Betty Joyce Nash

Ross Lawrence

English

Research Papers in Economics

2 Region Focus | Second Quarter | 2010 
UPFRONT
Regional News at a Glance
Crossing the Border
As Taxes Rise, Locals May Buy Cigarettes Elsewhere
P
H
O
T
O
G
R
A
P
H
Y
:
 
G
E
T
T
Y
 
I
M
A
G
E
S
During a time when revenue is difficult to come by for many local and state governments, a 
number of city councils and state legislatures are looking for ways to raise money. For many of
these governing bodies, raising excise taxes, such as those for cigarettes, could seem to offer the
least politically contested route to increasing revenue.
Washington, D.C., imposed a 50 cent increase in its 
cigarette tax, effective October 2009. The tax is now $2.50
per pack. 
The economic impact of excise taxes like those for 
cigarettes has garnered attention from politicians and 
academics alike. A recent contribution came from econo-
mist David Merriman of the University of Illinois at
Chicago. Merriman arranged teams to collect a represen-
tative random sample of littered cigarette packs in parts of
Chicago and neighboring jurisdictions for his paper, “The
Micro-Geography of Tax Avoidance: Evidence from
Littered Cigarette Packs in Chicago,” published recently
in the American Economic Journal: Economic Policy.
Merriman’s results suggest that tax avoidance may be a
significant concern. In Chicago, 75 percent of the littered
packs displayed no city tax stamp, indicating that they
were purchased outside the city. Given the tax differential
between Chicago and neighboring locales, it’s no surprise.
In July 2007, Chicago proper had a combined state and
local cigarette tax rate of $3.66 per pack, while nearby
Indiana had only a 55.5 cent state levy and no local taxes.
Merriman also looked at a sampling of properly disposed
packs in Chicago, and those results indicate that the 
littered boxes were representative of all packs. 
Akey subtlety that Merriman noticed is when it comes
to tax avoidance, distance matters. In Chicago, “the degree
of avoidance diminishes rapidly with distance from the
[Indiana] border,” he said in a phone interview. That obser-
vation holds true in cities where he has conducted similar
studies. In New York City, for example, about half of lit-
tered packs did not include a NYC tax stamp. But in
Warsaw, Poland, where consumers must travel much 
farther for lower-cost cigarettes, only 11 percent of smok-
ers were thought to have participated in the illicit market. 
In the case of Washington, D.C., comparisons to New
York City and Chicago may be more apt. At $2.50 per
pack, the excise tax in D.C. is currently the ninth highest
among state taxes in the country, more than $1 higher than
the national average for state cigarette taxes. More impor-
tant, D.C. residents must pay a tax that is more than $2 a
pack higher than in neighboring Virginia, which levies a
fee of 30 cents per pack. “The proximity of D.C. to
Virginia and the ease of transportation between the two
lead me to think you could find a ton of Virginia packs
there,” Merriman says. 
From a revenue perspective, the latest numbers from
D.C. certainly are not encouraging. For the six-month 
period following the October 2009 tax increase, cigarette
tax revenues in the District of Columbia actually have 
fallen 23.6 percent, or $4.9 million, compared to the same
period a year earlier. Of course, high taxes may not be the
only culprit — a slumping economy can diminish con-
sumption and hurt tax revenues as well. But recessionary
effects on excise tax income elsewhere seem more modest.
In Virginia, for instance, tax revenue from cigarettes fell
only 0.32 percent between fiscal years 2008 and 2009.
According to the Washington Business Journal, D.C. Chief
Financial Officer Natwar Gandhi speculated in a February
2010 revenue estimate that D.C.’s tax increase sent local
smokers to Virginia and Maryland to buy cigarettes. 
While tobacco-industry lobbyists point to decreases in
tax revenue as a reason to keep cigarette taxes low, certain
advocacy groups, such as the Campaign for Tobacco-Free
Kids, argue that cigarette tax avoidance is overhyped and
not widespread enough in many places to result in a
decline in government revenue. 
Merriman suggests that policymakers should avoid
generalizations and instead pay close attention to the 
different circumstances and conditions each locality faces,
especially distance to alternative markets. “In D.C., [prox-
imity to Virginia and Maryland] makes avoidance a prime
issue, but say for a large city in the middle of a state, it
shouldn’t feel like it can’t raise taxes without encountering
a significant avoidance effect.”   —ROSS LAWRENCEEnd of an Era
South Carolina Hikes Tax on Smokes
Region Focus | Second Quarter | 2010  3
Vermont
Highest Rates
New York
Rhode Island
Washington
Connecticut
Hawaii
$2.51
$2.50
New Jersey
Wisconsin
Massachusetts
District of Columbia
$2.24
Missouri
Louisiana
Alabama
North Dakota 
North Carolina
$4.35
$3.03
$3.00
$3.00
$2.70
$2.52
$0.17
$0.30
$0.36
$0.37
$0.43
$0.44
$0.45
$0.55
$0.57
$0.57
Idaho
South Carolina 
$3.46
Lowest Rates
Virginia
Georgia
West Virginia
State Cigarette Excise Taxes 
NOTES: Average state tax: $1.45 per pack.
Chart lists state tax rates noninclusive of
federal excise tax or any local taxes.
SOURCE: Campaign for Tobacco-Free Kids
I
n South Carolina, lawmakers in May voted to raise the 
cigarette excise tax from 7 cents a pack to 57 cents a pack.
For 33 years, South Carolina had the lowest cigarette tax in
the country — a reign that ended when the tax hike took
effect July 1.  
South Carolina has long been a significant tobacco-
producing state, which may partially explain its historical
commitment to keeping cigarette taxes low. Although the
state’s economy has diversified considerably from its mostly
agrarian origins, tobacco remains an important crop.
According to the U.S. Department of Agriculture, South
Carolina dedicates about 20,084 acres to tobacco cultivation,
the fifth highest of any state. Grown mostly in the northeast
part, known as the Pee Dee region, it is South Carolina’s
most profitable crop by acre and the fourth highest by cash
receipts.
The rate increase moves South Carolina closer to the
Fifth District average of $1.06 for cigarette taxes. Virginia
now sits with the lowest tax in the District at 30 cents per
pack, while North Carolina and West Virginia levy 45 cents
and 55 cents per pack, respectively. Washington, D.C., on the
other hand, charges $2.50 per pack in taxes, while Maryland
levies $2 a pack. Both the Fifth District average and South
Carolina’s tax rate remain considerably lower than the 
average for all states of $1.45. 
Legislators hope the tax increase will provide additional
financing for Medicaid programs for the poor and disabled.
Of the $135 million the hike is expected to raise in revenue
for the state, $125 million will be allotted to Medicaid. That
money should largely replace federal bailout dollars that have
kept the program in the black for two years. 
Although the impetus for the new law may have been
financial in nature, antismoking groups have stepped up
pressure on states in recent years to use excise taxes —
among other policy options — to reduce demand for 
tobacco products. In April, the Centers for Disease Control
and Prevention issued a report about state excise taxes, high-
lighting that a 10 percent increase in the effective price of
cigarettes can curb consumption by 4 percent. Of the states
that increased cigarette taxes in 2009, or thus far in 2010,
South Carolina is the first to allocate some of the projected
revenue to tobacco prevention and control. The state will 
set aside $5 million for cancer research and smoking 
cessation programs.   — ROSS LAWRENCE4 Region Focus | Second Quarter | 2010 
Taxing e-Commerce
Amazon Fights N.C. Access to Records
P
eople owe sales taxes on goods purchased online, even if
remote sellers don’t collect. Some catalog and Internet
retailers don’t charge the tax in states where they have no
stores (or other physical presence). So several states have
intensified efforts to collect. North Carolina, for instance,
asked Amazon late last year for information on transactions to
North Carolina addresses. Amazon subsequently sued.
Sales and use collection on Internet purchases are mired in
the confusing concept of “nexus,” or physical presence, and
the issue will likely go unresolved until the U.S. Congress
weighs in. Until then, states will keep trying to persuade 
retailers to collect. 
For example, North Carolina unveiled a compromise for
Internet retailers who have operated affiliate programs in the
state. Those who agree to collect future sales/use taxes 
and sign onto the program by Aug. 31, 2010, won’t pay penal-
ties, back taxes, or interest. Earlier efforts to extract taxes
included a 2009 law requiring online retailers to collect when
affiliate Web sites operated by state residents refer customers
to those retailers. 
Other states have passed these “Amazon” laws, named for
the major online-only seller. In response to the North
Carolina law, Amazon ended its agreements with bloggers and
business Web sites that referred business to the seller. The
firm did likewise last spring in Colorado when the state passed
a similar law. Amazon lost its court challenge to New York
state’s Amazon law, but is appealing. 
Amazon’s federal lawsuit seeks to block the request of the
North Carolina Department of Revenue (DOR) for seven
years’ worth of customer order information. The legal action
reads, in part: “The DOR’s actions threaten to chill the exer-
cise of customers’ expressive choices and to cause Amazon
customers not to purchase certain books, music, movies, or
other expressive material from Amazon that they might oth-
erwise purchase if they did not fear disclosure of those
choices to the government.” Amazon wants the court to
agree, so that other states won’t do likewise. In late June, 
the American Civil Liberties Union filed a complaint on
behalf of one named and six anonymous North Carolinians, in
support of Amazon’s complaint. The ACLU intervened,
according to its press release, because of free speech and 
privacy issues.
The secretary of the DOR, Kenneth R. Lay, wrote the
American Booksellers Association in June, in response to a
request, that the department isn’t interested in customers’ 
specific book titles but needs product codes to calculate the
taxes.
The stakes are rising, along with the value of goods and
services sold online. In 2008, the value reached $3.7 trillion,
according to the U.S. Census Bureau’s latest adjusted figures.
About $142 billion were business-to-consumer retail sales. 
As consumer spending picks up, it’s likely that online and 
catalog sales will too.
Donald Bruce, William Fox, and LeAnn Luna of the
University of Tennessee estimate state and local revenue 
losses nationwide may grow to $11.4 billion by 2012. Estimates
of losses in North Carolina, with a 5.75 percent sales tax, could
reach $213.8  million. 
Warehouses are apparently excluded from the definition of
“physical presence.” Amazon operates a warehouse in
Virginia, from which merchandise is shipped, but pays no
sales and use tax in Virginia. An Amazon bill introduced 
during the Virginia General Assembly in 2010 failed to pass.
The courts last weighed in on remote sellers and tax 
collection in 1992. The U.S. Supreme Court ruled in Quill
Corp. v. North Dakotathat a business wasn’t required to charge
sales tax in states where it had no physical presence. The
opinion suggested Congress had the authority to resolve the
issue. So far it has not, though some states have simplified tax
rates and administration to make collection easier. Remote
sellers have objected to the complexity and variation among
state and local tax regimes. Through the Streamlined Sales
and Use Tax Agreement, 23 states of the 45 that collect sales
taxes have legislated changes conforming to the agreement.
North Carolina and West Virginia are two Fifth District
states that have done so.
There’s a possible advantage for remote sellers who don’t
collect taxes. “Theory would suggest you have out-of-state
firms competing on something other than a level playing
field,” says Don Bruce, one of the University of Tennessee
economists who has studied sales tax revenue losses from
electronic commerce. They operate at an advantage over local
firms that do remit this tax. “So there’s an inflow of activity
from those sellers, presumably at the expense of a local busi-
ness.” The lack of clarity on the sales tax issue also can distort
remote sellers’ organization and location decisions, he notes.
States are likely to get more aggressive in trying to collect
from catalog and Internet retailers, but many customers are
unlikely to voluntarily pay the tax when it’s not collected at
the time of purchase. —BETTY JOYCE NASH

Upfront : Regional news at a glance.

http://www.richmondfed.org/publications/research/region_focus/2010/q2/pdf/upfront.pdf

Upfront : Regional news at a glance.

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics