Washington lawmakers have proposed a bill (SB5266) that would make it the second state to ban all flavored tobacco and, for the first time, impose a nicotine cap on vape products and raise taxes on vape to one of the highest in the nation.
The excise duty on steam products, when it comes into effect, will be levied at 45 percent of the retail price at retail. Although several states have higher statutory tax rates on steam products, most apply these taxes at the wholesale level. Washington’s imposition of the tax on retail would make it one of the highest effective tax rates in the country. The new tax would take effect on January 1, 2022.
The proposed tax would be a substantial increase in the existing volume levy of $ 0.27 per milliliter for closed tanks and $ 0.09 per milliliter for open tanks larger than five milliliters. The change not only increases the tax burden on the state’s vaper and steam companies, it also makes tax structuring less fair. A price-based (ad valorem) design leads to unequal treatment, as products with similar qualities and in similar quantities should have the same tax liability regardless of design or price. Ad valorem taxes also encourage downtrading as consumers switch from premium products to cheaper alternatives. Downtrading effects do not reduce the damage and are not related to external factors that should be included in the tax.
The volume-based tax was superior because volume is a better substitute for the damage associated with consumption (the negative externality). In addition to capturing the externality, this is the easiest and easiest way for governments to tax a good administratively as no valuation is required and therefore no expensive tax administration is required. Ad valorem taxes unnecessarily increase the complexity of the system, which makes enforcement difficult. For example, in vertically integrated companies (e.g. manufacturers and wholesalers), the taxable value must be calculated in order to estimate the tax liability. It is an expensive and time consuming task for tax authorities to ensure that these companies’ internal prices (transfer pricing) are close to market value.
In addition to increasing the excise tax on steam products, the bill also bans all flavored tobacco products. Due to their narrow structure, excise duties on tobacco and steam products are initially unstable sources of tax revenue. Another restriction on the tax base by banning some tobacco and steam sales altogether could worsen the instability of this source of income. At the same time, a ban could increase tax administration and law enforcement costs, especially if the lost revenue is offset by increasing the tax rate on the remaining tobacco tax base.
The excise duty on steam products does not generate any significant revenue and the tax implications for the ban on flavored steam products would likely be manageable. However, the bill also bans menthol cigarettes. Recent figures from Massachusetts, the only state to ban menthol nationwide, show that menthol bans are both expensive and ineffective.
In Massachusetts, cigarette sales declined after the ban, but for every pack that was not sold in the state, one pack was sold in a neighboring state. From June to September last year, 230,797,000 stamps were sold in the region. In the same period of 2019, that number was 225,897,000. This slight increase can be seen compared to the national figures, in which a sales decline of around 2 percent was forecast for 2020. In other words, sales in Massachusetts fell, but not because people quit smoking – just because those sales went elsewhere.
In the first half of 2020, sales in Massachusetts were down 10 percent. While the ban is still in its infancy and the accelerated decline of over 20 percent in FY 2021 is expected to continue later in fiscal year, the cost of the taste ban in FY 2021 could be around $ 120 million ( without sales tax losses)). In the first six months of fiscal 2021, Massachusetts lost more than $ 60 million in excise tax revenue – more if we add sales tax revenue. Conservatively, the loss this fiscal year will be at least $ 100 million. This is a significant cost to the state, especially given that sales are simply being relocated to other states and not actually eliminated.
If Washington has a similar experience, the state will lose $ 90 million in excise revenue in the first full fiscal year after implementation. This is revenue that is allocated to the general government fund and any losses must be offset by taxpayers through other taxes or through spending cuts. The tax return for the invoice does not estimate the impact on excise tax revenue.
Flavored products are not banned from the bill alone. Any vapor product that contains nicotine in excess of 20 milligrams per milliliter (2 percent) is also banned. This would prohibit most of the popular closed systems currently available. In addition to the taste ban and the nicotine cap, the bill also limits the number of cartridges that can be shipped to a consumer (16 per month) and adds new fees for businesses.
To make matters worse, Washington already has a rampant influx of untaxed cigarettes. In 2018, over 40 percent of cigarettes consumed in the state were not taxed by the state. This means that well-established networks of illegal tobacco product suppliers are ready to add a new product to their inventory. In other words, banning a popular and widely available product will only make smuggling worse. A $ 90 million drop in sales could keep expectations low.
Perhaps lawmakers understand this negative impact on revenue well as they are proposing to exempt all marijuana products from the restrictions. Washington earns more income from taxes on marijuana than from taxes on tobacco products.
The only positive part of the bill is the funding allocation. The revenue from the steam tax will be used for health care expenses related in some way to the harm caused by the consumption of nicotine products rather than being used for the general fund. However, given the multitude of prohibitions offered in SB5266, it is unclear how much revenue the excise duty can ultimately generate.
Overall, data from Massachusetts suggests a taste ban will not reduce tobacco use, and it is not in the interest of other states to pursue a public health measure that merely sends tax revenue to neighboring states without improving public health. Additionally, flavored tobacco bans highlight the complications of conflicting tax and regulatory policies, the instability of excise duties beyond external cost pricing, and the public risks of driving consumers black market through excessive taxes or regulations.
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