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May 18, 2016

States should answer a few questions before taxing e-cigarettes

May 18, 2016

A version of this post was originally published on TaxVox.

State and local governments often use taxes to influence consumer behavior. They subsidize conduct they like (e.g., California offers a rebate for buying zero-emission vehicles) and penalize behavior they do not through corrective or sin taxes (e.g., Washington, DC, levies a five-cent tax on plastic bags).

But what about e-cigarettes and other vapor products? These devices, introduced roughly a decade ago, provide nicotine without the tar and chemicals found in traditional cigarettes. Some people view them as a way to quit smoking, while others warn they’re merely a new way to hook kids on nicotine. The Centers for Disease Control reports that 12.6 percent of adults and 16.0 percent of high school students have used e-cigarettes.

On May 5, the US Food and Drug Administration announced it would regulate e-cigarettes, suggesting the agency is concerned about the product’s health consequences. In contrast, Public Health England found e-cigarettes less harmful than traditional smoking and a potential tool to end tobacco addiction.

Given the uncertainty about the health effects of vaping, states face a number of tough questions. Should they tax e-cigarettes at all, and by how much? Should states impose a unit tax on the vape/e-cigarette or the refillable nicotine cartridges or both? Or should they use a percentage-of-price tax?

There is also the matter of complexity. Many states already have different tax rates for cigarettes, snuff, and chewing tobacco. Some states exempt premium cigars entirely. Should e-cigarettes get yet another rate or piggyback on one of these existing taxes?

And what about tax avoidance? Every state has a cigarette tax, but per-pack taxes range from 17 cents in Missouri to $4.35 in New York (plus another $1.50 in New York City). The result: some consumers dodge the highest state taxes by shopping elsewhere.

States also need to think about what to do with the revenue. Corrective taxes are often tied to popular spending programs (such as Philadelphia’s proposed soda tax to fund early-childhood education) although the money is often diverted during a budget crunch.

Finally, what’s the goal? Does the state want to eliminate e-cigarettes? Discourage their use but still leave vapor products as a cheaper alternative to traditional cigarettes? Or is the state only interested in new revenue?

Numerous states have debated taxing e-cigarettes, but only four states and DC have passed specific excise taxes. DC and Minnesota include all vapor-related products (vapes, refillable cartridges, etc.) in their definitions of “other tobacco products” (OTP) and tax them at their OTP rates: 65 percent of wholesale price in DC and 95 percent of wholesale price in Minnesota. Because the OTP rates in DC and Minnesota are equivalent to or higher than their cigarette taxes, both effectively tag e-cigarettes as equally as bad as traditional cigarettes. As DC councilmember Charles Allen said, “[W]e are treating [vapor] products the same way we treat nicotine products.”

In contrast, Kansas, Louisiana, and North Carolina imposed per-unit taxes only on the refillable liquid nicotine cartridges: five cents per milliliter in Louisiana and North Carolina, and 20 cents per milliliter in Kansas. If we assume one milliliter of vapor liquid equals half a pack of cigarettes, then these rates are well below cigarette taxes in Louisiana (86 cents per pack), Kansas ($1.29), and North Carolina (45 cents). While these states push consumers away from vapor products with a tax, smokers still have an incentive to choose e-cigarettes over traditional packs. All these taxes, and the Minnesota and DC taxes, go to general funds.

So what were the goals? DC and Minnesota clearly wanted to dissuade if not stop use of these products. As such, DC councilmembers should have welcomed news that their new tax helped close vape shops in the city. In Louisiana and Kansas, policymakers were probably motivated by health concerns, but both taxes passed when these states were desperate for revenue to fill huge budget gaps. Meanwhile, North Carolina didn’t have a budget crunch, but lobbying from tobacco companies helped the pass the vapor tax.

With these five taxes in place, states have models for creating their own tax. But they still have questions to answer.

In this Feb. 20, 2014 photo, Talia Eisenberg, co-founder of the Henley Vaporium, uses her vaping device in New York. Photo by Frank Franklin II/AP/File

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