As more people kick the drinking & smoking habit, 'sin tax' revenue drops

Taxes on marijuana and vaping could replace the shrinking revenue, but analysts caution against setting new taxes without considering how they will impact behavior.

Image by Ethan Parsa from Pixabay

With people drinking and smoking less, governments are getting less money from so-called sin taxes. But the good news for states and localities is that more people are using cannabis and vaping, creating new ways to raise money.

“As the tax base shrinks on traditional excise taxes,” said a new report by the center-right Tax Foundation, “more and more products will be targeted for excise taxes.”

But before going all in on a new tax, policymakers must consider how taxes will impact behavior, said the report’s author, Adam Hoffer, the foundation’s director of excise tax policy.

Take cannabis. Hoffer suggests policymakers ask: What should the tax rate be, could taxing it too much drive people to buy illegal cannabis and how should the money it raises be used?

The report advises policymakers to keep new taxes low because high taxes might drive people to buy illegal cannabis products. Researchers note that the cannabis tax in Canada might be too high because it raises the price for legal cannabis products to about a third more than for illegal products.

“This overpricing causes users, who would otherwise prefer legal cannabis, to continue to purchase illicit market cannabis,” the report said.

In the U.S., it’s legal to use marijuana recreationally in 21 states. In those states, the report found that excise taxes have raised an estimated $220 a year from each marijuana-using resident. The Tax Foundation report estimates that states could generate hundreds of millions of dollars a year in tax revenue if they legalize marijuana. Florida, for instance, could yield more than $448 million a year and Arizona could raise over $183 million.

Medical marijuana is legal in Florida but so-called recreational, or adult-use, cannabis is not. In 2020, Florida's medical marijuana sales exploded to nearly $1.23 billion, according to a story in USA TODAY. This put Florida ahead of every state except the cannabis powerhouses of California and Colorado – where recreational marijuana is legal under state law – in terms of sales.

"While Florida does not have an excise tax on medical marijuana, these figures are subject to the statewide 6% sales tax. This would mean Florida generated around $73.8 million in tax revenue in 2020. This is on top of the $50 million in licensing fees the state receives from each of the 22 cannabis business licenses they offer," the story said in July 2021. 

Those figures are significant as tax revenue shrinks from declining alcohol and cigarette use. New York, whose $4.35 per pack tax on cigarettes is among the highest in the country, has seen the amount of tax it collects drop from $1.6 million in 2010 to $900,000 in 2020, the report said.

Gallup’s annual survey on alcohol use in December found 63% of American adults said they drink, down from 71% between 1976 and 1978.

Governments have been taxing products since around 3000 B.C. when grain, heads of cattle, oil and beer were taxed in ancient Egypt, according to the report. Today, governments around the world tax items like alcohol and cigarettes, not only to raise money but to discourage people from doing things that can hurt them or create problems.

The Canadian Substance Use Costs and Harm Scientific Working Group in 2018 estimated that cannabis created $2.8 billion in national societal costs, including for health care, the criminal justice system and lost productivity, the report found.

The decision to use taxes to encourage or discourage vaping, however, is more complicated.

The Centers for Disease Control and Prevention warned that 99% of the e-cigarettes sold in the U.S. contain nicotine and some vape products do not disclose that. Nicotine can harm the parts of adolescents’ brains that control attention, learning, mood and impulse control.

The Tax Foundation report, though, pointed to a study by The Royal College of Physicians in the United Kingdom, which found that e-cigarettes are less harmful than cigarettes. “‘[I]n the interests of public health it is important to promote the use of e-cigarettes, NRT [Nicotine Replacement Therapy] and other non-tobacco nicotine products as widely as possible as a substitute for smoking,” the physicians wrote.

As a result, the U.K. promotes vaping, even allowing vape shops to open in two National Health System hospitals. So, rather than taxing vapes, the report said, “the economic rationale for [Electronic Nicotine Delivery Systems] products would suggest a subsidy.” 

But rather than promoting vapes, 32 countries prohibit their sales and 50 countries tax them at different rates. The 30 U.S. states that tax vapes also have varied rates. Taxes on the wholesale price of vapes, for instance, range from just 7% to 95%, the report said. 

And then there’s the question of how the money raised by the tax should be used. 

Excise taxes should be used sparingly, Hoffer told Route Fifty, in part because they disproportionately impact lower-income people.“There has to be some sort of negative or external harms associated with the product to justify their being taxed at all in the first place.”

In addition, the revenue from excise taxes should be tied to addressing the issue they’re associated with. That’s because if the taxes reduce consumption, the revenue from them will go down.

“It's important to link the taxes on cigarettes with sort of public health expenditures related to tobacco consumption. If smoking rates are falling, that means we should have fewer and fewer people needing help,” he said. 

However, less than 1% of the revenue generated in the U.S. from tobacco taxes goes toward smoking cessation, the report said, while about 61% goes for health care. Another 18.4% goes to social services. But 4.4% funds capital projects, and 1.5% is used to pay down governments’ debts. 

Hoffer criticized Colorado’s decision to fund projects to increase the state’s water supply through a tax on sports betting. Funding for water, he argued, shouldn’t be reliant on people in the state continuing to place bets on games.

How some states are trying to find new ways to pay for roads, however, is a good example of tying taxes to spending. It made sense to tie funding for roads to the people who drove on them through gas taxes, Hoffer said.

With the revenue from gas taxes expected to continue going down as the Biden administration pushes policies to make more of the vehicles on the roads electric, states are looking for new ways to tax people using the roads. 

In addition to increasing vehicle registration fees, several states have pilot projects in which devices are installed in vehicles, measuring how many miles they drive. Other states are considering taxing kilowatt hours sold. Both approaches are based on how much a driver uses the roads.

Kery Murakami is a senior reporter covering Congress and federal policy for Route Fifty, where a version of this story was first published. He can be reached at kmurakami@govexec.com

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