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How Sin Taxes Work

        Money | Taxes

Sin-less
A new federal sin tax on tobacco started April 1, 2009, driving the per-pack tax from 39 cents to $1.01. The tax affected all tobacco products, including cigars and pipes, and the money earned will be used to expand health coverage for low-income kids.
A new federal sin tax on tobacco started April 1, 2009, driving the per-pack tax from 39 cents to $1.01. The tax affected all tobacco products, including cigars and pipes, and the money earned will be used to expand health coverage for low-income kids.
Spencer Platt/Getty Images

Sticking with the cigarette tax example, skeptics argue that while cig sin taxes might be able to reduce smoking to a point, there seems to be a limit. If you keep upping the ante, the reductions often start levelling off. The reason for this is that some people just won't, or can't, quit, and since these same people are often poor, they can't afford to continue to buy cigarettes — legally.

In the early 1990s, the Canadian government sharply increased the tax rate on cigarettes. The hike was too steep, and it spawned a giant black market in contraband cigarettes. While black market sales of cigarettes accounted for only 1 percent of sales in 1987, they high-jumped to 31 percent in 1993. That's a result nobody wants. Not only does it mean the tax isn't having its desired effect on public health, it also means lost revenues. In 1994 Canada abruptly cut its sin taxes on cigarettes, a measure that helped reduce contraband sales and bring legal sales (and revenues) back up [source: Kelly-Gagnon].

This question of revenues is a big one. If you decide to raise a tax on a "sinful" product, you have to have a plan for what to do with the money that comes in. Often, the revenue is allocated for spending on health care. In some ways, this seems like an elegant, win-win solution. But sometimes it backfires.

In February 2009, Arkansas nearly doubled its tax on cigarettes to $1.15. The state had lots of great health-related plans for the projected $86 million in revenue this measure would bring in. But to the astonishment of legislators, rather than having more money, they ended up with $10 million less than they'd collected the previous year. The reason? Increased black market sales plus the more expedient (and legal) solution of simply crossing state lines to buy cheaper cigarettes [source: Moser].

And this brings us to yet another objection to sin taxes. Remember how the U.S. government was largely dependent on sin taxes for revenue up until 1913? That's no longer the case, but some sin-tax skeptics estimate that taken together, both state and federal governments collect $96 billion annually from our bad behavior [source: Otero]. This, they argue, puts government in a moral bind. On the one hand, they impose the taxes to encourage people to sin less, while on the other, the government then comes to depend on the income from all that sinful spending. In other words, lawmakers have to hope that people will behave better, but not too much.


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