In times of financial trouble, a state may look to increase taxes, expand the tax base or repeal existing tax benefits in an attempt to balance the budget. When discussing a state tax increase, individuals often think of individual income tax, corporate income tax, property tax and sales tax. A much less discussed and often overlooked source of state income is sin tax.
Sin taxes are excise taxes on substances and activities that are considered sinful or harmful. The most widely recognized substances and activities subject to sin taxes are alcohol, tobacco and gambling. Sin taxes are considered excises taxes because they are levied on some but not all commodities. Unlike sales tax, which is levied on almost all products, specific substances and activities are targeted for sin taxes.
Many individuals support sin taxes because sin taxes deter sinful behavior and raise revenue, in part to compensate society for the negative impact that results from engaging in the “sinful” behavior. Additionally, it is often easy to get a majority of voters to support the imposition of a sin tax because the majority likely does not engage in the activity or buy the product subject to the sin tax. Many voters would rather see a tax imposed on someone other than themselves.
Despite the easily identifiable benefits of sin taxes, there are some costly detriments. First, sin taxes are regressive in nature because they subject all taxpayers to the same tax rate regardless of income status. Accordingly, sin taxes take a larger percentage of income from low-income individuals. Consider the following example: Taxpayer X has $10 of income and must pay $1 of tax on a pack of cigarettes. This tax represents 10 percent of taxpayer X’s income. In contrast, taxpayer Y has $100 of income and must pay the same $1 of tax on the pack of cigarettes. This tax only represents 1 percent of taxpayer Y’s income. As the example illustrates, the sin tax burden falls more heavily on low-income individuals.
This is problematic for a few reasons. First, placing a greater burden on low-income individuals supports regressive tax policy in general and is inconsistent with the duty to help those in need. Second, substances and activities subject to sin taxes, such as tobacco and gambling, are often addictive. When forced with a decision to forego something beneficial, like fresh vegetables, or something addictive, like cigarettes, an addiction will make it difficult for an individual to make the right decision. Lastly, government assistance programs are in place to help low-income individuals. Imposing a tax that more heavily burdens those same individuals is counterintuitive.
States are inherently conflicted between the dual goals of sin taxes, which are to generate revenue and discourage sinful behavior. As the intended consequences of sin taxes takes effect, the state that imposed that tax is generating less and less revenue. For example, assume that state X imposes a $1 sin tax on a pack of cigarettes and generates $500,000 per month as a result of the tax. Once state X increases the sin tax by 50 percent to $1.50, half of the cigarette smokers in state X quit smoking. As a result of the sin tax, half of the people in state X have quit smoking, which suggests that one of the dual purposes of the sin tax has been fulfilled. However, due to the fulfilled purpose and despite the tax increase, state X has lost $125,000 or 25 percent of the revenue previously generated by the sin tax. The conflict is clear — both goals of sin tax cannot be furthered simultaneously.
The existence of these dual and competing interests raises a difficult policy dilemma. As the intended consequences of sin tax take effect, less revenue is generated. As less revenue is generated, a need exists to fill that void left by the impact of that sin tax. Sin taxes are an attractive means by which to generate revenue because not all individuals are impacted by the tax. Therefore, a state is incentivized to correct the tax base by simply imposing another sin tax on another activity or behavior. This is a slippery slope. If society is supportive, or complacent, with regards to the imposition of an additional sin tax, there is no reason for a state not to continue to impose sin taxes or encourage the imposition of sin taxes. As a state imposes a sin tax on an additional substance or activity, such as the consumption of sugary drinks, the use of tanning beds, or the purchase of plastic bags, more limitations are being imposed upon individuals.
Finally, not only are states bringing more substances and activities into the sin tax purview, some states have gone so far as to legalize an illegal activity in order to generate revenue from the imposition of a sin tax. In November of 2012, Colorado voters approved Amendment 64, which legalized the personal use, possession, and limited home-growing of marijuana for adults 21 year of age and older, despite the federal government’s position on the matter. Colorado has benefited financially from the legalization of marijuana. According to the Colorado Department of Revenue, recreational and medical marijuana shops have sold more than $1 billion worth of marijuana and related products as of December 2016, which has produced roughly $49.7 million in sin tax revenue.
Despite the windfall, it is difficult to overlook the negative consequences of legalizing marijuana. In addition to the influx of homelessness in Colorado, the costs associated with the need for additional law enforcement, an increase in the number of drugged-driving incidents and classroom expulsions due to marijuana use call into question the cost-benefit of legalizing an illegal activity in order to generate revenue through the imposition of a sin tax.
Conventional wisdom suggests that sin taxes are here to stay. However, the manner in which states choose to utilize this revenue-generating mechanism in the future remains unknown. It would be prudent for voters to become educated on the benefits and detriments of imposing sin taxes. Voters have an opportunity and an obligation to intelligently weigh their options in determining how, and in what manner, to utilize the sin tax. D
Ryan Carnes is a senior tax associate at RSM US LLP in Denver. He currently lives in Washington, DC, where he takes part in a Washington National Tax rotation focused on state and local tax and controversy and procedure. He can be reached at email@example.com.