Minnesota's Misguided Cigarette Tax

Minnesota failed to fix its budget with a cigarette tax in 2005. And the state will fail if tries again.

There is a sense of bitter irony in Democratic Minnesota Gov. Mark Dayton's new cigarette tax proposal, which is aimed at bridging the Gopher State's budget gap. In 2005, then-Gov. Tim Pawlenty used an increase in cigarette taxes—which he called a "user fee"—to solve a state budget crisis that had shut down the government. Yet today Minnesota finds itself right back in state finance hell.

With his government ground to a halt for a week now, Gov. Dayton's proposed $1 per pack increase on cigarette taxes was offered as an alternative to an income tax surcharge on millionaires, but state Republicans rejected it anyway, on the grounds that any tax increase was off the table.

Lost in the shuffle is the fact that Pawlenty's "user fee" and Gov. Dayton's proposed pack attack are problematic for more than just political reasons. Trying to cover a budget shortfall with a cigarette tax—or any sin tax—is an irresponsible idea. Taxes on cigarettes tend to drive business out of state and yield unreliable revenue, which only creates future budget woes. And cigarette taxes are not user fees—since the specific tax revenues are not used on services for smokers, but instead go towards general state spending.

Lawmakers in St. Paul and in other state capitols should read the warning label from Minnesota's 2005 tax "solution" and recognize that revenue from cigarettes does not tackle the underlying issue—government spending that has outpaced revenues.

Even if the proposed tax were accepted and the budget passed in Minnesota, the state could be right back where it started within just a few months. Additional revenue from Gov. Pawlenty's 2005 tax increase was estimated to generate $174 million per year, but Minnesota's cigarette tax revenue has only increased by an average of $4 million per year—a paltry 2.72 percent of the estimate.

And Minnesota isn't alone: A 2008 Maryland cigarette tax increase only yielded 50 percent of projected additional revenue while cigarette tax revenue in Illinois has decreased by $69 million since 2007. Overall, only 30 percent of cigarette tax increases between 2003 and 2007 have met revenue projections—not a record on which to stake a state's future. No matter what projected additional revenue Gov. Dayton thinks a $1 per pack cigarette tax increase will yield, it will most likely not come to fruition as regular smokers go elsewhere to purchase their cigarettes and causal users cut back.  

When New York raised its cigarette tax in 2010, neighboring counties in Vermont and Pennsylvania saw an increase in cigarette sales of between 17 and 30 percent. This is because while increases such as Gov. Dayton's proposal—which would raise the total tax per pack to $2.23 in Minnesota—are not enough to impact consumption, they are enough to drive smokers to shop out of state. New Yorkers simply took a little trek across the state border to save a few dollars. Those few dollars add up over time.

Minnesotans might do the same, traveling to the Dakotas or Iowa where tax rates on cigarettes are much lower. And the current rate in Minnesota is already three times North Dakota's rate.

More damningly, the "Land of 10,000 Lakes" would lose revenue from cross border purchases from Wisconsin, where a $2.52 tax rate on cigarettes drives business away. The lost consumer traffic and subsequent depleted tax revenue would not be good for Minnesotan businesses or the state's budget shortfall.

States with high cigarette taxes tend to be more fiscally irresponsible than others. Of the top 10 highest cigarette taxing states, six received a C+ or worse in the most recent Pew Center Money Performance rating, which examines a state's fiscal responsibility. The correlation is typically because increasing cigarette taxes is often a last resort when real fiscal responsibility has been eschewed.

Minnesota has a spending problem, as do a number of other states facing budget gaps for next year—such as Nevada, Oregon, and Texas. It is time for governors and state lawmakers to take a cue from the Minnesota déjà vu and recognize that taxing cigarettes won't solve the underlying problem.

Anthony Randazzo is director of economic research at Reason Foundation. Carson Bruno is a research assistant at Reason Foundation.