Raising Cigarette Taxes Just to Raise Revenue

It has been a common theme recently for elected officials to go after cigarettes for a tax hike to pay for some spending program that is supposed to provide general public benefits. What is the justification of this type of policy from the perspective of sound public finance? Unless one wants to argue for an across-the-board switch to Ramsey Rule taxation, there is none. It's pure democratic politics: use the coercive power of the state to take from an unpopular minority to finance a majority's wishes.

The latest two examples come from California and South Carolina. Gov. Schwarzenegger (yes, the same man who used to loathe socialist policies in Free to Choose videos) wants to use the revenue to pay for universal healthcare in California. Gov. Sanford wants to raise the South Carolina cigarette tax to pay for a flat tax in his state.

Neither has justified higher cigarette taxes on the grounds of empirical evidence on their negative externalities. They just want the revenue. It's kind of scary that in a supposedly free country a politician with the political support of a majority could raise taxes on an arbitrarily selected minority to finance a program that benefits the majority.

Our recommended holiday reading for these politicians: Federalist Paper No. 10 by James Madison
(Caution: May contain words not used often in everyday readings or talk such as "liberty.")

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Inflation adjustments for tax brackets, exemptions, and deductions will mean that your first paycheck in 2008 will be slightly higher than your last paycheck of 2007, even if your salary remains the same. While the increase this January will not be nearly as large as last January, it will still be noticeable.

For a single person earning $50,000 per year (assume all wages/salaries and no adjustments), his federal individual income tax bill under 2007 tax parameters would be calculated as follows:

AGI = $50,000
Taxable Income = AGI less Standard Deduction ($5,350) and Personal Exemptions ($3,400) = $50,000 - $5,350 - $3,400 = $41,250
Income Tax Before Credits = Tax Paid at 10% Rate + Tax Paid at 15% Rate + Tax Paid at 25% Rate = (($41,250 - $31,850) * .25) + (($31,850 - $7,825) * .15) + ($7,825 - 0) * .10) = $2,350 + $3,603.75 + $782.50 = $6,736.25
Credits = 0 (we assume no credits)
Income Tax After Credits for 2007 tax law = $6,736.25

Now for a person earning $50,000 under the 2008 tax parameters:

AGI = $50,000
Taxable Income = AGI less Standard Deduction ($5,450) and Personal Exemptions ($3,500) = $50,000 - $5,450 - $3,500 = $41,050
Income Tax Before Credits = Tax Paid at 10% Rate + Tax Paid at 15% Rate + Tax Paid at 25% Rate = (($41,050 - $32,550) * .25) + (($32,550 - $8,025) * .15) + ($7,825 - 0) * .10) = $2,125 + $3,678.75 + $802.50 = $6,606.25
Credits = 0 (we assume no credits)
Income Tax After Credits for 2007 tax law = $6,606.25

The person would save $130 on the year assuming no pay change, which would be about a $5.42 pay increase per pay period (assuming two per month).

Note also that inflation adjustments do reduce somewhat any growing income gap between those whose real incomes did not grow as fast as others as higher exemptions and deductions make the tax system more progressive.

Finally, a pay raise will not apply to some of those who live in Maryland as paychecks for high-income Marylanders are set to shrink significantly starting Jan. 1, 2008 thanks to the recent tax hike approved by the legislature and Gov. O'Malley. Those not high income in Maryland may see higher paychecks thanks to a slight increase in the exemption amount, but they will see higher taxes when they shop as the sales tax is going from 5 percent to 6 percent effective January 3rd.

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