Topping a list of “proposals of no cost to the state government” in Mayor Michael Bloomberg’s preliminary budget is a nearly eighteen-fold increase New York City’s cigarette tax, to $1.50 from the current 8 cents a pack. Bloomberg says this would raise $250 million to help close his $4.8 billion budget gap.

But a closer look reveals the state could lose almost as much money as the city gains from such a proposal—thus endangering a major portion of the financing for Governor George Pataki’s newly enacted health care initiative.

Picking the Same Pocket

If approved by the state Legislature, the city cigarette tax hike would come right on the heels of an increase in the New York State cigarette tax, which will rise to $1.50 a pack, from an already nation-leading $1.11, effective April 3. Pataki expects this to generate $250 million a year dedicated to state Health Care Reform Act (HCRA) programs.

However, Bloomberg’s revenue estimate assumes that raising the city tax to the same level as the state tax—a combined $3 per pack—would wipe out nearly half of all legal[1] cigarette purchases in New York City, as many more smokers quit, cut back or turn to non-taxed sources for their Camels and Marlboros. This, in turn, would wipe out a chunk of Pataki’s HCRA financing.

Extrapolating from figures in the state and city budgets,[2] adoption of the mayor’s proposal could eliminate up to $212 million in state cigarette tax revenues—85 percent of the gain Pataki is budgeting in this category.

Higher Taxes = Lower sales = Less Revenue

The actual impact of the proposed city tax hike on state tax revenues would depend on how much of the loss in taxable sales in the city (or “leakage,” as tax enforcers call it) is offset by increased sales in neighboring New York jurisdictions such as Nassau and Westchester counties, as opposed to other states, on-line Indian vendors and other non-taxable sources.

The correct answer is literally anyone’s guess—but it’s not unreasonable to speculate that if New York’s combined city and state cigarette is allowed to reach a whopping $30 per carton of 10 packs, the existing revenue leakage would turn into a veritable hemorrhage. Smokers could save at least $18 a carton by buying their cigarettes in any neighboring state [3]—or even more by using a tax-free Internet site.[4]

After all, New York’s high taxes and the resulting higher prices already provide what Pataki’s own budget admits is “an added incentive for smokers to purchase cigarettes in surrounding states, bootlegged cigarettes, or cigarettes sold through mail order or on the Internet to avoid paying the tax.”[5]

Indeed, it’s quite possible that Bloomberg’s plan would raise less revenue than he expects, in which case it would erode even more of the state’s cigarette tax base in the process. All New Yorkers—smokers and non-smokers alike—would have to make up the difference through broad-based taxes or spending cuts, since Pataki’s new HCRA spending is targeted for Medicaid and public health purposes.

A huge increase in cigarette taxes also will require the diversion of more law enforcement resources to fight an inevitable increase in what the Governor’s budget admits is already “a serious problem” of cigarette tax evasion in New York.

It obviously makes little sense to encourage more criminal activity at a time when the city and state budgets are strained by the increased security needs of the war on terrorism. But the potential loss of state revenue is enough to make the Legislature sit up and take notice—and, in all likelihood, reject Bloomberg’s proposal.[6]

Originally Published: FISCALWATCH MEMO

Notes

1. Under state law, all cigarettes sold in New York must bear a state tax stamp. The stamping is done by wholesalers, and licensed cigarette dealers face stiff penalties for selling unstamped cigarettes.
2. Here’s how the revenue numbers in this analysis are derived:* The city’s fiscal 2002 projects cigarette tax revenues of $28 million. At 8 cents per pack, that works out to 350 million packs sold in the city.
   * Cigarette tax estimates in Governor Pataki’s 2002-03 budget indicate that 881 million packs were sold statewide in the current state fiscal year; this figure, combined with the city’s own budget estimate above, would indicate that the city generates 40 percent of taxable sales.
   * The cigarette tax estimates in the Governor’s budget further indicate that, at the newly increased rate, taxable sales in the state are expected to drop by 7.5 percent, to 815 million packs in the state’s 2002-03 fiscal year. Assuming geographic distribution of taxable sales remains constant, this would reflect the expectation that 326 million packs will be sold in the city.
   * Bloomberg’s preliminary budget estimates that a tax increase of $1.42 could yield $250 million in added revenue, on top of $28 million in existing tax receipts. At a tax of $1.50 per pack, total revenue of $278 million would reflect sales of 185 million packs. That’s a decrease in taxable consumption of 47 percent — 141 million fewer packs that is assumed by the state revenue estimate, which would translate into a state revenue loss of $212 million (141 million X $1.50).
3. The state cigarette tax per pack as of 2001 was 50 cents in Connecticut (increasing to $1.11 effective April 3), 76 cents in Massachusets, 80 cents in New Jersey, 31 cents in Pennsylvania and 44 cents in Vermont.
4. See, for example, http://www.salamancacigaretteoutlet.com/, a web site run by Indians in upstate New York, where a carton of Marlboros is listed at $28.80 – nearly $20 less than the current discounted price for the same cigarettes at licensed stores in New York City. If Bloomberg’s tax hike is enacted, this price differential will expand to nearly $35 per carton.
5. 2002-03 New York State Executive Budget, Appendix II, page 159.
6. As predicted, Albany did not accept Bloomberg’s proposal. Instead, in a package of city revenue measures approved in June, the Governor and the Legislature approved the new $1.50 city tax on the condition that the city share roughly half the projected additional revenues with the state, reducing the city’s share to $133 million. Because fewer packs sold will also result in lower sales tax collections, the net cigarette tax revenue gain estimated in the adopted city budget for fiscal 2003 was further reduced to $110 million.