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NY Post:

“The underground tobacco market is spreading like a fast-growing cancer in the wake of tax hikes that make New York cigarettes the most expensive in the nation — and it’s costing the state tens of millions a month in lost tax revenue.

Illegal cigarettes are pouring into neighborhood bodegas by the truckload from neighboring Indian reservations, lower-tax states in the South and even as far away as China. Government data show that New York state is being smoked out of as much as $20 million a month from all these illegal cigarette purchases — an estimated 7.3 million packs a month sold off the state tax radar.

Sales of taxed cigarettes have plummeted 27 percent since July, when state lawmakers raised the excise tax to $4.35 a pack on top of the city’s tax of $1.50, making the average price of Marlboros here $11.60, with some shops charging as much as $14. About 30 million packs are being sold legally each month — down from 41 million packs a month before July.

The plunge far exceeds tobacco-control experts’ predictions that sales would fall 8 to 10 percent, indicating that smokers are finding other means to get their nicotine fix.”

Additionally, minors are more likely to have access to cigarettes on this expanded black market.

Mark Perry offers some economic lessons:

1. Taxes are always distortionary because people can change their behavior to avoid the tax.  Elected officials almost always underestimate the ability of taxpayers to change their behavior to avoid taxes, and the New York cigarette tax example is no exception – experts predicted a 8-10% reduction in sales vs. the actual 27% decline.

2. In any discussion about taxes, we have to distinguish between “tax rates” and “tax revenues,” especially when we talk about “increasing or decreasing taxes,” with the assumption being that increases (decreases) in tax rates and increases (decreases) in tax revenues automatically happen together. In the case of cigarettes in New York the “tax increase” in rates resulted in a “tax decrease” in revenues because of what happened to the “tax base” (the amount of activity subject to the tax). In this case (as often happens), the increase in tax rates on cigarette caused the tax base (amount of cigarettes subject to state taxes) to shrink so significantly, that there was a decrease in tax revenue.

The same outcome often happens, whether the tax increase is on income, dividends, capital gains or retail sales.

Gherald filed this under: ,  
  1. Metavirus says:

    “The same outcome often happens, whether the tax increase is on income, dividends, capital gains or retail sales.”

    Good post right up until that last bit. Perry’s analogy is a really shitty one. A tax targeted at particularly disfavored items will always run into a theoretical limit where the tax has the effect of being effectively prohibitionary. Perry is right to a certain extent with regard to sales taxes (i.e., there are a good number of circumstances where misguided sales tax rates can have complicated spillover effects that effectively reduce the tax base) but is dead wrong when it comes to income, dividend and capital gain rates. This is just the flip side of the tired old canard that cutting income tax rates increases the tax base and therefore increases net revenue -- which is a steaming pile of republican orthodoxy that has been disproven over and over and over again (see, e.g., Bush Tax Cuts).

    • Gherald says:

      Actually the effect is more pronounced on capital gains taxes than income or sales--this is something economists of all stripes have figured out.  Bruce Bartlett noted it in The New American Economy.

      • Metavirus says:

        true in some ways, but not so in others.  it’s not as simple as targeted, e.g., “sin” taxes.  for sales taxes one has to consider things like the proximity of population centers to states with lower sales taxes, etc.  on capital gains, we are nowhere near the realm of capital gains rates that would arguably have a negative effect on the tax base.

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