not correspond to better health. An increase in overall health in the city's population may be difficult to measure and attribute solely to the soda tax.
iii. Cook County, Illinois
Cook County's brief experiment with a sweetened beverage tax bears mentioning. The Cook County Board of Commissioners passed the Cook County Sweetened Beverage Tax ordinance on November 10, 2016. The tax became effective August 2, 2017 and is being imposed at a rate of one cent per ounce on the retail sale of all sweetened beverages in Cook County. The tax is applied to the retail sale of bottled sweetened beverages (soda, sports drinks, flavored water, energy drinks, pre-made sweetened coffee and tea with less than 50 percent milk content, etc.) and beverages produced from syrups using a beverage dispensing machine.
The Cook County Sweetened Beverage Tax was originally scheduled to become effective on July 1, 2017. However, a temporary injunction was granted on June 30, 2017, halting the implementation of the tax. The challenge was brought by the Illinois Retail Merchants Association and several grocers who argued that the tax violated the uniformity clause of the Illinois Constitution and is unconstitutionally vague. The Circuit Court of Cook County later dismissed the Illinois Retail Merchants Association lawsuit against Cook County on July 28, 2017 and dissolved the Temporary Restraining Order prohibiting collection of the tax. As such, the tax went into effect on August 2, 2017. Despite Cook County's success in court, continued outcry over the tax, the potential revenue effect of purchasers going outside Cook County to purchase sweetened beverages free of the tax, and confusion on how the tax should be applied led to Cook County's repeal of the tax on October 11, 2017, effective December 1, 2017.
iv. United Kingdom
The United Kingdom announced a tax on sweetened beverages in 2016 with the stated goal of addressing childhood obesity. It levied a tax on sweetened beverages with added sugar and a total sugar content of at least 5 grams per 100 millilitres (approximately 5 percent sugar content). Additionally, there is a higher tax for drinks that contain 8 grams or more per 100 millilitres (approximately 8 percent sugar content).
While the tax is not scheduled to start until 2018, many companies have decided to proactively address the tax. Several companies, including PepsiCo, Coca-Cola, and Lucozade Ribena Suntory, have indicated that they plan to reduce the amount of added sugar in some of their products by 2017.
Mexico saw a 17 percent decline in consumption by low-income households after the first year of its tax and an overall reduction of approximately 5.5 percent across the board during the first year of the tax. [M. Arantxa Cochero et al., In Mexico, Evidence Of Sustained Consumer Response Two Years After Implementing A Sugar-Sweetened Beverage Tax , 36 Health Aff. 564 (March 2017)] Studies show that the second year reduced sales even further, indicating a 9.7 percent reduction in sales of sugary beverages.
Several cities in the United States have enacted a tax on plastic bags. The tax is designed to deter people from using plastic bags and encourage the use of reusable bags in order to reduce the negative environmental impact of plastic bags.
i. Washington D.C.
Washington D.C. enacted a tax on plastic bags on January 1, 2010. The tax is imposed on all businesses that sell food or alcohol and requires a 5 cent tax for every carryout paper or plastic disposable bag sold or used. The business retains one cent (or 2 cents if it offers a rebate when customers bring their own bag), and the remaining 3 or 4 cents primarily goes to the Anacostia River Clean Up and Protection Fund. Additionally, Washington D.C. disallowed the sale or distribution of bags made from anything other than #2 or #4 polyethylene. Further, if paper bags are used, they must be recyclable, contain a minimum of 40 percent post-consumer recycled content, and be printed with a phrase that encourages recycling. The tax was brought to the Washington, D.C. City Council after the Department of Energy and Environment (DOEE) conducted a trash study which found that disposable plastic bags were one of the largest sources of litter in the Anacostia River.
There are mixed reports as to whether the bag tax is successful. For example, the Alice Ferguson Foundation, which organizes river clean-ups in the Washington D.C. area, released a report in 2014 finding a 72 percent decrease in bags found during river clean-ups after the enactment of the bag tax. However, a 2015 Washington Post article pointed out several issues with studies and surveys reporting the success of the tax. The article cited to several documents noting that there were no official measurements of bag usage prior to the enactment of the tax. Therefore, studies that show a reduction may be flawed and based on inaccurate assumptions. Regardless of whether the tax is successful in curbing behavior, it is a revenue generator, producing over $1.3 million during the first nine months of the tax, less than the original estimate of $3.6 million, but substantial nevertheless.
ii. Chicago, Illinois
The Chicago Checkout Bag Tax became effective on February 1, 2017. It is imposed on the retail sale or use of checkout bags in Chicago, Illinois. The rate of tax is 7 cents per bag sold or used in the City. Stores remitting the tax to the City are allowed to retain two cents per checkout bag purchased.
Initial reports indicate that the number of checkout bags used in the City dropped by 42 percent during the first month of the tax. Further, approximately half of the customers who stopped using disposable bags switched to using reusable bags or no bags at all.
Residents of both Chicago and Washington D.C. have anecdotally indicated that the bag tax has reduced their consumption of plastic bags when grocery shopping. Many residents have opted to bring reusable bags or have forgone a bag altogether. As such, it appears that there is a reduction of plastic bags in these jurisdictions for industries impacted by the tax. Chicago specifically excluded restaurants (dine-in or take-out) from the bag tax and, as such, many plastic bags continue to be used by restaurants in the City. With food delivery services, such as GrubHub, UberEATS, and Amazon Prime Now, on the rise, it is unclear whether the bag tax will actually reduce consumption of plastic bags in Chicago. [A similar tax has been enacted in Montgomery County, Maryland, a suburb of Washington, D.C. At the very least, the authors of this article can claim from an anecdotal perspective that these efforts do make a difference. In addition, these taxes have created an ancillary cottage economy of sorts revolving around supermarket canvas bags. To drive down the use of plastic bags, supermarkets sell canvas bags with their names prominently emblazoned on the product to customers. Supermarkets make a profit from the sale of these bags, and also receive incremental amounts of free advertising when customers carry the bags around town. Customers often receive a minimal rebate from the supermarkets for using the bags. In addition, the purchase of the bags typically are subject to sales and use tax, which maintains some level of revenue for states and localities.]
Economists, behavioral scientists, and lawmakers have long debated whether sin taxes are actually successful in discouraging the behavior that state and local governments are seeking to adjust. Studies show that a number of factors come into play in determining how successful a sin tax is, as well as the behavior it is seeking to adjust. However, the longer a tax is in place, the more difficult it may be to determine if the tax is actually curbing the behavior, or rather, other societal, social, or cultural pressures are causing the decrease in use.
For instance, the evidence in favor of taxes on cigarettes is unclear. While it is understood that cigarette taxes cut cigarette consumption, there is little data illustrating how such taxes affect overall health, specifically deaths from diseases like lung cancer that are attributable to cigarette use. The few, small studies that do exist show high taxes are in fact correlated with decreases in strokes, heart attacks, and lung cancer. However, tax hikes generally have the most notable effect on young and poorer smokers. This indicates that if a user has enough money, a tax hike may have little effect on their use of the product.
A study on alcohol taxes in Illinois found that, after the state's tax of one cent per serving of beer and five cents per serving of spirits was imposed in 2009, there was a total monthly decrease of 25 percent of drunk-driving deaths. The news was even better when measuring the reduction of deaths of younger people, as the decrease in the percentage of young-person drunk-driving deaths was 37 percent in the two years after the imposition of the tax. The study also found a decrease in drunk-driving deaths in heavy drinkers. This was a new revelation because economists believed alcohol demands among populations prone to heavy drinking were inflexible and immune to taxes. While the results of the study are encouraging, it is unclear if the tax alone was the cause for this reduction. During the same time period, the use of ride-sharing services, such as Uber, became popular, and this may have led to fewer drunk drivers on the road. Additionally, state and local governments have implemented aggressive advertising to deter such behavior and have enacted steep penalties for drunk driving. This is also a generation that grew up with D.A.R.E. programs and M.A.D.D. presentations in school. As such, it would be naive to think that the tax is solely responsible for the reduction in drunk driving deaths.
Sin taxes are imposed at a variety of rates and in many different ways. For example, liquor taxes, sugary beverage taxes, marijuana taxes and even bag taxes are often imposed based on the amount consumed, such as one cent per ounce or seven cents per bag. Tobacco taxes are often “sticker” based, similar to tagging yard waste bags in many areas. While the sticker may equate to consumption, the compliance and remittance responsibilities may differ.
But what is the right rate for a sin tax and how should it be imposed? The answer may depend on the goal of the tax. Euromonitor International released a report on sin taxes which found that these taxes only encouraged a temporary reduction in sales of the taxed items. The higher the tax, the longer the tax affected sales of that item. However, the long term effect was lessened if the tax rate did not continue to increase. The report was primarily focused on sugary drink taxes but its findings are applicable to most sin taxes. Similarly, a prominent health organization in India demanded at least a 40 percent sin tax on all types of tobacco in the country in order to discourage their consumption and combat addiction because it noted that any rate lower than 40 percent would be ineffective in reducing consumption.
It is apparent that higher rates (up to the point where such rates begin to create mass levels of avoidance through black markets) do often lead to reduction in consumption. However, the rate also has to continue to increase for the tax to remain effective from the perspective of curbing consumption. If the rate does not increase over time, the tax becomes “normalized” and consumers begin to view it as the price of the product. As such, it is complicated to understand whether a tax is effective in curtailing behavior. It appears that sin taxes generally do reduce certain behaviors in cases in which the tax is high enough. Further, when the ultimate goal of the tax is revenue, such as in the case of the marijuana tax, there may be no actual reduction in behavior at all.
Often there is a significant investment in bureaucratic infrastructure in order to implement a new tax through the creation of new positions within the administering taxing jurisdiction, the need for the tax authorities to process the new tax, the development of forms, and ultimately audit tax compliance of the tax. As such, if a tax does not produce revenue initially, will the state be able to justify the initial start-up cost? Colorado was one of the first states to legalize the recreational use of marijuana in the U.S. Initial revenue estimates indicated that the tax would become one of the largest revenue generators in the state. However, the initial years of the tax did not generate the revenue that was estimated. This experience is in line with the early years of adopting sin taxes in other states where it took several years for the tax to start to produce the way the state expected.
Similarly, the Chicago bag tax is not generating nearly the amount of revenue expected by the City. The bag tax went into effect in February 2017 and the City expected to generate approximately $9 million from the tax. However, while the tax has failed to meet expected revenue targets, it has been very effective in reducing consumption of the taxed product, with about 40 percent of Chicagoans indicating that they now either bring their own bag or do not use one at all. To date, the tax has only generated approximately $2.5 million, a figure that is problematic for Chicago's government because the projected tax revenue was actually part of balancing the budget. Chicago's failure to meet revenue targets with its bag tax raises an interesting question: should governmental budgets rely on untested sin taxes that are designed to reduce consumption?
State tobacco tax audits are frequent and can be damaging to wholesalers and distributors that are not correctly taxing their products. Many states argue that the tobacco tax should be fairly easy to implement because it is typically based on “stickers.” In many states, tobacco products are sold with a “sticker,” which is purchased by the wholesaler, placed on the box or other packaging and included in the price to the retailer. The customer then reimburses the retailer for the tax. As such, the number of stickers used should equal the amount of tax remitted to the taxing jurisdiction. Due to the ease of implementing this tax, many businesses that sell tobacco are audited on a regular basis. However, newer forms of sin taxes may be more difficult to implement and audit. For example, marijuana is a cash-based business which has been difficult for many states to manage. In Alaska, the majority of the marijuana tax is paid in cash, rather than through online payments. This is because banks across the country are hesitant to accept money made in the marijuana business, even in states where it is legal. As a result, it may be difficult to accurately enforce the tax against these cash-based businesses. Cash-based businesses have often plagued tax administrators. For example, in Illinois, there have been multiple instances of cash-based businesses “cooking their books” to remit less tax. Could this be an issue with marijuana taxes, given that most distributors cannot even deposit their receipts into a bank?
Sugary beverage taxes also have implementation issues that could come up under audit. These taxes are often based on units consumed. However, it is difficult to determine how much a customer has consumed when there are unlimited refills, and when customers can choose their beverage (sugar-free or otherwise) after they purchase a cup from a vendor. Will these implementation issues inherent in sugary beverage taxes force unlimited refills to be a thing of the past?
Sin taxes will likely never go away. Ultimately, they are large revenue generators for federal, state, and local governments. Further, it does appear that taxes do have some effect in reducing the use of a product that society is trying to deter. Going forward, traditional sin taxes will likely remain somewhat constant. However, governments will look to identify new ways to tax undesirable behavior. This is because one of the major items that is currently taxed, tobacco, is becoming less popular. Tobacco products generate the majority of sin tax revenue; over $17 billion of the $32 billion generated in 2014 was attributable to tobacco taxes. However, studies indicate that tobacco usage has and will continue to decline. [“An analysis by the Government Accountability Office estimated Americans consumed 299 billion cigarettes in 2010, down from 456 billion in 2000.”]
The new sin taxes imposed on marijuana, sugary drinks, plastic bags, and other targeted products will likely become more popular and be enacted in more cities and states across the United States. [As an example, the Seattle City Council recently approved a sweetened beverage tax on June 6, 2017 which will be effective January 1, 2018. The City Council went to great lengths to explain the need for the tax from a society perspective, indicating that it was necessary to public health. The funds will be used to support public health initiatives, promote public awareness of the dangers of a high-sugar diet, and educate the community regarding healthier eating options. For additional details, seeGT SALT Alert: City of Seattle Approves New Personal Income and Sweetened Beverage Taxes, August 8, 2017.] This is because these taxes appear to be successful in both deterring behavior and raising funds, the two main functions of a sin tax. Finally, in a move that would be celebrated by vegetarians and derided by steakhouse owners, we may even see efforts to create new sin taxes targeted at activities like excessive meat consumption.
As sin taxes continue to grow in popularity and evolve, it is not outside the realm of possibility that states will move away from the behavior deterrent aspect of these taxes and focus solely on their revenue generating potential. For example, because both Colorado and Massachusetts went from marijuana prohibition to legalization, the sin tax for this product was not necessarily designed to curb behavior but rather focused on revenue generation. Other governments may also conclude that their main focus should be on revenue generation and any benefit from the reduction of certain behaviors is ancillary to this primary focus. While the future of sin taxes holds many possibilities, one thing is certain: they aren't going away any time soon.
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