By Chris Girard, CEO & President of Plaid Pantries, Inc. and ONSA Past President

 

As the 2005 Oregon Legislature gets underway this month, our State is again facing an estimated $1 billion budget shortfall. There is little doubt that legislators will again look to our largest product category, cigarettes, for additional revenue. However, increasing cigarette taxes will not increase the net revenue received by the State and help balance the budget. Instead, increasing cigarette taxes will reduce the net revenue received by the State, provide incentives to engage in illegal trade, increase tax enforcement costs, and harm Oregon businesses.

In November of 2004, the Oregon Department of Revenue acknowledged that expected revenue from cigarette taxes fell well short of projected income. ONSA repeatedly warned that the huge tax increases on cigarettes would drive smokers to untaxed sources of product; the Internet, Indian reservations, black/gray market bootleggers, cross-border shopping, and other means of avoiding and evading state excise taxes. Unfortunately our warnings were unheeded.

Tobacco trade data, for 2003, shows that legal (i.e. taxed) cigarette shipments declined 1.6% nationwide. However, in Oregon , legal cigarette shipments declined 6.6% after Oregon increased its cigarette tax to $1.28 (5th highest in the nation in 2002). This 6.6% decrease represents a 5% additional loss of carton volume beyond the national average. According to Oregon cigarette tax revenue data, the State of Oregon collected taxes on about 29 million cartons of cigarettes in 1992, but in fiscal year 2004 (ending 6/30/04) collected taxes on only 18 million cartons. In the first five months of FY 2005, legal cartons have rebounded somewhat to about a 19 million annual carton rate, arguably reflecting the $1 per carton tax, which expired January 1, 2004.

There is a very strong mathematical correlation between Oregon 's cigarette excise tax rates and the number of legal carton shipments within the State. The data indicates that for every $1 per carton tax increase (10-cents per pack), the number of legal carton shipments decreases by about one million. As the State receives $11.80 in total revenue for every pack of cigarettes sold, the loss of one million legal carton shipments reduces the revenue the State receives by $11.8 million. This loss of revenue diminishes the $19 million in “expected” revenue from a dime-a-pack tax increase by $11.8 million, netting the state only $7.2 million in additional tax revenue.

The story gets worse. Oregon , like other states, participates in the Master Settlement Agreement (MSA) in which tobacco companies pay money to the states based on each taxable carton sold. Oregon is already falling considerably short of expected income from this source, due to the steep decline in legal carton movements through the state. MSA money is currently paid at an average rate of about $3.85 per carton. Therefore, a $1 per carton tax increase (10-cents per pack), which results in a loss of one million legal cartons, causes the State an additional revenue loss of $3.85 million. The lost revenue is from a different account but is still very real. When this $3.85 million of lost revenue is taken into account; the cigarette tax increase “expected” to produce $19 million in additional revenue has, in fact, only produced $3.35 million.

Raising this relatively small amount of revenue carries a horrific price for Oregon businesses. Lost sales of one million cartons by legitimate tax-abiding and income-tax-paying retailers and wholesalers, at $42 average retail per carton, means that $42 million in economic activity will be destroyed, replaced by black/gray market untaxed product. Further, assuming a 24% combined wholesale and retail profit margin, $10 million in income will be lost by Oregon businesses; income that should be available to share with employees, reinvest in store facilities and technology, and of course, pay Oregon income tax.

Aside from this huge loss to Oregon wholesalers and retailers, the 6.6% state corporate income tax that is lost on those profits reduces the State's revenue by $660,000. This figure reduces the “expected” $19 million of additional revenue from the $1 per carton cigarette tax increase to $2.69 million and does not account for the income tax revenue lost by cities and counties or the cost of tax enforcement. When such factors are taken into account, the net revenue generated by the $1 per carton (10-cents per pack) cigarette tax increase is negligible at best. Any incremental tax which wipes out $10 million in business income while failing to clearly provide net revenue to the State should be critically reviewed by the incoming legislature.

The State of Oregon presently relies on tobacco income to an even greater degree than Oregon wholesalers and retailers. The State currently receives about $315 million annually in tobacco related revenue (excise taxes, MSA payments, corporate income tax). Meanwhile, Oregon wholesalers and retailers gross about $180 million annually. Because of the relationship between taxes and legal carton shipments, and the availability of untaxed product from literally thousands of out-of-state suppliers; further increases in the cigarette tax will actually generate less revenue to the State and further punish legitimate Oregon businesses.

The reality is that Oregon 's cigarette tax rate actually becomes financially unproductive at around $8.50 per carton, when viewed as a complete picture of revenue to the State and corporate profits on cigarettes. The first five months of FY 2005 indicate that Oregon is generating more revenue at a lower tax rate, with the sunsetting of the temporary $1 per carton tax, which expired in 2004. It is not necessary for Oregon to eliminate tobacco taxes to shutdown bootleggers. Oregonians who buy untaxed product must pay shipping costs. Mail order purchasing requires planning ahead and is inconvenient. Many Oregonians would prefer purchasing smaller quantities more often from their local retailer. There is also a risk the customer will be caught and punished for breaking the law. All of these points create value above the cost of illegal product. Oregon put itself considerably ahead of this value equation when it instituted the 2002 tax increase. While it would be naïve to suggest that Oregon roll its cigarette excise tax back to the $8.50 level; it is clear that any further increase in the tax rate would be bad for Oregon 's revenues and very bad indeed for Oregon business.

ONSA will continue to energetically present these facts to our 2005 Legislators.