Vapor products have dominated the news for the last several months. States and the federal government have tried to restrict access to the products and many have debated creating new taxes on them too. Policymakers should tread lightly, however. A new working paper published by the National Bureau of Economic Research finds that vapor taxes have a significant impact on adult smoking rates. Under one such proposal, higher taxes could dissuade up to 2.75 million adult smokers from quitting.
E-cigarettes, or vapor products, are a relatively new creation. They allow the user to consume nicotine, but they avoid the traditional combustion of cigarettes, reducing the risk of smoking. Some studies have found that e-cigarettes are actually 95 percent safer than traditional tobacco products.
That’s important. Smoking is a high-risk activity and providing smokers with a way to consume nicotine in a safer way is a large public health benefit, increasing life expectancy and reducing mortality.Thus, it stands to reason that our policy environment should not overly restrict the availability of e-cigarettes.
But it’s important for another reason too: tax policy design. Excise taxes are special taxes assessed on products that pose a risk to others, known as an externality. Creating a special, product-specific tax raises the cost of the product, reducing consumption of the product and the externality. We use excise taxes for any number of items, such as alcohol, gasoline, tanning booths, and yes, cigarettes.
With the launch of e-cigarettes, states have wondered how to tax them. Should the tax rate match that of traditional cigarettes or should the rate be different? Ideally, economic theory tells us the rate should match the risk of the product, since it’s related to the externality caused by the product. So if e-cigarettes are safer than cigarettes, the rate should be lower. Using the study above, economists would say that rate should be up to 95 percent lower than the excise tax imposed on cigarettes.
Not all states have followed that approach. Minnesota was the first state to impose a tax on e-cigarettes, taxing vapor products at 95 percent of their wholesale price. (The tax started at 35 percent.) This natural experiment allowed economists to investigate the impact of high vapor taxes, using other states as controls. The assumption is that if vapor taxes are set too high it would discourage individuals from quitting smoking. Many smokers should want to switch to vapor products to reduce their health risk, but there is a financial calculation too. If the vapor product is too expensive, they would be unable or unwilling to make the switch. Put another way, setting the rate too high could increase the adult smoking rate.
Unfortunately for the state of Minnesota, they set their tax rate far too high.
According to the authors, “we find consistent and robust evidence that the e-cig tax in MN increased adult smoking relative to what it would have been in absence of the tax.” Their estimates are that “32,400 additional adult smokers would have quit smoking in Minnesota in the absence of the tax.”
The authors went a step further. They estimate that a new national vapor tax would deter 1.8 million smokers from quitting. If Congress went a step further and adopted a proposal that taxed vapor the same as cigarettes, 2.75 million smokers would be deterred from quitting smoking. Sadly, many in Congress have endorsed such a policy. In October, the House Ways and Means approved a bill that would have created a new federal vapor tax equaling the current tobacco tax rate.
Excise taxes play an important role in the tax policy toolkit, but policymakers must be careful. Setting rates incorrectly has real-world consequences.