Sin Taxes are not sustainable and are often out into place for the wrong reasons

This is the paradox of sin taxes, the class of taxes that includes tobacco. These extra dollars and cents levied on products and activities considered detrimental to consumers—traditionally tobacco, alcohol, and gambling—are intended to accomplish two contradictory goals: Like all taxes, they generate revenue for the taxing entity, but they also aim to deter the behavior being taxed—which can ultimately negate the first goal.

Indeed, research suggests that higher cigarette prices play a role in curbing smoking.4 A reduction in smoking is good for public health, but it has been so significant that inflation-adjusted tobacco tax revenue nationwide has waned in recent years despite frequent tax rate hikes. Revenue from tobacco taxes depends on high rates of smoking—which the taxes discourage—making these taxes an unreliable source of long-term revenue, especially for funding recurring budget items.

Research by The Pew Charitable Trusts and the Nelson A. Rockefeller Institute of Government similarly found that state revenue growth from taxes on alcohol and gambling is unlikely to be sustained due to how the products are taxed, changes in demand, and casino competition. In addition to studying state revenue trends for long- standing sin taxes, Pew and Rockefeller analyzed newer taxes on e-cigarettes and recreational marijuana. This report examines trends from 2008 through 2016 and relies on federal and state revenue data, academic and other relevant literature, and interviews with state officials.

The key findings include:

Revenue from tobacco taxes dropped on average during the study period, with states that did not increase tobacco tax rates recording the most drastic decline. Overall, tobacco tax revenue declined in over half the states.

Because of greater consumption of alcohol, tax revenue from those products, unlike tobacco, rose over the study period without significant tax hikes. However, the long-term revenue potential of tobacco and alcohol taxes is limited by their shared structure—a tax on the quantity sold, not its value, and thus requires either increased tax rates or increased consumption to generate more revenue.

While lawmakers are enticed by taxes on gambling, revenue growth from newly legalized casinos and “racinos” (casino-racetrack hybrids) tends to be short-lived. Competition is a significant contributing factor, suggesting that as more states legalize these activities, states already collecting gaming revenue could see further erosion in these tax streams.

Nonetheless, states are increasingly looking at sin taxes to generate new revenue. This trend is demonstrated by the steady flow of casino openings, a majority of states considering implementing sports betting, and continued interest in legalized recreational marijuana.

States are experimenting with ad valorem taxation—which is based on the price of the good, not quantity sold—and other tax structures on e-cigarettes and legalized recreational marijuana. Under the current structures, recreational marijuana revenue has been strong in the states with available data, but the markets for it and e-cigarettes are too new to gauge their long-term revenue potential.

The findings suggest that policymakers should carefully evaluate the purpose of these revenue-raising measures. Recent and historical trends in sin tax revenue point to three main takeaways:

Sin taxes are a useful tool for supporting public health objectives and can be effective in raising revenue in the short term.

States should carefully assess the sustainability of these revenue sources in the long term, especially for funding ongoing budget commitments, to avoid structural budget challenges.

Policymakers can benefit from considering historical experiences with sin tax revenue as they seek to implement new, related tax policies. States should be especially cautious about pursuing emerging sin taxes where markets are volatile and forecasts rely on limited data. Given this uncertainty, and the trends in revenue from these sources, states should also be mindful of potential pitfalls in directing new sin tax revenue toward recurring expenditures.