Order Code RS22681
June 19, 2007
The Cigarette Tax Increase to Finance SCHIP
Jane G. Gravelle
Senior Specialist in Economic Policy
Government and Finance Division
Summary
The Senate Budget Resolution, S.Con.Res. 21, 110th Congress, permits an increase
in the cigarette tax to pay for the State Children’s Health Insurance Program (SCHIP).
Current federal taxes are 39 cents per pack, and taxes imposed at all levels of
government account for about a third of the price of cigarettes. A 50 cent increase, for
example, would raise nearly $7 billion a year, but would cost state and local
governments about $1 billion. (An original proposal to raise the tax by 61 cents was not
adopted, so the likelihood of a tax increase and its potential size is uncertain.) A
justification for the tax is to discourage smoking, particularly by teenagers. Most
evidence suggests there is likely to be a reduction, but that the response may be small.
One reservation about the tax is that the burden falls heavily on low-income individuals.
Introduction
The Senate Budget Resolution, S.Con.Res. 21, 110th Congress, allows the cigarette
tax to be raised to help pay for re-authorization of the State Children’s Health Insurance
Program. An original proposal would have mandated a 61 cent tax increase per pack, but
the resolution makes such a tax possible but not mandatory and does not set the level.
This report describes current taxes, discusses potential revenue gains, and discusses some
of the basic issues surrounding a tax increase.
Current Federal Taxes on Tobacco
Tobacco excise tax rates vary by tobacco product, but the vast majority of these taxes
are on cigarettes, which account for 90% of sales of tobacco products, and totaled $88
billion in 2005.1 Federal cigarette taxes are $0.39 per pack, and account for 97% of federal
tobacco tax revenue. There is a 4 cent tax on small cigars. Large cigars carry a tax of
20.719% of sales price, not to exceed $48.75 per 1,000 units, leading to a maximum tax
1 Standard and Poor’s Industry Surveys: Alcoholic Beverages and Tobacco, November 30, 2006.

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of 5 cents per cigar. Per ounce, the tax is 7 cents on pipe tobacco; 1 cent on chewing
tobacco; 4 cents on snuff; and 7 cents on roll-your-own tobacco. There are also taxes on
cigarette paper and cigarette tubes.
Tobacco tax receipts in the United States include $7.8 billion in federal tax, $13.6
billion in state and local taxes, and $7.5 billion in payments from the Master Tobacco
Settlement.2 State and local taxes, therefore, are roughly 68 cents per pack and the tobacco
settlement payment is approximately the same as the federal tax, 39 cents per pack.
Although the tobacco settlement payments resulted from negotiations between the tobacco
companies and the states to settle state lawsuits, the payments function as if they were a
national tobacco excise tax that is allocated to the states, and any changes that alter
consumption would affect these payments. Some of the states have securitized their
payments (exchanged the stream of payment for a fixed up-front amount). According to
estimates, about a quarter of payments are made to private investors, rather than to state
and local governments.3 As a percentage of sales revenues, the federal, state and local, and
tobacco settlement payments are respectively 8.8%, 15.5% and 8.5%, for a total of 32.5%.
Revenue Gain from Tax Changes and Effects on the
State and Local Governments
In their 2005 Budget Options study, the Congressional Budget Office estimated that
a 50 cent increase in the cigarette tax would result in a revenue gain of $6.7 billion. This
gain may appear low, since a 50 cent increase is 1.28 times the current tax of 39 cents per
pack, and would appear to raise around $10 billion. That is, the revenue could be roughly
estimated as 1.28 times $7.8 billion. But the projected gain is only $6.7 billion. The most
important reason for this difference is the interaction between the corporate income tax
and the excise tax. Since excise taxes are deducted from income taxes by manufacturers,
there is a revenue loss from the income tax, and a rule of thumb is typically that about 25%
is lost, making the estimate $7.5 billion.
The second reason is that the increased tax raises the price and reduces consumption.
Consider the case where the price elasticity (capturing the response of consumers’
purchases to a change in price) is 0.4, a typical assumption for smoking. That means that
a 10% increase in price will reduce quantity consumed by 4%. In the example considered
2 Data on federal tax revenues from Alcohol and Tobacco Tax and Trade Bureau, Cumulative
Summary, Fourth Quarter FY2006. Data on state and local taxes from U.S. Census Bureau tables:
State Government Tax Collections: 2005 and State and Local Government Finances by Level of
Government and by State: 2003-04. Data on tobacco settlement payments for 2005 are from
Nieman Watchdog, “Not Much Tobacco Settlement Money Goes to Reducing Smoking,”
December 6, 2006, at[http://niemanwatchdog.org/index.cfm?fuseaction=ask_this.view&askthisid
=00156].
3 Payments received by the states are estimated at $5.8 billion in FY2005 and $5.4 billion in
FY2006, because many states have securitized their tobacco settlement payments. Data on
tobacco payments received by the states are from Government Accountability Office, Tobacco
Settlement: States’ Allocation of FY2005 and Expected FY2006 Payments, GAO-06-502, April
2006.

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here, given the tax as a share of price, the price increase would be 11.3% (1.28 times 8.8),
and the quantity consumed would fall by 4.5%. That reduction in quantity (considered
before the excise tax interaction) is applied to both the old ($7.8 billion) and the new ($10
billion), to yield a fall in revenues of approximately $0.8 billion. Thus, the net excise tax
gain is not $10 billion, but $9.2 billion. The number should also be multiplied by 0.97 to
eliminate the 3% of the tax levied on other tobacco products. The net yield is therefore
projected at $9.2 billion times 0.97 times 0.75 (to account for the excise tax effect), for a
net gain to the federal government of $6.7 billion. This same method could be applied to
any tax change.
This behavioral response from a federal tax increase would reduce state and local
taxes — by 4.5% in the case of the 50 cent tax increase. Therefore, state and local
revenues of $13.6 billion would fall by $0.61 billion, and tobacco settlement payments of
$7.8 billion would fall by $0.35 billion, for a total of almost $1 billion, unless states and
local governments also raised their taxes.
Issues Surrounding Tobacco Taxes
There are many alternative sources of revenue (or offsetting spending) for funding
the child health program. Are tobacco taxes the most desirable source of revenue?
Compared to other taxes, the incentive effects may be desirable. At the same time, the
burden falls heavily on lower income people, which may be of concern. Thus, there is
generally a trade-off between the objective of discouraging smoking, and particularly
discouraging youth smoking, and the distributional effects of the tax. The remaining issue
involves an economic efficiency question relating to arguments that have been made that
additional taxes are appropriate to cover costs smokers impose on others. A number of
economic studies have questioned that proposition. There is also a question of the degree
to which, having covered these costs, government policies should interfere in private
decisions that create health risks. The following sections discuss these issues.
Effect on Smoking and Health
A large body of literature has suggested that increases in the price of tobacco reduce
smoking. However, this response is not very large (in economists’ parlance, the response
is relatively “inelastic”). Most of the evidence has found the price elasticity to be between
0.3 and 0.5 in absolute value, meaning that a 10% increase in price would cause a 3% to
5% decrease in the number of cigarettes smoked.4 For older adult smokers, about half of
this effect was due to fewer smokers (a participation response) and about half due a
reduction in smoking (a quantity response). For younger smokers, the participation
response was more important. There is some evidence that the response declines with age
4 For a review of the literature on price elasticities for cigarettes, See CRS Report 94-214,
Cigarette Taxes to Fund Health Care Reform: An Economic Analysis, by Jane G. Gravelle and
Dennis Zimmerman, and CRS Report 97-995, The Proposed Tobacco Settlement: Effects on
Prices, Smoking Behavior, and Income Distribution, by Jane G. Gravelle (out of print and
available from the author). For a review, see also Badi H. Baltagi and Rageev K. Goel, “State
Tax Changes and Quasi-Experimental Price Elasticities of U.S. Cigarette Demand: An Update,”
Journal of Economics and Finance, vol. 28, fall 2004, pp. 422-429.

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and that it rises with income, and that it is higher for women, African-Americans, and
Hispanics.5 A recent study, however, found no variation with income.6
Some recent studies suggest that the response may be less, or that the benefits of
reducing smoking may be less. There is some evidence that the response has been
declining, an outcome that might not be surprising, since, given a decline in smoking, the
remaining smokers are more resistant to price signals. In addition, there is evidence that
elasticities might be overstated in studies that compare state smoking levels because states
with higher taxes may also have populations more hostile to smoking.7 Also, recent
studies found that smokers may respond to price increases by increasing the intensity of
smoking by buying cigarettes with more nicotine and tar, inhaling more deeply and
smoking closer to the filter, which could have deleterious effects since more intensive
smoking can be more harmful.8
Due to the limited effects on adult smoking, some arguments have been made that the
increased taxes on adults are necessary over the interim to discourage teenage smoking.
Evidence has suggested that teenage smoking is more responsive to price; the original
responses were estimated at elasticities over one, but subsequent analysis led to an
estimate of around 0.7 and a number of recent studies have confirmed this general range.9
Other studies have found smaller responses,10 or a very small response by younger
5 The previous CRS reports cited provide evidence of the age effect; see also Matthew C.
Farrelly, Jeremy W. Bray, Terry Pechacek, and Trevor Woolery, “Response by Adults to
Increases in Cigarette Prices by Sociodemographic Characteristics,” Southern Economic Journal,
vol. 38, July 2001, pp. 156-165.
6 Greg Colman and Dahlia K. Remler, Vertical Equity Consequences of Very High Cigarette Tax
Increases: If the Poor are the Ones Smoking: How Could Cigarette Tax Increases be
Progressive?, National Bureau of Economic Research Working Paper 10906, November 2004.
7 Baltagi and Goel, “State Tax Changes and Quasi-Experimental Price Elasticities of U.S.
Cigarette Demand: An Update;” Theodore E. Keeler, The-wei Hu, Williard G. Manning, and
Hai-Yen Sung, “State Tobacco Taxation, Education and Smoking: Controlling for the Effects of
Omitted Variables,” National Tax Journal, vol. 54, March, 2001, pp. 83-102. Both studies found
a decline over time and the latter study found an overstatement of elasticities because of state
effects. Another study found variations in elasticities across states; Macki Aissoko, “Cigarette
Consumption in Different U.S. States, 1955-1998: An Empirical Analysis of the Potential Use
of Excise Taxation to Reduce Smoking,” Journal of Consumer Policy, vol. 25, March 2002, pp.
89-106.
8 Jerome Adda and Grancesca Cornaglia, “Taxes, Cigarette Consumption, and Smoking
Intensity,” American Economic Review, vol. 96, September 2006, pp. 1013-1028. This study
reviews other studies that also found smoking intensity effects.
9 Jonathan Gruber and Jonathan Zinman, Youth Smoking in the U.S.: Evidence and Implications,
National Bureau of Economic Research Working Paper 7780, July 2000; John A. Tauras, Patrick
M. O’Malley, and Lloyd D. Johnston, Effects of Price and Access Laws on Teenage Smoking
Initiation: A National Longitudinal Analysis, National Bureau of Economic Research Working
Paper 8331, June 2001; Hana Ross and Frank Chaloupka, The Effect of Cigarette Prices on Youth
Smoking, ImpacTeen, Research Paper Series No. 7, February 2001.
10 William Evans and Lynn Huang, Cigarette Taxes and Teen Smoking: New Evidence from
Panels of Repeated Cross Sections, Working Paper, University of Maryland, April 15, 1998.

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teenagers.11 One recent study replicated the 0.7 elasticity using one statistical approach,
but in using another the authors consider superior, they found essentially no response of
the initiation of smoking to price.12 Another paper found a weak and insignificant effect
after controlling for anti-smoking sentiment.13 While much evidence suggests that
teenagers are more responsive to prices, these recent studies raise some questions about
the effectiveness of tax increases on teenage smoking, especially among young teenagers.
The evidence on smoking indicates that higher prices will decrease smoking
participation and quantity. It is possible, however, that other types of interventions, such
as stricter regulations on sales to teenagers, counseling, education, and assistance with
smoking cessation might be more effective.
Distributional Effects
It is generally recognized that cigarette taxes are one of the most regressive taxes, that
is, a tax that falls more heavily on lower income individuals as a percentage of income.
Indeed, it is probably the most regressive of the federal taxes. Smokers tend to smoke a
fixed amount of cigarettes, so that they pay a fixed amount of tax. (Since the tax is a fixed
amount per pack, lower income individuals who buy cheaper brands still pay the same
amount of tax.) In addition, smoking is more prevalent among lower income individuals.
To illustrate, in 1998 the Joint Committee on Taxation estimated that a 76 cent tax
increase (brought about through a proposed federal tobacco settlement) would raise the
effective tax rate on average by 0.3% of income, but would increase the burden of those
with incomes below $10,000 by 2% of income and the burden of those in the $10,000-
$20,000 income by 0.6% of income.14 Since this rate applies to all families, those families
with smokers would pay more. For example, a family with one smoker who smokes 1.5
packs a day would pay, with a 76 cent tax, an additional $417 in taxes, which is 4.2% of
a $10,000 income and 8.4% of a $5,000 income.
To the extent the burden of the tax falls on low-income families and the individuals
in those families continue to smoke, low-income children in some families could be
harmed even though the child health care provision helps low-income children in general.
11 Jonathan Gruber, Youth Smoking in the U.S.: Prices and Policies, National Bureau of
Economic Research Working Paper 7506, January 2000.
12 Philip DeCicca, Donald Kenkel, and Alan Mathios, “Putting Out the Fires: Will Higher Taxes
Reduce the Onset of Teenage Smoking?,” Journal of Political Economy, vol. 110, February 2002,
pp. 144-169.
13 Philip DeCicca, Donald Kenkel, Alan Mathios, Yoon-Jeong Shin, and Jae-Young Lim, Youth
Smoking, Cigarette Prices, and Anti-smoking Sentiment, National Bureau of Economic Research
Working Paper 12548, August 2006.
14 Joint Committee on Taxation, Description and analysis of revenue-related provisions of S.
1415 relating to the national tobacco policy as modified by the manager’s amendment, JCX-45-
98, June 3, 1998.

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Economic Efficiency
A final issue that may arise relevant to cigarette taxes is the argument that higher
taxes should be imposed on smokers because they impose costs on others largely through
higher health care costs that may be paid for through insurance plans, both government
and private, and because of lost days at work, and some other costs. Some economists
have questioned this argument, however, because smokers’ premature deaths, while
harmful to smokers and their families, reduce costs of certain government programs such
as Social Security, Medicare, and Medicaid.15 These calculations do not account for more
subjective effects such as irritation to others, although such problems might be better
addressed through private market mechanisms (provision of smoking and non-smoking
commercial establishments) and regulation. Some disputes about the magnitude of
environmental tobacco smoke remain.
If smokers are not imposing costs on others, or imposing costs that are less than
existing taxes, and if they are making rational decisions to engage in an activity which,
while damaging to their health, is nevertheless pleasurable, then an additional tax would
not increase economic efficiency. It is not clear, however, whether young smokers, where
smoking is generally initiated, are able to fully assess the costs of smoking.
15 For a discussion, see W. Kip Viscusi, “Tobacco Taxes,” In The Encyclopedia of Taxation and
Tax Policy, Ed. Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle, Washington, DC, Urban
Institute, 2005.

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