By E. Frank Stephenson
The General Assembly convened this year facing the daunting challenge of closing a billion-dollar budget hole, partly caused by the slumping economy and the consequent decrease in tax revenues. Few, if any, forecasters or policy-makers foresaw a recession or revenue decline this sharp. Feckless Washington policy-makers have exacerbated the problem by creating an uncertain investment climate for families and entrepreneurs.
Georgia’s leadership is certainly better than the Potomac residents hurling heated rhetoric at the private sector and infatuated with thousand-page legislation, but the state’s budget gap is also partly the result of poor choices made by its leaders. One was the rapid spending increases during years of flush revenue growth instead of enhancing the state’s rainy day fund. Another was last year’s decision to accept federal stimulus funding that restricts the ability of the state to include Medicaid cuts as part of closing this year’s budget gap. Medicaid cuts may pain affected recipients, but should be on the table along with education and other programs.
Fortunately, news reports indicate that tax increases are mostly off the table in solving the budget mess. The experience of states such as New York, California and Michigan demonstrates shows raising taxes to fill budget gaps further depresses economic activity. The rinse-and-repeat pattern of tax hikes and budget deficits is unsustainable; it damages states’ economic climates.
One exception in Georgia is a proposal to fill part of the budget hole by increasing the state’s cigarette tax from 37 cents to $1.37 per pack. Such a measure reportedly would raise another $400 million of tax revenue. (As an aside, it would be a true act of chutzpah for Georgia – ranking next to last among the states in spending Master Settlement Agreement money on prevention – to disguise a revenue-grabbing tax hike as an attempt to reduce smoking.)
Revenue projections from cigarette tax increases are notoriously inaccurate. Higher taxes result in only small consumption decreases by smokers but revenue gains are still difficult to project because cigarette taxes are one of the most easily avoided forms of taxation. Smokers who purchase their cigarettes out of state, over the Internet or from smugglers all escape the tax increase. Consequently, cigarette tax revenue increases often fail to meet projections. In one recent, and admittedly rare, case, New Jersey increased its cigarette tax rate and saw cigarette tax revenues decrease.
Although a drop in cigarette tax revenues in Georgia is unlikely, concerns about Georgians purchasing elsewhere are real. A $1.37 tax per pack would greatly exceed Alabama’s 42.5-cent per pack tax, Tennessee’s 62-cent tax, and North Carolina’s 45-cent tax. The gap between Georgia’s increased tax and South Carolina’s 7-cent per pack tax would be so large that “North of the Border” cigarette establishments would probably spring up along I-85 and I-95.
Cross-border shopping damages more than cigarette tax revenue. People who cross borders to buy cigarettes add purchases such as gasoline, groceries or lottery tickets. Hence there is collateral economic damage from reduced gas tax revenue, sales tax revenue (especially for counties, which apply the sales tax to groceries), and lottery revenue. A complete analysis of potential gains from cigarette tax hikes must therefore include any offsetting declines in other forms of tax and lottery revenue.
Collateral damage includes the convenience store industry. These retailers are not as glamorous to ribbon-cutting politicians as, say, auto plants sprinkled with tax credits and other largesse, but Georgia has more than 4,700 gas station/convenience stores employing more than 26,300 people and with an annual payroll exceeding $436 million. Another 770 convenience stores that do not sell gasoline employ 2,500 Georgians with an annual payroll of $41.5 million.
Beyond the tax revenue and economic impacts of cigarette tax hikes, there are also equity concerns. Smoking is more prevalent among low-income people, so cigarette taxes are highly regressive. Even if smoking were equally prevalent across all income levels, a tax that cost a smoker, say, a dollar a day or $365 per year would take a larger share of income from someone making $20,000 than someone making $75,000. The tax hike would be a particularly unjust approach to plugging the budget gap.
Georgia leaders face some difficult budget decisions, but they should avoid the quick, nicotine-like fix of tax hikes. If additional revenue must be part of closing the budget gap, the first source should be the repeal of special-interest tax exemptions. Longer term, in anticipation of improving economic conditions and improving tax receipts, they should enact meaningful spending restraint in order to accumulate a robust rainy day fund instead of returning to the bad habit of funding unsustainable spending growth.
Frank Stephenson, chairman of the Economics Department at Berry College in Rome, Georgia, wrote this commentary for the Georgia Public Policy Foundation. The Foundation is an independent think tank that proposes practical, market-oriented approaches to public policy to improve the lives of Georgians. Nothing written here is to be construed as necessarily reflecting the views of the Georgia Public Policy Foundation or as an attempt to aid or hinder the passage of any bill before the U.S. Congress or the Georgia Legislature.
© Georgia Public Policy Foundation (January 29, 2010). Permission to reprint in whole or in part is hereby granted, provided the author and his affiliations are cited.