Decreasing Tobacco Taxes in New Hampshire

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The Fiscal and Economic Impacts of Decreasing the Cigarette Tax in New Hampshire

April 2011

Prepared by:

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

TABLE OF CONTENTS Executive Summary __________________________________________________ 3 I. Introduction and Overview___________________________________________ 6 II. Historical Tax Rates, Sales, and Revenues in NH _____________________ 8 III. Cigarette Prices and Cigarette Sales in NH__________________________ 11 IV. Impact on Cigarette Tax Revenues _________________________________ 18 V. Impacts on Other Tax Revenues____________________________________ 23 VI. Economic Impacts _______________________________________________ 27 VII. Impact on Cigarette Consumers ___________________________________ 34 VIII. Review Of NH Grocers Association Report ________________________ 35 IX. Conclusions ____________________________________________________ 40 References __________________________________________________________ 41 Appendix A _________________________________________________________ 43 Appendix B _________________________________________________________ 44 Appendix C _________________________________________________________ 45

PolEcon Research was commissioned by the American Cancer Society (ACS), the American Lung Association, the American Heart Association, and Tobacco Free Kids, to examine the fiscal and economic impacts of a decrease in New Hampshire’s cigarette excise tax. Although commissioned by these organizations, this report was prepared independently. PolEcon chose the data, methods, and models used in the analysis.

PolEcon presented this report to the sponsoring organizations without advance notice of the results. PolEcon agreed to make editorial changes in the report but did not make any changes to the results of the analysis unless an error in model inputs or calculations could be clearly demonstrated. All data used in the construction of models and in calculating impacts is publicly available from federal and state government agencies, or from readily available private sources. All interpretations of data, conclusions and any errors contained in the report are the responsibility of PolEcon and not the sponsoring organizations.

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Executive Summary New Hampshire is considering a proposal to decrease the state’s excise tax on cigarettes. The proposed decrease comes after a decade where NH’s cigarette excise tax increased $1.41, rising from $0.37 to $1.78. During that same time, the federal excise tax on cigarettes increased $.0.77, and industry determined prices increased $1.47, including a $0.66 increase in FY2000 and a $0.38 cent increase in FY2010. Despite these price increases, the average price of a pack of cigarettes in New Hampshire fell from 89 percent to 81 percent of the average price per pack in Massachusetts. Industry and excise tax price increases along with the long-term trend of declining cigarette consumption nationwide have combined to produce drop in cigarette sales in New Hampshire of over one-third since 1999. Despite declining sales and claims that tax revenues would fall each time NH raised its cigarette tax, state government excise tax collections more than tripled during the past decade, going from $75 million in 1999, to $230 million in 2010.

Additional cigarette tax revenues since 2008 were used to help offset some of the 25 percent decline in business taxes during the recession and were also seen as a way to “export” NH’s tax burden. Approximately one-half of the cigarette tax in NH is paid by residents from out-of-state, some who enter NH specifically to purchase cigarettes more cheaply in the Granite State, and some who purchase cigarettes and other items during the course of the 52 million tourist visits to NH that occur annually.

Over time, cigarette sales will decline in NH even if no changes occur in their tax or non-tax price. Greater awareness of the health risks associated with smoking, demographic changes and societal shifts in perception of smoking all are combining reduce the number of smokers and volume of cigarettes purchased annually. To slow or possibly stem this trend, the tobacco industry and some policymakers are looking to increase the volume of cigarette sales in NH by lowering the excise tax applied by the state. A wealth of research over decades has shown that cigarette sales respond only modestly to overall changes in price that are prompted by either a change in tax rates or industry prices.

The analyses in this report use publicly available data and transparent statistical methods and models that can be replicated by any researcher, to document the impact that price changes and other variables have on NH cigarette sales. Historical data reveal several years where sales increased in NH despite either industry or excise tax (or both) price increases. Econometric models demonstrate that cigarette price differences between NH and other states have a stronger impact on NH sales than does a change in NH prices, and that price differences affecting sales result from both industry pricing decisions and state government excise tax rates.

Supporters of a tax decrease have argued that a small price decline will produce large enough sales gains in NH to generate a substantial increase in cigarette tax revenue.

Their argument is seemingly supported by an industry commissioned report that suggests

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

a 1.7 percent (or 10 cent) decline in NH’s cigarette excise tax would result in an 11.4 percent (or 14.6 million pack) increase in cigarette sales in NH, making it the third largest increase in sales in the past thirty years.

Claims that cigarette sales would increase by 14.6 million packs in response to a 1.7 percent price decline imply a price elasticity of demand (the responsiveness of cigarette sales to changes in price) of -6.5, or roughly 16 times larger than those typically found by researchers nationally. This elasticity is about seven times that found by PolEcon’s model over more than 10 years of using NH specific data to analyze NH cigarette sales and revenues. The claim of outsized sales gains from the tax decrease appears more extraordinary because the statistical models used and reported by the authors suggest that a $0.10 cent tax decrease would result in a sales increase of just 3.88 million packs. Using a sales gain figure of 14.6 million to estimate revenue impacts, when models suggest increases only one fourth as large, invite concerns that results may be manipulated to demonstrate revenue neutrality or gains from an excise tax decrease.

This report uses historical cigarette sales, tax, and price data for NH and other states going back to 1955 to determine the relationship between cigarette prices in NH, tobacco tax rates, cigarette sales, and tobacco tax revenue. Using NH specific data, econometric models can determine the historical relationships between the price of cigarettes in NH and nearby states, and NH cigarette sales. We develop price elasticity estimates (the impact that price increases have on cigarette sales) that forecast the impact of excise and industry price increases on cigarette sales in New Hampshire. Unlike other reports on cigarette sales and prices in NH, our models or calibrated or “fit” based only on NH-specific data and explicitly incorporate price difference across states, so called “border effects” to account for how price differences affect sales in NH. We estimate the change in revenue that would occur in response to declines in the excise tax rate and examine historical NH data to demonstrate the circumstances that would be needed to produce a scenario where cigarette sales increased by the volume suggested by proponents of the tax decline.

Rather than simply rely on a series of assumptions for our estimates, we use conventional econometric techniques to demonstrate how other sources of NH revenue respond to changes in cigarette sales in the state and we show how NH’s high level of cigarette sales is a side effect, as much as it is a cause, of visits to the state of NH. The report also examines historical evidence of the relationship between employment in NH and cigarette sales, This report also reviews a report (Tasto, Randolph and Keip, 2011) used by advocates to support a decline in the tax rate and the estimates of cigarette sales and revenue in response to changes in the excise tax that it produces. We review the model for its theoretical basis and application of the key concept of price elasticity of demand, its transparency and the statistical validity of the results is produces. Finally, we evaluate the plausibility of the results it produces using historical NH data and in comparison with the results produced by other models.

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Key Findings Of The Report Include: •

NH’s cigarette tax continues to be a strong producer of revenues and has shown no sign of a significant decline in response to recent tax increases.

•

Higher prices reduce cigarette sales in NH, but NH prices in relation to Massachusetts are a stronger determinant of changes in NH cigarette sales.

•

States with higher or increasing excise taxes generally experience higher industry price hikes. This amplifies the impacts of excise tax increases on sales declines (allowing claims that tax hikes produce smaller than forecast revenue gains). Since 1999, industry price increases have exceed excise tax increases in NH.

•

Factors besides price are exerting stronger influences than ever on cigarette sales in NH. High gasoline prices reduce visits to NH and revenues generated by those visits. A 10 percent increase in the price of gasoline reduces cigarette sales by between 1.5 and 2.0 percent, when other factors remain unchanged.

•

Cigarette sales will increase by about 1.6 percent in response to the proposed excise tax decrease but tax revenue will decline by about $9 million.

•

The cigarette industry has strong economic incentives to increase prices after a tax decrease, creating substantially greater risk to the state that revenues will decline by more than our forecast of $9 million.

•

Using appropriate statistical methods, there appears to be no empirical evidence to support the belief that cigarette sales exert a significant influence on other state revenues such as meals and rental, gasoline, liquor, or business tax revenues.

•

Employment at NH convenience stores has declined but employment at convenience stores that sell gasoline has more than offset that decline.

Combined, the two industries experienced greater employment growth than did NH overall since 1998, despite a decline in cigarette sales of about 50 million packs.

•

There is a small and not statistically significant negative relationship between retail employment and cigarette sales in NH.

•

Recent reports by advocates of an excise tax decrease use inconsistent and undocumented methods to estimate the cigarette sales and state revenue impacts of the excise tax decrease. Their results predict extraordinary

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

changes in cigarettes sales that are demonstrably implausible and unrealistic by historical standards in NH or any state in the nation.

I. Introduction and Overview New Hampshire, like nearly all states, is confronting an extraordinarily difficult gap between expenditures and the state revenues, at the same time policymakers are looking for ways to speed economic recovery and job growth. Lowering various tax rates has been offered by some lawmakers as one strategy for increasing economic activity and stabilizing or increasing revenues. Others, for ideological and political reasons, argue that tax increases enacted in New Hampshire during the previous decade should be lowered or eliminated. The opposing view offered by some lawmakers is that despite tax increases over the decade, New Hampshire citizens continue to bear among the lowest tax burdens of any state in the nation. In addition, the state’s economy performed better than every New England state and most states across the country during the recent recession, and it is recovering jobs faster even as revenues struggle to rebound.

Reducing the rate of New Hampshire’s excise tax on cigarettes is just one of many proposals being considered by lawmakers to reduce tax rates as a strategy to bridge the gap between state expenditures and revenues. Whether the budget gap is the result of excess spending or declining revenues is a matter for elected officials and the public to decide and is not a subject for this report. Unlike many of the analyses entered into the budget policy debates, this report makes no judgments about the appropriate level of taxation in NH. Rather this report looks to inform the decisions of policymakers by presenting empirically based estimates of the impacts of decisions that may be made and to transparently use, standard methods of economic analysis, and historical data to help lawmakers evaluate some of the arguments entered into the debate over cigarette excise taxes.

Forecasting the revenue impacts of tax changes, especially the cigarette tax in NH, is especially challenging because the tax rate is just one of many factors that influence both prices and the demand for cigarettes in the state. History shows that cigarette sales can rise in NH even after significant price increases if the difference between the price per pack in New Hampshire and neighboring states increases by a large enough amount. History also shows that when gasoline prices rise above a certain threshold, NH’s cigarette price advantage is sufficiently eroded by travel costs to minimize the price advantage enjoyed by retailers and reduce cigarette sales in the state.

Industry price increases have the same impact as tax increases on the price of cigarettes to consumers. Price increases and their magnitude are difficult to predict and appear to be based on different strategies across states. The price differences between neighboring states are a function of both excise taxes, and the pricing strategy of the industry. States with lower tax rates can help increase the sales and revenues of the industry and sellers of cigarettes, but only to the extent that the industry and retailers do not charge prices that erode the advantage provided by lower tax rates. By keeping excise tax rates low, states forego cigarette tax revenue. States can also look to gain more revenue from a smaller or declining cigarette sales base by enacting higher excise tax

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

rates. In high tax states the tobacco industry and retailers face the same choice of increasing prices to extract the maximum amount of revenue from a smaller or declining sale bases, or looking to minimize sales losses by keeping price hikes low at the expense of some per pack revenue. The evidence presented in this report shows that industry prices and price increases are generally higher in states with higher excise tax rates. Both the industry and state governments reduce cigarette sales by increasing prices and each confronts the choice between supporting sales and increasing revenue. As importantly and as we demonstrate in this report, the choices made by the industry and state government affects the revenue that the other derives from cigarette sales.

The purpose of this report is to document how the choices made by NH state government, the tobacco industry, and cigarette retailers in the Granite State, as well as the actions of policymakers and the industry in neighboring states have affected the sale of cigarettes in NH over the past four decades. Policy debates regarding tax rates are often framed and sometimes decided from an ideological perspective but this report seeks to provide an evidence-based, empirical, non-ideological assessment of the fiscal and economic impacts of changes in cigarette prices and excise taxes.

Our report begins with an analysis of trends in cigarette sales and tax revenues in NH in light of the many recent changes that have occurred in the excise tax rate. We then discuss factors that affect the volume of cigarette sales in NH and present a model to estimate the sales and revenue impacts of potential changes in the excise tax rate and demonstrate how the state government and industry revenues are affected by changes under different price change scenarios of. We examine the historical and current role that cigarette sales play in the NH economy and use historical data on employment and cigarette sales to determine the impact that changes in the volume of cigarette sales in NH have on NH’s employment. Finally, we review the analysis and results of a recent report on the impacts of a decrease in NH’s cigarette excise tax.

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

II. Historical Tax Rates, Sales, and Revenues in NH New Hampshire’s excise tax on cigarettes continues to produce substantial revenues for the state despite industry price increases and large combined increases in state and federal excise taxes. Because of changing demographics and the long-term erosion in the percentage of adults smoking in the United States and in New Hampshire, cigarette sales in the U.S. will decline annually, even if no change in the price of cigarettes occurs. Because sales continue to decline, in the aggregate, revenue across all states will also decline unless excise taxes are raised or unless individual states capture more a the declining base of cigarette sales.

Each recent excise tax increase in NH has been met by arguments that cigarette tax revenues would decline as a result of the increase. Each time those claims have proven inaccurate. In NH, industry opponents of cigarette excise taxes have amended the claim of declining revenue to revenues “disappoint” after tax hikes. Claims that any additional tax increase will result in revenue losses or “negative revenue” are still made but the repeated demonstration of the inaccuracy of the claims have modified some of the more extremes claims. Although some still incorrectly state that “NH loses revenue when it increases its tax rate,” the more carefully hedged “we are close to the “tipping point” where revenue will decline has become more common. Figure 1 shows that NH revenues have always risen after tax cigarette tax increases, including after FY2010’s $0.45 state tax increase, $0.62 federal tax increase, and industry initiated price increase of $0.38 per pack (to compensate for revenue from declining sales). Combined, these increases resulted in an overall price increase of $1.45 per pack in NH and the result was a large drop in cigarette sales but also a large increase in revenue.

Figure 1

Despite Claims That Recent Excise Tax Increases Would “Reduce Revenues” The Cigarette Tax Continued to Grow With Each Increase, Despite Declines in Cigarette Sales $.62 Fed T ax Hike & $.45 NH Hike

Cigarette Tax Revenue ($ Million s) 250

$.25 NH Ta x Hike 200

$.28 NH Tax Hikes

150 $.28 NH Tax Hike

,H Cigarette Tax Revenue ($ Millions)

100

,H Cigarette Sales (Millions of Packs) 50

$.10 Fed Tax Hike & $.15 NH Hike $.08 NH Tax Hike

$.05 NH Tax Hike 0

80

82

84

86

88

90

92

94

96

98

00

02

04

06

08

10

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Because of longer-term trends in smoking, industry advocates argue that cigarette taxes are an “unreliable and unsustainable” source of revenue. Figure 1 indicates that to the contrary, NH’s cigarette tax revenue continues to grow as a result of recent tax increases. It is the nature of much of NH’s revenue structure that revenues do not automatically increase over time. Historically, that characteristic of NH’s revenue structure was seen as a virtue by many, and a check against growth in government.

Similarly, the fact that no source of revenue could eliminate NH’s budget gaps was viewed as a virtue. It meant, however, that many if not most of the states revenue sources would have to play a role in meeting the revenue needs of state government.

In some years cigarette tax revenues have been higher than forecast following a tax increase and in some years they have been lower than forecast. This should caution policymakers about accepting simplistic arguments about how cigarette sales and tax revenues respond to price and policy actions. Through March of 2011, NH’s cigarette tax collections are $9 million or 5.4 percent ahead of the monthly revenue plan for FY2011 that was forecast to yield $220 million revenues.1 As we demonstrate later in this report, however, factors beyond the control of policymakers or the tobacco industry can affect cigarette sales in NH. Notably the price of gasoline which both reduces the number of visitors to NH who may purchase cigarettes while they are here for other purposes, as well a narrows the price advantage NH enjoys by increasing the cost of travel for those coming to NH for the purpose of buying cigarettes.

Still, there can be no dispute that excise taxes have risen significantly in “These above average industry price recent years in NH. Figure 2 shows how increases serve to increase industry industry price increases and state and revenue on the remaining sales (sales federal excise tax increases have combined that are not lost because of excise tax to increase the price of cigarettes in NH. increases), but they also magnify the The chart shows that state excise taxes have loss of sales and allow opponents of increased as a share of the price of cigarette excise taxes to claim that tax cigarettes in NH, but the chart also shows hikes produced larger than estimated that the response by the industry to declines in sales, and smaller than increases in excise taxes is often outsized estimated revenue yields.” price increases. Notably a $0.38 increase in 2010, a $0.20 increase in 2008, and a $0.66 increase in 2000. These above average industry price increases serve to increase industry revenue on the remaining sales (sales that are not lost because of excise tax increases), but they also magnify the loss of sales and allow opponents of cigarette excise taxes to claim that tax hikes produced larger than estimated declines in sales, and smaller than estimated revenue yields. Three price increases totaling $1.18 in 1999, 2000, and 2002 were initiated by the industry to cover the cover the costs of the Master Settlement Agreement between cigarette manufacturers and the states that sued them over health related medical expenses.

1

State of NH Dept. of Administrative Services, Monthly Revenue Focus, March FY2011.

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire Figure 2

Taxes are Now a Larger Portion of NH’s Total Cigarette Price, but Tax and Industry Price Increases Often Occur Together, Magnifying the Declines in Sales Attributed Entirely to Tax Increases Compone nts of Cigarette Prices in NH

$7.00

State Tax Federal Tax Base Price

$6.00 $5.00 $4.00 $3.00

$2.00 $1.00 $0.00 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Despite the direct evidence from NH and other states that have increased their cigarette tax rates, there appears to be a common myth that increasing the cigarette tax will not produce new revenue and that all price related declines in sales are the result of excise tax increases. A careful analysis of actual tax and industry price increase experiences in NH does not support this argument. Cigarette sales will continue to diminish in NH and the nation, but NH excise tax has proven to be a reliable and important source of revenue for the state that is consistent with the state’s unofficial policy of exporting as much of the tax burden as possible.

Figure 3

Industry Price Increases Also Narrowed Price Differences Between NH and Neighboring States and Lowered Sales $1.60 $1.40 $1.20

Prices Ra ised to Pay for “M aster Settleme nt Agreeme nt

Industry State Excise Fed. Excise

$1.00 $0.80 $0.60 $0.40 $0.20 $0.00 ($0.20)

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

III. Cigarette Prices and Cigarette Sales in NH A large body of research indicates that changes in the retail price of cigarettes influence cigarette consumption (see Chaloupka & Warner – 2000, for an extensive review of this literature). Fewer studies have been done on the impact of price differentials on cigarette sales in neighboring states (see Gruber et. al 2003 for a review of that literature). Some of these studies examine the impact on cigarette sales of total changes in retail price and others explicitly examine changes in excise taxes.

Despite a large price increase in 2010 resulting from federal and state tax and industry increases, NH’s price in relation to other states remains well below other states when all components of prices (not just excise taxes) are included. As Figure 4 shows, even with recent tax increases, NH prices remain well below those of neighboring states.

These existing price differences suggest that the large gains in cross border sales estimated by some advocates are not likely to occur in response to small changes in relative prices between NH and neighboring states. Claims of large sales increase in response to small price changes in excise tax rates appear, in part, to be a function of the fact that excise tax rate differentials have narrowed and are much narrower than are total cigarette price differentials. However, the relevant price comparison is the total price of a pack of cigarettes across states, not simply the tax rate differential.

Figure 4

New Hampshire Has Both The Lowest Excise Tax and Industry Determined Price in New England. The State Excise Tax Portion of Cigarette Costs in NH is About One-Half the Cost in NH. Components of the Total Price per Pack of Cigarettes RI CT

$2.24

$3.60

ME

$2.00

$3.45

,H $1.00

$2.00

,on-Tax Price

$3.00

$4.00

State Excise Tax

$0.41

$0.32

$1.78

$3.17

$0.47

$1.01

$1.01

$0.45

$2.51

$3.92

VT

$0.55

$3.00

$3.54

MA

$0.00

$3.46

$3.33

$1.01

$1.01

$1.01

$1.01

$5.00

$6.00

State Sales Tax

$7.00

$8.00

$9.00

Fed. Excise Tax

Source: Prices as of Nov. 2010 from The Tax Burden on Tobacco, Orzechowski and Walker, 2010 Edition

Figure 4 also shows that industry prices are lower in NH than in other New England states, suggesting that to maximize revenue the industry has adopted a sales volume strategy, while in Massachusetts the industry may look to maximize industry revenues via higher prices on a small and declining number of sales. Industry price increases have been large by historical standards in NH in recent years. These price 11

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

increases coincide with recent excise tax increases, indicating that the industry may be looking to move its revenue maximization strategy more toward a higher price and away from a higher volume strategy. In addition, as noted above, timing price hikes with tax increases allows the industry to claim that tax increases are responsible for the entire decline in sales volume. The implication for state revenue of such a shift in pricing strategy, in combination with a decrease in NH’s excise tax rate is enormous and discussed later in this report. There is reason for policymakers to be mindful of this possibility. Figure 5 shows that in general, the industry-determined component of cigarette prices have risen more in states with higher excise tax rates. Each marker represents one state’s percentage increase in both industry determined prices and state excise tax rate.

Figure 5

There is a Significant Correlation Between Higher Tax Rates and Larger Industry Price Increases Between 2000 and 2010 5 4.5

State Tax Rate

4 3.5 3 2.5

NH

2 1.5 1 0.5 0

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

% Industry Price Increase 2000-2010

Our analysis of the relationship between state excise taxes and industry price increases suggests that for every 10 percent higher are state excise taxes, industry price increases are 5.8 percent higher, and that higher tax increases also result in larger price increases (prices increase, on average, 4.5 percent more for every 10 percent larger are tax increases). Industry price hikes thus help compensate for revenue declines due to lost sales volume, but in the process they “State revenue forecasters in H and also accelerate the decline in sales elsewhere cannot accurately account for and help explain why tax hikes often the pricing decisions of the tobacco result in lower than forecast industry but they should factor in historical revenues. These finding highlight pricing patterns of the industry in their how the policy actions of state state when estimating the revenue governments can be can be implications of potential changes in excise influenced by the pricing policies of the industry. Unlike ad valorem taxes taxes” (taxes based on the price) where

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

price increases generate more revenue for state governments, excise tax revenues do not benefit from price increases. Rather, state revenues generally decline with industry price increases (unless the tax rates is raised) because higher prices reduce sales volume. State revenue forecasters in NH and elsewhere cannot accurately account for the pricing decisions of the tobacco industry but they should factor in historical pricing patterns of the industry in their state when estimating the revenue implications of potential changes in excise taxes.

It is clear that higher prices reduce cigarette sales in NH (Figure 6), but policymakers must also be aware that prices increase because of changes in both tax rates and industry pricing decisions. Policymakers should also be aware that sales are affected by a number of variables and price changes do not always produce large gains or loses in sales in NH. Figure 6 shows that cigarette sales have increased even in years where prices increased, suggesting that other factors play a prominent or more prominent role in determining sales. This finding suggests the following:

• •

Other factors, such as price in relation to Massachusetts and gas prices (discussed below) also have a strong impact on NH sales.

Policymakers should be mindful of the limits of a decline in the excise tax to increase sales in NH.

Figure 6

Higher Cigarette Prices Reduce Sales, But NH Prices in Relation to Massachusetts Matter More $5.0

250

$4.5 $4.0

200

$3.5 $3.0

150

$2.5 $2.0

100

$1.5 $1.0

Real (Inflation Adjuste d) NH Cigarette Prices

$0.5

NH Cigarette Sales

50

$0.0

0 80

82

84

86

88

90

92

94

96

98

00

02

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10

Higher prices reduce cigarette sales whether the price increase is the result of a tax increase or an industry price increase. Later in this report we review the analysis of cigarette sales and prices included in a February 2011 report issued by the NH Grocers Association, like most industry sponsored research, it ascribes responsibility for all price increases (and thus price related sales declines) to changes in excise tax rate. During the

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

past decade (since 1999) industry price increases of $1.47 have exceeded excise tax increases in NH of $1.41, thus accounting for much of the decline in cigarette sales during that time

Modeling Cigarette Sales in ,ew Hampshire Cigarette sales and revenue can be accurately forecast with econometric techniques using a few key variables: The volume of cigarette sales in NH during the prior year (the magnitude of changes in annual sales volume will occur from the base of the prior year’s sales), the average retail price of cigarettes in NH, the average retail price of cigarettes in NH as a percentage of the price in Massachusetts (there are some small border effects with Vermont and Maine however the volume of border sales between those states and NH is a smaller percentage of NH’s total sales and these price differences are captured in the NH/Massachusetts price differential variable and do not add to the predictive ability of the model), and a time trend variable that accounts for longer-term trends in cigarette sales not expressly accounted for in the NH model.

Combined, these variables explain 90 percent of the variation in annual cigarette sales in New Hampshire.2 As Figure 7 shows, our model can produce accurate forecasts. While our 2008 forecast erred more than usual on the high side, this was primarily the result of unexpectedly high gasoline prices that reduced driving and trips to NH by non-residents.

Figure 7

Using Econometric Techniques, Cigarette Sales and Revenues Can Be Modeled With Accuracy, But Gasoline Price Spikes and the Recent Recession Both Dramatically Reduced Visits to NH and Affected Our Forecasts

,H Cigarette Sales (Millions of Packs)

260

PolEcon Model Predictions vs. Actual NH Cigarette Sa les

240 220 200 180 160 140

Ac tual ,H Sales Predicted ,H Sales

120

Gasoline Price Spikes Dramatically Reduced Trips to NH in 2008 as Did Re cession in FY2008-2010

100 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

The generic form of our model is presented in the equation below. Models were estimated using both nominal and real, inflation adjusted (to year 2000) prices, as well as in log-linear form (a standard econometric practice that converts the values of all variables to their natural logarithm, allowing the estimation of the elasticity of one 2

Model statistics are presented in Appendix A.

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The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

variable with respect to another variable). Little difference in the predictive ability of the models were found using any model forms, although variable coefficients change somewhat. For consistency with prior forecasts and reports we use the same nominal, non-log-linear form of the model below. ( HSales ) = α + β ( HPrice) + β ( HSalesLag ged ) + β ( H % Pr ice) + β (Time) + ε Where:

α = Constant HSales = Cigarette sales (packs) in NH. HPrice = The average retail price per pack of cigarettes in NH. HSalesLagged = Lagged value of prior years NH sales.

Time = Time trend variable.

ε

= Error term

Combined, these four variables explain about 90 percent of the annual variation in cigarette sales in NH. The tables in Appendix A provide detail on the relationship between each of the independent or “predictor” variables and cigarette sales in NH. Results of this model suggest that prior year cigarette sales have the strongest relationship to sales, and that NH cigarette prices in relation to Massachusetts has a larger impact on changes in cigarette sales in NH than does the absolute price of cigarettes in the Granite State. Figure 8 shows that when prices in NH are high in relation to Massachusetts cigarette prices, sales in NH are lower.

Figure 8

When NH Cigarette Prices in Relation to Prices in Mass are a Stronger Predictor of Sales Than NH Cigarette Prices. But High Gasoline Prices Can Offset Some of NH’s Price Advantage 110%

2 40

100%

2 20 2 00

90% 1 80 80% 1 60 70%

1 40

,H Price as a% of Mass. Price 60%

1 20

,H Cigarette Sales

50%

1 00 80

84

88

92

96

00

04

08

15

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

This finding is of particular importance to lawmakers because it points to the difficulties in forecasting the impact of changes in excise taxes on cigarette sales in NH when variables outside the control of lawmakers or the industry in NH exert strong influences on sales. .

Our model results suggest that the combined price and cross border elasticity of demand for cigarettes in NH is larger than that found in studies in many other states and nationally, and likely in the range of -.7 and – 1.0. With a large population in neighboring states that is in close proximity to NH, each having significantly higher cigarette prices, it is not surprising that the combined elasticity of demand in NH is greater than that found in some other studies.

Other Factors Such as Gasoline Prices Are Having a Greater Impact on Cigarette Sales “Prediction is very difficult, especially if it is about the future�

Niels Bohr, Nobel laureate in physics Figure 7 showed the accuracy of our model when fitted to historical data, but other factors outside of our explanatory models can also affect cigarette sales. The impact of excise taxes on cigarette sales dominates policy debates and there is a tendency to attribute all changes in the volume of cigarette sales to changes in excise tax rates.

Price changes, whether from taxes or industry decisions, tend to be exclusively attributed to changes in excise tax rates by the industry, but factors such as demographic shifts also affect longer-term sales trends, while factors like gasoline prices have more immediate impacts on NH cigarette sales even if they may have little or no affect on cigarette sales in other states.

Figure 9

Gas Price Spikes Reduce Monthly Cigarette Sales 30% 25%

% Change in Cigarette Sales over Same Month Prior Year (3 mos. Moving Average) % Change in NH Gasoline Prices Over Same Month Prio r Year (3 mo s. Moving Average)

70 %

50 %

20% 15%

30 %

10% 5%

10 %

0%

2004 -5%

2005

2006

2007

2008

2009

2010

2011 -10%

-10%

-30% -15% -20%

-50%

16

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Gasoline prices affect the relative price of NH cigarettes compared to other states.

When consumers spend more to travel to NH to make purchases, NH’s cigarette price advantage is eroded. If prices are high enough, and the distance to NH is far enough, cigarette consumers will chose to make fewer purchases of cigarettes in NH. Figure 9 presents the monthly year-over-year percentage change in NH cigarette sales and the monthly year-over-year percentage change in gasoline prices in the state.

The chart clearly shows that when gasoline prices spike higher, cigarette sales growth is much smaller. This same trend is apparent for rooms, meals, and rental expenditures and other state sources of revenue. Gasoline prices appear to be exerting a greater influence on cigarette sales and other purchases in NH in recent years and when gasoline prices exceed $3.00 per gallon for several months. Figure 10 shows the changes in monthly cigarette sales and NH gasoline prices during the corresponding month and shows the significant impact that gas price above $3.00 per gallon have had on cigarette sales in NH. Figure 10

As Gasoline Prices Reach $3.00 and Above, Cigarette Sales are Significantly Eroded 450

18

400

17

350

16

300

14 200

Millions

15 250

13 150 12

100

NH Gas Prices (cents) 11

50

NH Cigarette Sales

0

10 03

04

05

06

07

08

09

10

11

Gasoline price spikes likely accounted for some of the forecast error in cigarette sales in recent years, rather than the often cited “tipping point� being reached in cigarette prices. To test that possibility, we modeled cigarette sales while including gasoline prices in the model. As expected, gasoline prices have a significant negative relationship to annual cigarette sales. Because both gasoline prices and cigarette sales rise during months when visits to NH are highest (especially summer months) it is easy to misinterpret the relationship between gas prices and cigarette sales. Adjusting both NH cigarette sales and gasoline prices to account for normal seasonal variations allows us to estimate the true impact that gasoline prices have on cigarette sales in NH. Modeling the impact of monthly gas prices (both real and inflation adjusted), on seasonally adjusted monthly cigarette shows that high gasoline price reduce seasonally adjusted cigarette 17

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

sales3 (model reported in Appendix B). Estimating the relationship between seasonally adjusted monthly cigarettes sales and real (inflation adjusted) gasoline prices controlling for economic conditions (the U.S. unemployment rate) in log-linear form suggests that for every 10 percent rise in real, inflation adjusted gasoline prices, seasonally adjusted monthly cigarette sales are reduced by 1.2 to 2 percent over what they would have been with the gasoline price increase. We estimate that high gasoline prices in 2008 reduced cigarette sales in NH by almost 10 million packs over what they would have been without the higher gasoline prices.

Several difficulties, however, prevent us from including gasoline prices in our cigarette sales and revenue forecasting model: • •

•

Good monthly gasoline price data for NH is only available from the U.S. Energy Information Agency going back to 1984.

The effect of gasoline prices does not appear to be linear at lower levels of gas prices. Rather, the effect appears to be triggered at prices above $3.00 gallon, and increases linearly above that threshold.

Most importantly, including gas prices for forecasting cigarette sales and revenue purposes would require an accurate forecast of future gasoline prices as an input to the forecasting model. The volatility of gasoline prices makes this extremely difficult and would likely enter more error into the forecasting model.

The difficulties of including gas prices in forward looking models of cigarette sales and tax revenue, however, does not preclude policymakers from factoring the importance of gasoline prices into recent cigarette sales and revenues trends or from developing cigarette sales estimates under scenarios of both higher and lower gasoline prices. At a minimum, as gasoline prices rise, policymakers should expect cigarette tax revenues to underperform expectations.

IV. Impact on Cigarette Tax Revenues The model of cigarette sales in New Hampshire presented in this report can be used to estimate the revenue implications of decreasing NH’s cigarette excise tax by the proposed $0.10 or by any amount. Using our cigarette sales model and altering the average retail price per pack in NH as a result of lowering the state’s excise tax by $0.10 results in several key findings: If nothing else changes (besides the $0.10 change in the excise tax) to affect the price of cigarettes in NH or the price of cigarettes in NH relative to the price in Massachusetts, taxed cigarette sales in NH can be expected to increase by 1.6 3

Seasonal adjustment on monthly data was accomplished using the U.S. Census Bureau’s X12a seasonal adjustment program. Seasonal adjustment of data is needed because monthly cigarette sales are affected by periodic increases in travel and tourism visitors to the state and to estimate the true relationship between gas prices and cigarette sales these seasonal variations in the data must be eliminated.

18

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

percent, or 2.05 million packs. However, the probability that none of the other factors that influence cigarette sales in NH will change is small.

Based on data through November of 20104, a $0.10 decrease in NH’s cigarette excise tax would reduce prices by 1.7 percent, an increase in cigarette sales of 1.6 percent thus indicates a combined price and cross-border elasticity of -.98, higher than our estimates from prior years and well above most estimates found in the research literature on cross-border sales and cigarette tax avoidance.

Cigarette tax revenues will decline by $9 million from what they would have been in the absence of a tax decrease, as the state loses $0.10 of revenue on approximately 122 million packs of cigarettes (for a loss of over $12 million), but gains $1.68 from the 2 million pack increase in sales. The net impact then is a loss of about $9 million. Larger excise tax reductions result in substantially larger loses of cigarette tax revenue.

Even accepting the unrealistic assumptions about non-cigarette sales gains included in the 2011 NH Grocers Study (discussed later in this report), revenue to the state of NH declines by $8 million in this scenario.

If, instead of resulting in a $0.10 reduction in the price of cigarettes, a decline in the excise tax is partially or completely offset by industry price increases, the industry greatly increases its revenue above what it would have received from just an excise tax cut, while the state of New Hampshire loses substantially more revenue than if only the excise tax is cut.

If prices or no other variables changed, long-term trends indicate that cigarette sales would decline by about 500,000 annually in New Hampshire, indicating that annual revenue losses will increase over time. However, because prices and other variables will also change, annual revenue losses could be much larger.

The revenue loss estimated in this report is less than estimated by some organizations and more than estimated by others. However, the methods used here are transparent, with statistics and models fully reported and based on NH data and relationships among variables evident over decades. In contrast, a recent industry sponsored study used statistical procedures (without reporting full results of their analysis) that estimated a increases in cigarette sales in NH of 3.88 million packs in response to a $0.10 excise tax decrease. Their result is higher than our estimate of a 2.05 million pack increase, and implies a price elasticity of demand of -1.5 to -1.8 (depending on which base year of sales they are using), an elasticity much greater than would be expected based on most studies of price elasticity of demand for cigarettes and especially high given that their model contains no variable to capture price difference or cross border sales between states. Nevertheless, it is a result that is not inconceivable.

4

Orzechowski and Walker The Tax Burden on Tobacco, 2010 Edition

19

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Table 1

Sales and Revenue Impacts of a ,H Cigarette Tax Decrease

,H Tax Decrease ($0.01) ($0.02) ($0.03) ($0.04) ($0.05) ($0.06) ($0.07) ($0.08) ($0.09) ($0.10) ($0.11) ($0.12) ($0.13) ($0.14) ($0.15) ($0.16) ($0.17) ($0.18) ($0.19) ($0.20) ($0.21) ($0.22) ($0.23) ($0.24) ($0.25) ($0.26) ($0.27) ($0.28) ($0.29) ($0.30) ($0.31) ($0.32) ($0.33) ($0.34) ($0.35) ($0.36) ($0.37) ($0.38) ($0.39) ($0.40)

Total ,H Tax $1.78 $1.77 $1.76 $1.75 $1.74 $1.73 $1.72 $1.71 $1.70 $1.69 $1.68 $1.67 $1.66 $1.65 $1.64 $1.63 $1.62 $1.61 $1.60 $1.59 $1.58 $1.57 $1.56 $1.55 $1.54 $1.53 $1.52 $1.51 $1.50 $1.49 $1.48 $1.47 $1.46 $1.45 $1.44 $1.43 $1.42 $1.41 $1.40 $1.39 $1.38

,H Price W/Tax Decrease $5.96 $5.95 $5.94 $5.93 $5.92 $5.91 $5.90 $5.89 $5.88 $5.87 $5.86 $5.85 $5.84 $5.83 $5.82 $5.81 $5.80 $5.79 $5.78 $5.77 $5.76 $5.75 $5.74 $5.73 $5.72 $5.71 $5.70 $5.69 $5.68 $5.67 $5.66 $5.65 $5.64 $5.63 $5.62 $5.61 $5.60 $5.59 $5.58 $5.57 $5.56

% Price Decrease -0.2% -0.3% -0.5% -0.7% -0.8% -1.0% -1.2% -1.3% -1.5% -1.7% -1.8% -2.0% -2.2% -2.3% -2.5% -2.7% -2.9% -3.0% -3.2% -3.4% -3.5% -3.7% -3.9% -4.0% -4.2% -4.4% -4.5% -4.7% -4.9% -5.0% -5.2% -5.4% -5.5% -5.7% -5.9% -6.0% -6.2% -6.4% -6.5% -6.7%

Cigarette Sales (Millions)

% Change in Sales

Implied Price & Border Elasticity

124.69 124.89 125.10 125.30 125.51 125.71 125.92 126.12 126.33 126.53 126.74 126.94 127.15 127.35 127.56 127.77 127.97 128.18 128.38 128.59 128.79 129.00 129.20 129.41 129.61 129.82 130.02 130.23 130.43 130.64 130.84 131.05 131.25 131.46 131.66 131.87 132.07 132.28 132.48 132.69 132.89

0.2% 0.3% 0.5% 0.7% 0.8% 1.0% 1.2% 1.3% 1.5% 1.6% 1.8% 2.0% 2.1% 2.3% 2.5% 2.6% 2.8% 3.0% 3.1% 3.3% 3.5% 3.6% 3.8% 3.9% 4.1% 4.3% 4.4% 4.6% 4.8% 4.9% 5.1% 5.3% 5.4% 5.6% 5.8% 5.9% 6.1% 6.3% 6.4% 6.6%

-0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98 -0.98

Total Tax Revenue $221,944,967 $221,061,161 $220,173,253 $219,281,242 $218,385,128 $217,484,912 $216,580,594 $215,672,173 $214,759,649 $213,843,023 $212,922,294 $211,997,463 $211,068,529 $210,135,492 $209,198,353 $208,257,112 $207,311,768 $206,362,321 $205,408,772 $204,451,120 $203,489,366 $202,523,509 $201,553,550 $200,579,488 $199,601,323 $198,619,056 $197,632,687 $196,642,214 $195,647,640 $194,648,962 $193,646,183 $192,639,300 $191,628,315 $190,613,228 $189,594,038 $188,570,745 $187,543,350 $186,511,852 $185,476,252 $184,436,549 $183,392,744

Total Revenue Decrease

Incremental (Marginal) Revenue Decrease

($883,806) ($1,771,714) ($2,663,725) ($3,559,838) ($4,460,054) ($5,364,373) ($6,272,794) ($7,185,318) ($8,101,944) ($9,022,673) ($9,947,504) ($10,876,438) ($11,809,474) ($12,746,613) ($13,687,855) ($14,633,199) ($15,582,645) ($16,536,195) ($17,493,846) ($18,455,601) ($19,421,457) ($20,391,417) ($21,365,479) ($22,343,643) ($23,325,910) ($24,312,280) ($25,302,752) ($26,297,327) ($27,296,004) ($28,298,784) ($29,305,666) ($30,316,651) ($31,331,739) ($32,350,929) ($33,374,222) ($34,401,617) ($35,433,114) ($36,468,715) ($37,508,418) ($38,552,223)

($887,908) ($892,011) ($896,113) ($900,216) ($904,319) ($908,421) ($912,524) ($916,626) ($920,729) ($924,831) ($928,934) ($933,036) ($937,139) ($941,242) ($945,344) ($949,447) ($953,549) ($957,652) ($961,754) ($965,857) ($969,959) ($974,062) ($978,165) ($982,267) ($986,370) ($990,472) ($994,575) ($998,677) ($1,002,780) ($1,006,882) ($1,010,985) ($1,015,088) ($1,019,190) ($1,023,293) ($1,027,395) ($1,031,498) ($1,035,600) ($1,039,703) ($1,043,805)

20

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

In producing their revenue estimates, however, they inexplicably use a figure of 14.6 million as their estimate of the cigarette sales increase resulting from the reduction in the state’s excise tax. They do write in a footnote that their model using historical data was used to develop elasticity estimates but “projections of pack sales beyond the statistical model utilize alternative methods.” Those “alternative methods,” however, are not reported or even described. The undocumented alternative methods increase estimated gains in cigarette sales due to a $0.10 excise tax decrease from 3.88 million, based on a statistical analysis (which results in a loss of over $6 million in cigarette tax revenue) to an increase in sales of 14.6 million packs based on unknown procedures. A 14.6 million pack (11.4%) increase would be the third largest increase in cigarette sales ever recorded in NH and based on a 1.7 percent decrease in price implies a price elasticity of demand of about -6.5, or roughly 16 times the price elasticity found in most scholarly research on cigarette demand and roughly 4 times the elasticity found in the researchers own statistical modeling.

Revenue Losses Will Be Larger if Industry Prices Hikes Offset the Excise Tax Decrease One advantage of our model of NH cigarette sales it that it allows policymakers to easily introduce alternative excise tax and cigarette price scenarios to see how cigarette sales and revenues will respond. In addition, policymakers can introduce different scenarios based on the decisions lawmakers in other states make about excise taxes, as well as the cigarette pricing decisions of the industry in NH and in other states.

This capability is particularly important because estimates of sales and revenues offered by advocates of an excise tax cut using static models that assume a $0.10 excise tax reduction will translate into a $0.10 price reduction. Policymakers should be wary of any estimate or model that does not allow lawmakers to test the impacts of alternative scenarios on cigarette sales and revenues. For instance, the recent study conducted for the NH Grocers Association used cigarette prices, the NH unemployment rate, and NH per capita personal income to derive elasticity estimates and impacts of prices changes.

But the model does not account for changes in the price of NH cigarettes in relation to Massachusetts prices. What happens to their model estimates if Massachusetts raises or lowers its tax rate by $1.00: nothing, because the model does not include variables to estimate cross-border elasticities. Since lawmakers, or the cigarette industry are unlikely to be able to influence per capita income or even the unemployment rate in the shortterm, the model is not especially useful in performing the kind of “what if” and sensitivity analyses that are important for lawmakers to consider in making important fiscal decision.

Figure 11 demonstrates how important it is for policymakers to consider the dynamic nature of cigarette sales and revenues. The chart uses the model presented earlier and its derived estimated combined price and cross-border ealsticity of -.98. The chart demonstrates how industry sales revenues (net of excise taxes) vary under a scenario where NH excise taxes are decreased by varying amounts, other scenarios where

21

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

industry prices are raised but excise taxes not lowered, and scenarios where excise taxes are lowered and price increases of an equal amount are enacted. The chart also shows what happens to state government revenues with the excise tax decreases and under scenarios where the industry also raises prices.

Figure 11

A Tax Cut Increases Retailer’s Revenues More Than Does an Equivalent Industry Price Increase, but There is a Strong Economic Incentive to Increase Prices When the Excise Tax is Cut – Producing Much Larger Declines in Excise Tax Revenue Changes in Retailer & State Tax Revenues ($ Millions) $40 $35

$0

Industry Rev enue - Excise Ta x Cut Only (Left Axis)

($5)

Industry Rev enue - Industry Price Increase Only (Left Axis) $30

($10)

Industry Rev enue - Tax Cut & Equal Industry Price Increa se (Left Axis) Tax Revenue - Tax Cut Only (Rig ht Axis)

($15)

Tax Revenue -Tax Cut a nd Industry P rice Increase (Right Axis) $20

($20)

$15

($25)

$10

($30)

$5

($35)

$0

Millions

$25

($40)

$0.00

$0.05

$0.10

$0.15

$0.20

$0.25

$0.30

Tax Cut/Pric e Inc rease

Industry revenue (net of excise taxes) is estimated to increase by $6.5 million with a $0.10 decrease in the states excise tax. However, if the industry increases prices by the average over the past 20 years ($0.10 – the median is $0.08), industry revenue increases by an estimated $12.5 million. Clearly there will be a strong incentive to capture the potential surplus from an excise tax decrease (rather than allow it to be passed on to consumers). At the same time, a $0.10 excise tax decrease will lower state government cigarette tax revenues by $9 million, but if the industry raises prices by $0.10 then revenues will decline by $12.5 million.

Industry price increases have averaged $0.10 cents over the past ten years with a median increase of $0.08 cents, suggesting a strong possiblity that prices will rise and compensate for excise tax declines. In the process, more revenue will be secured for the industry but state government revenue will fall more than forecast.

The chart illustrates several important points for policymakers to consider: •

An excise tax cut increases industry revenue more than does a price increase.

This occurs because a price increase generates more industry revenue per sale but also lowers sales. An excise tax decrease generates additional sales (and industry revenues) without the industry having to lower prices and generates enough additional sales to make up in volume what is forgone in a price increase.

22

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

•

•

•

•

•

The industry maximizes its revenue with a combination of excise tax decline and price increase. In essence, the industry captures the foregone revenue of state government rather than passing on the price decrease as a benefit to cigarette consumers. This aspect of the chart shows how strong the incentives are for price increases in the face of excise tax decreases.

State government loses revenue with an excise tax cut because revenue gained from the 1.6 percent increase in sales does not compensate for the decrease in revenue from the 100 percent of existing sales.

The maximum revenue loss for the state occurs when a price increase accompanies an excise tax cut. This occurs because the state continues to lose revenue on existing sales while industry price increases eliminate or reduce state government revenue gains from any increase in sales that result from the excise tax decrease. In a worst case scenario, price increases exceed excise tax decreases and the state receives less revenue from from each pack of cigarettes sold and fewer sales occur as price increases above tax decreases result in a decline in sales in the state.

The chart shows that the maximimun risk (in terms of changes in revenues) with an excise tax decrease is born by state government, while the industry can control how much its revenues will increase.

The industry has the most economic incentive to increase prices in the face of a decline in the excise tax and this results in greater than anticipated revenue losses for the state.

Our model allows for estimating revenues under scenarios where other variables such as the price of cigarettes in other states changes by various amounts but the inability to depict the complexity of those relationships in a two-dimensianl graphic precludes their presentation here. Changes in relative prices between NH and Massachusetts will also influence the sales and revenue impacts of an excise tax increase as will gasoline prices if their increase or decrease reduces the number of vistors to NH and/or erodes the price advantage (by increasing travel costs) of cigarettes in NH. This analysis should offer caution to policymakers regarding the potential risks for greater than anticdipated declines in cigarette tax revenues.

V. Impacts on Other Tax Revenues Advocates of an excise tax decrease have argued that a decrease will stimulate other tax revenue and mitigate revenue losses. In the extreme, industry advocates argue that an excise tax will actually increase state government revenues. Although the notion that lower tax rates mean more revenue has always had an ideological and feel good appeal, it is rarely combined with empirical evidence to support it. That appears to be the case with cigarette excise taxes in NH. A recent report prepared for the cigarette industry suggested, supported only by a series of assumptions with no statistical or empirical evidence of any kind, that a decrease in the cigarette excise tax will increase revenues from NH’s meals and rentals tax, business, gasoline, and beer taxes by a combined $1 23

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

million. Intuitively the belief that cigarette sales result in revenue increase in other sources has appeal. The accuracy of these claims can easily be verified by standard statistical and econometric analysis.

For our analysis we used standard econometric techniques to determine the relationship between annual and monthly seasonally adjusted cigarette sales and several sources of revenue for the state of NH. We find little or no relationship between the volume of cigarette sales in NH and meal and rentals, business, gasoline, or other taxes (results of all of our statistical procedures are presented in Appendix C). Rather, it appears that cigarette sales are as much a result of other activities that generate revenue for the state as they are a causal factor in generating these revenues.

Meals and Rentals Revenue Meals and rentals revenue and cigarette revenue increase in the same monthly seasonal pattern, leading some to conclude that cross-border shoppers purchasing cheaper NH cigarettes are a driver of increased meals and rentals revenue (Figure 12 ) Figure 12 Smokers Don’t Smo ke More or Cro ss-Border Shop to Save Money More in Some Months Than Others. Econometric Tests Indicate that Cigarette Sales Get a Boost From Travel and Tourism Visits Rather Than Vice Versa Monthly Cigare tte Sales and Meals and Rental Revenues

300

21 19

250

15

Millions

200

13

150

Millions

17

11 9

100

Meals & Rentals Expenditures (Left Axis) 7

Cigarette Sales (Right Axis) 50

5 03

04

05

06

07

08

09

10

11

A relationship between two variables, in this case monthly meals and rentals revenue5 and cigarette sales is not, however, an indication that changes in one variable cause changes in the other variable nor does it indicate the direction of any causality where it may exist. If cross-border cigarette shoppers seeking cheaper NH cigarettes were a driver of rooms and rentals revenue we would not expect to see the same seasonal pattern among these revenue sources. Smokers do not smoke more during some months 5

In this chart meals and rental revenue refers to industry revenues or expenditures in NH on meals and lodging. Applying tax rates to these figures yields the state of NH’s revenues.

24

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

and cigarette consumers seeking cheaper prices are not more likely to seek lower prices in some months more than during other months of the year. The fact that cigarette sales increase more during months when meals and rental revenues also increase is an indication that a significant amount of NH’s cigarette sales to out-of-state residents is a result of other visitor and tourism activities, and is thus a by-product of other activities rather than simply the result of price sensitive cross-border cigarette shoppers.

That is not to suggest that price “If cross-border cigarette shoppers sensitive cross-border shoppers do not seeking cheaper H cigarettes were a significantly increase NH sales, clearly driver of rooms and rentals revenue we they do, rather it suggest that some of would not expect to see the same seasonal NH’s high cigarette sales volume is a bypattern among these two revenue sources. product of visits to the state rather than Smokers do not smoke more during some simply a function of NH’s cigarette price months and cigarette consumers seeking advantage. To test this hypothesis we cheaper prices are not more likely to seek used econometric techniques to examine lower prices in some months more than the relationship between real, seasonally 6 during other months of the year.” adjusted meals and rental revenues and cigarette sales, controlling for other variables known to affect rooms and rentals revenues – real gasoline prices (which affect the number of visits to the state), and the NH unemployment rate which is a surrogate measure of overall economic conditions. When meals and rental revenues are tested as a function of changes in cigarette sales, the NH unemployment rate, and real NH gasoline prices, a significant relationship is found but both the unemployment rate and gas price variable exhibit the wrong sign (they show that higher unemployment and gas prices increase meals and rentals revenue. In fact, we know that both higher unemployment and higher gas prices are actually associated with lower meals and rentals revenues. Testing the relationship by modeling seasonally adjusted monthly cigarettes sales as a function of meals and rental revenue, unemployment, and gas prices, also produce a significant relationship and the coefficients (the statistical measure of the strength of the relationship between variables) show the proper signs (unemployment and higher gas prices are associated with lower meals and rental revenue). These results suggest that the direction of causality between cigarette sales and meals and rentals revenue is actually one where higher meals and rental revenue produces higher levels of cigarette sales when factors such as gasoline prices and economic conditions are controlled (or held constant). This means that a significant portion of cigarette sales are the result of visits that are not specifically for the purpose of cross-border cigarette price shopping.

These results suggest that policymakers could boost cigarette sales by increasing tourism promotions as an alternative to losing revenue from an excise tax decrease.

6

Seasonal adjustment was performed using the U.S. Census Bureau’s X12a seasonal adjustment program.

25

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Liquor, Gasoline, Beer and Other Selective Sales Tax Revenues NH’s beer tax has not varied by more than $2 million dollars in more than 20 years (it is typically around $12 million). Suggesting that cigarette sales that have dropped by more than 30 percent during that time period have an affect on NH’s beer tax revenues strains credulity.

Monthly NH liquor revenues and seasonally adjusted monthly gasoline sales in NH exhibit the same pattern as is seen in the relationship between meals and rentals revenue and cigarette sales.

Figure 13

2,200

25

2,100

23

2,000

21

1,900

19

1,800

17

1,700

15

1,600

13

1,500

11

1,400

Average Daily Gasoline Sales (00 0s gal.)

9

1,300

Cigarette Sales (Right Axis)

7

1,200

Millions

NH Cigarette Sales and Gasoline Sales

5 99

00

01

02

03

04

05

06

07

08

09

10

11

Using the same econometric techniques as we used with meals and rental revenue data we obtain similar results, albeit with different magnitudes of the relationship between cigarette sales and both liquor revenue and gasoline sales. That is, when sales or revenues are modeled as a function of NH cigarette sales, the relationships between the key variables of NH’s unemployment rate (a surrogate for overall economic conditions) and real gasoline prices exhibit the wrong sign (suggesting higher unemployment and gas prices increase sales and revenue). Modeling cigarette sales as a function of these variables, however, results in the expected sign for the coefficients. Again, cigarette sales increases seem to be a result rather of increases in the sales of travel-related goods and services rather than a cause of expenditures on those good and services. Model results are presented in Appendix C. Travel and tourism visits certainly do not explain most of the variation in cigarette sales in NH, but they clearly account for a much larger portion than commonly believed.

These results indicate that rather than cigarette sales providing a boost to other revenue

26

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

sources, activities that generate other revenue for the state, such as travel and tourism, provide a boost to cigarette sales in NH.

Business Tax Revenues

“These results indicate that rather than cigarette sales providing a boost to other revenue sources, activities that generate other revenue for the state, such as travel and tourism, provide a boost to cigarette sales in H.”

We tested the relationship between cigarette sales and business profits tax collections on an annual basis. Results (presented in model form in Appendix C) show a small and not significant relationship between cigarette sales and BPT revenues. This should not be interpreted as an indication that cigarette sales do not generate profits; rather, it is an indication that cigarette sales are responsible for such a small percentage of BPT revenues that the typical fluctuations in cigarette sales are not discernable in the annual BPT data. As we document in the next section, cigarette sales account for about 1.6 percent of NH’s retail sales (or about $400 million in sales not including taxes). With a reported markup of 16.4 percent this means that cigarettes account for about $65 million in gross earnings of cigarette sellers. Gross margins are not the same as reported profits but even if they were these data imply that all cigarette sales in NH would account for only about $5 million in BPT revenue. A small increase in sales will thus have little or no effect on BPT revenues. The business enterprise tax (BET) was enacted in 1993 and thus there are too few annual data points to do a meaningful statistical test of the relationship between the BET and cigarette sales.

Overall the results of our analysis suggest that: • • • •

Conventional notions of the importance of cigarette sales to other state revenues in NH are likely inaccurate.

Cigarette sales are more likely to benefit from, than provide a benefit to, activities that generate revenues for state government.

Efforts to increase non-cigarette tax revenues by increasing cigarette sales in NH are likely to have little effect on state revenues.

Policies that increase tourism, business-related, or other visits to the State of NH will not only increase state revenues but also increase cigarette sales in the process.

VI. Economic Impacts Concerns over the economic impacts of declining cigarette sales have been a primary argument against cigarette tax increases and are now appear to be a basis for advocating for lower excise tax rates. Cigarette sales total only about $400 million (net of taxes) and comprise only a small percentage of retail sales (1.6%) in NH. Their impact on overall economic activity is limited, nevertheless for some, increasing cigarette sales in NH is viewed as a viable strategy for economic and job growth.

27

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Cigarette sales have delined signfiantly over the past two decades in NH, but because of industry price increases7 the value of cigarette sales as a percentage of all NH retail sales has not fallen dramtically (Figure 14) Figure 14

Cigarettes Account for about 1.6% of Retail Sales in NH, a Percentage That Has Not Fallen Dramatically Despite Falling Sales Because the Non-Tax Price* of Cigarettes Has Increased by 16 0% Since 1992 Compared to 55% Overall Price Inflation Cigarette Sales as a Per cent of ,H Retail Sales 3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0% 92

93

94

95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

* The dollar Va lue of retail sa les calculated by the U.S. Census Bureau’s Economic Ce nsus exc lude s taxes

Figure 15 shows that the dollar value of cigarette sales in NH peaked in 2004.

Without industry price increases, long-term trends in the percentage of adults smoking, population, and other demographic trends suggest that the value of cigarette sales in NH will not recover to their 2004 peak. Long-term trends showing declining sales and suggest the industry will need to raise prices to offset sales declines in order to maintain or increase revenues. This should provide a cautionary note to policymakers about the prospect that excise tax reductions will actually translate into price reductions, increased sales, and additional excise tax revenue.

7

The value of retail sales is calculated net of taxes.

28

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Figure 15

The Dollar Value of Cigarette Sales in NH (Not Including Taxes) Peaked in 2004.

Industry Price Hikes Appear Likely in Order to Maintain Revenues in the Face of Longer-Term Trend of Fewer Smokers and Sales The Dollar Value of Cigare tte Sa les in NH $600 $500

Millions

$400 $300 $200

$ Value of Cigarette Sales $100

Real (Infl. Adj. $ Value of Sales)

$0 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 * The dollar Value of retail sales a s calculated by the U.S. Census Bure au’s Economic Census exc ludes taxe s

This report uses three methods to examine the economic impacts that will occur in response to a $0.10 decrease in NH’s cigarette tax and the resulting declines in cigarette sales that will occur.

Econometric methods to determine the relationship between cigarette sales and employment levels in NH. Examining direct evidence of the impact that changes in cigarette sales have had on industries that sell the largest quantity of cigarettes in NH. Employing a widely used economic model to asses the economic changes that would occur in NH in response to changes in cigarette sales in response to an excise tax decrease.

Results from these analyses fail to find evidence of large, economic impacts associated with changes in cigarette sales. Instead, extremely small increases or decreases in employment (depending on the modeling methods used) may occur in response to the change.

Historically, changes in cigarette sales have no statistically significant impact on retail employment in NH. When income levels and economic conditions are held constant, cigarette sales have a very small, not significant, and negative relationship to retail employment. Meaning higher cigarette sales are associated with lower levels of employment. Again, however, this relationship is not statistically significant.

29

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Using our forecast of a cigarettes sales increase of 2.05 million packs in response to the excise tax decrease, input-output modeling8 suggest an increase in grocery or convenience store employment of 24 in NH, and an increase in employment of 15 in other industries, for a total gain in employment of 39.

Projected increases of 2.05 million in NH cigarette sales in response to a proposed $0.10 excise tax cut will increase retailer revenue (net of taxes) by about $8.8 million. Using the 16.4 percent markup or margin retailers average on cigarette sales,9 this implies an increase in earnings of about $1.44 million by NH retailers.

Price “markups” or the margins of retailers are not a surrogate for reported profits.

Business tax collections from the $1.44 increase in earnings will be less than $8.8 million times the rate of business taxes. According to Internal Revenue Service data, profits as a percentage of net revenues of food and beverage stores operated as proprietorships is 5.2 percent. Corporate food and beverage stores have average profit margins of 3.0 percent.

A reduction of $9 million in state revenue, most of which will come from out-ofstate residents, will reduce employment in the state by about 100 jobs.

Between 1998 and 2009, Cigarette Sales Declined by 53 Million Packs in ,H, However, Combined Employment in Convenience Stores and Convenience Stores That Sell Gasoline Grew Faster Than Overall Retail Employment in ,H Convenience stores and convenience stores that sell gasoline account for the largest share of cigarette sales in NH and cigarette sales contribute the largest volume of sales at convenience stores according to the recent report released by the NH Grocers Association. Thus, any evidence of the employment impacts of declining cigarette sales would be most apparent in these retail operations. Examining employment data from the US Census Bureau’s County Business Patterns, and the U.S. Bureau of Labor Statistics between 1998 and 2009 (the most recent year for which data is available) allows us see the impact that a decline in sales of 50 million packs has had on employment in industries that sell the largest share of cigarettes. Figure 16 suggest that a decline in cigarette sales cannot be faulted for a decline in employment at convenience stores in NH. Small, so called “mom and pop” convenience stores have been acquired by chain-operated convenience stores that also sell gasoline. It is beyond the scope of this report to discuss these trends. It is an unfortunate fact, however, that declines in convenience store employment have been more than offset by increases in employment at conveneince stores that also sell gasoline This trend has been ongoing and does not appear to be affected by changes in the volume of cigarette sales in the state..

8

Using the IMPLAN model of the NH economy.

This percentage markup is attributable to industry sources that are cited in the Grocer’s Association report.

9

30

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Combined convenience store and convenience stores that sell gasoline employment in NH increase by 15 percent in NH between 1998 and 2009, while overall employment in the state increased by just 6 percent.

Figure 16

Smaller Convenience Stores Have Declined as Gasoline/Convenience Store Chains Proliferated. Combined, They Grew by 15%, Faster Than Overall Employment in the State Between 1998 and 2009, Despite a 50 Million Pack Decline in Cigarette Sales Changes in Convenie nce Store Employment in ,H

2,000

5,00 0 4,50 0

1,750

4,00 0 1,500

3,50 0 1,250

3,00 0

Emp. At ,H Convenie nce Stores

1,000

2,50 0

Emp. At ,H Conveneince Stores that Sell Gasoline 750

2,00 0 1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: U,S. Census, County B usiness Patterns, and U.S. Bureau of Labor Statistics..

Historically, Increased Cigarette Sales in ,H Have Been Associated With Small Declines in Total Retail Employment in the State Because of the number of retail establishments that sell cigarettes in NH, and their employment levels, we would expect that any impacts of declines in cigarette sales in NH would be first evident in the retail sector of NH’s economy. We examined the impact that cigarette sales have on retail employment in NH by constructing simple regression models in log-linear form, using employment, cigarette sales, and other economic data over the past 40 years. The model predicts NH retail employment based on real (inflation adjusted) income in the state, economic conditions in the state (unemployment rate), and total cigarette sales in the state.

Results indicate that the total number of packs of cigarettes sold in NH has a very small association with total retail employment in the state, but that the relationship is negative. That is, higher cigarette sales are associated with lower levels of retail employment with very small declines in total retail employment.

Retail employment model equation:

ln( H R etailemp ) = α + β ln( HIncome ) + β ln( HSales ) + β ln( HUnemp ) + ε

31

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Îą =

Constant HRetailEmp = Retail employment in NH HIncome = Real per capita personal income in NH HSales = Cigarette sales (packs) in NH HUnemp = The unemployment rate in NH

Îľ

=

Error term

The model allows us to determine the unique impact that changes in cigarette sales in NH have on retail employment in the state after factoring-out other explanatory variables such as the income and economic conditions (the unemployment rate) that exist in the state.

Model Summary Std. Error Adjusted R of the R R Square Square Estimate Model 1 .791 .626 .594 14.9382 a Predictors: (Constant), RETAILEM, LLUNEMP, RLNHCPI

Coefficients Unstandardized Standardized Coefficients Std. Error Coefficients B Beta Model 1 (Constant) -43972.7 52784.9 LNNHUNEMP -379349.9 189372.3 -.154 LNNHIncome 4.8 .693 .809 NHSALES -235.7 171.9 -.154 a Dependent Variable: LNRETAILEMP

t -.833 -2.0 6.9 -1.38

Sig. .410 .053 .000 .179

Collinearity Statistics Tolerance

VIF

.837 .361 .389

1.2 2.78 2.57

The model explains about 60 percent of the variation in retail employment in NH and indicates that the level of real (inflation adjusted) income in the state is the strongest predictor of retail employment in the state. Results from our employment model also show a small, negative, but not statistically significant relationship between cigarette sales and retail employment in NH. The model indicates that a 10 percent increase in cigarette sales in NH is associated with about a 1.5 percent decline in retail employment in the state.

Our results are consistent with other studies that show a small positive impact on retail employment in response to declines in cigarette sales (see Chaloupka and Warner, 1999, for a listing of these studies). The primary reason for this result is that any additional money spent on cigarettes as a result of a price decline will not be spent on other goods and services that have a great multiplier impact on the NH economy than do cigarette sales. The largest beneficiary of cigarette sales increases, in dollar terms, is among cigarette manufacturers of which there are none in NH.

32

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Importantly, these results also challenge the importance of any “collateral retail sales” that cigarette sales may generate.10 If collateral sales were a substantial part of the impact that cigarette sales have on NH employment, we would not expect a net gain in retail employment in the state from declines in cigarette sales. In addition, sales that occur at the same time as cigarettes are purchased are not necessarily sales that would not have occurred in the absence of cigarette sales. Consumers who buy potato chips or other snack foods, milk, or even gasoline when they purchase cigarettes will still purchase those products even if cigarettes aren’t purchased, they will just purchase them at a different time and perhaps a different location (supermarkets etc.).

Using a Different Methodolgy, An Excise Tax Cut of $0.10 That Increased Cigarette Sales Would Result in an Increase of 39 Jobs in ,H, But Revenue State Government Revenue Losses From Out-Of-State Residents Would Result in The Loss of Over 100 Jobs for a ,et Impact of a Loss of 90 Jobs.

The “IMPLAN” input-output modeling system developed by the U.S. Government and the University of Minnesota (available from the Minnesota IMPLAN Group, Inc.) was used in this analysis to calculate economic impacts of decreasing the cigarette tax by $0.10 per pack in NH.11 Along with the U.S. Department of Commerce’s RIMSII model, IMPLAN is the most widely used input-output model used in the U.S. for calculating economic impacts of economic events, projects and policies.

Applying our forecast of an increase of 1.6 percent in cigarette sales (2.05 million packs) would increase food and convenience store revenues by just under $9 million.

Margining12 this amount (using the 16.4% markup on cigarettes) gives us a real impact on NH businesses of about $1.44 million dollars. An increase in output of $1.44 million in food and convenience stores in NH would support about 24 retail jobs and another 15 in other industries.

Our revenue analysis indicates that the State of NH will lose about $9 million in cigarette tax revenue as a result of a $0.10 excise tax reduction. Because at least half of this revenue loss will be from out-of-state consumers, the State of NH will either have to cut expenditures, raise revenue from other sources, or some combination of the two to maintain service levels. Both raising additional revenues from in-state residents and reducing the demand for goods and services in the state (by cutting back on government purchases) potentially reduce employment levels in the state. Using the IMPLAN model of the NH economy and modeling a combined increase in of 2.05 million packs of cigarettes and a decline in state cigarette tax revenue of $4.5 million (we assume 50% of the revenue loss will be from out-of-state resident), suggests that employment in the state will decline by about 90 jobs.

10

“Collateral” sales here means the non-cigarette purchases that smokers make at the same time or in the process of purchasing cigarettes.

11 . A description of the IMPLAN model and technical references are available to readers via the World Wide Web at ftp://www.Implan.com/documents/implan_io_system_description.pdf.

12 The need to margin retail sales in determining economic impacts occurs because the markup of revenue above the cost of goods sold, is the portion of sales that benefits retailers and wholesalers. The remainder of the non-tax retail price impacts cigarette manufacturers’ of which there are none in NH.

33

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

VII. Impact on Cigarette Consumers The $0.10 Cigarette Tax Decrease Will Reduce a Pack-A-Day Smoker’s Average Annual Cigarette Expenditures by $37, But Only If the Industry Does ,ot Raise Prices The impact of a $.0.10 decrease in the cigarette excise tax will be minimal for a pack-a-day smoker who will cut, on average, just $37 dollars from his or her annual cigarette expenditure of $2,177 (based on November 2010 data13).

In addition, those “savings” would occur only if no industry price increase occurs.

Given that the median and average annual price increases have been $0.08 and $0.10 respectively over the past decade, the probability that NH smokers will see annual expenditures appears unlikely.

Figure 17

A 10 Cent Tax Cut Saves A Pack-a-Day Smoker $37 Annually, But Only if Industry Prices Don’t Rise (The Median Annual Non-Tax Price Increase is $.08, Average is $.10 Over 20 Years) Annual Cigarette Expenditures of a Pack-A-Day Smoker in ,H $2,250

Smo ker's Expend. With Current Tax Rate

$2,225

Smo kers Expend. With $ .1 0 Tax Cut Expenditures With Industry Price Increa se

$2,200

$2,175

$ 2,177 Average Annual ,on-Tax Cigarette Pric e Inc rease

$2,150 Median Annual ,on-Tax Cigarette Pric e Inc rease $2,125

$2,100

$0.00

$0. 05

$ 0.10

$0.1 5

$0 .20

$ 0.25

,on-Tax (Industry Determined) Price Increase

13

Orzechowski and Walker The Tax Burden on Tobacco, 2010 Edition

34

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

VIII. Review Of NH Grocers Association Report A February 2011 report on the impacts of a cigarette excise tax cut commissioned by the NH Grocers Association was conducted by capable analysts familiar with the economic principles that determine the demand for cigarettes. However, the application of those principles in obtaining the study’s reported results are unclear and undocumented. The report provides a veneer of scholarly, academic research, as would be expected given the university affiliations of two of the authors. However, the report fails to adhere to most of the standards for conducting scholarly research.

Lack of Reporting of Results and Statistics In estimating the price elasticity of demand for cigarettes in NH the authors of the study appear to replicate the model used by Gruber et. al (2003) to determine the incidence of smuggling and cigarette tax evasion in Canada. That approach has several limitations in its applicability to modeling NH cigarette sales. A more basic concern is that the others fail to report the specific results of their modeling (coefficients, significance, R Squares, etc.), that would allow readers and other researcher to evaluate for themselves the strength of the relationships between variables and cigarette sales in the state, as well as the accuracy and fit of the model and its results. Relevant academic, scholarly and even good policy research must make transparent the data, methods, models, and results of analyses so that others can both evaluate and replicate the results.

More importantly for policymakers, a complete reporting of data, methods, and results is necessary if lawmakers are to have any level of confidence in the research and information entered into policy debates.

Unexplained and Undocumented Estimates of Increased Cigarette Sales Aside from the reporting and methodological concerns, the cigarette sales and tax revenue estimates presented in the report are clearly implausible based on historical NH sales and revenue data (discussed more below and presented in Table 2). The estimated increase in cigarette sales in response to the excise tax decrease represents a price reduction of about 1.7 percent from FY2010 average prices in NH. The authors report that their statistical model used to estimate the price elasticity of demand for cigarettes suggests that cigarette sales would increase by about 3.88 million packs in response to a $0.10 decrease in the NH’s excise tax (see page 25 in the Methodolgy section of the report). However, the authors’ use an estimated increase of 14.6 million packs (contained in Table 1, pg. 7 of the Grocer’s Association report) to estimate revenue impacts of a the excise tax cut. This unexplained sales increase used to estimate state revenue impacts is a sales increase approximately four times the size of the increase that their own modeling suggests would occur. A $3.88 million pack increase as a result of a $0.10 excise tax reduction would result in cigarette tax revenue losses for the State of New Hampshire of $6.5 million, while the 14.6 million pack increase used by the authors to estimate revenue impacts generates a reported increase in cigarette tax revenue of $11.8 million. The unexplained increase in estimated sales accounts for the study’s conclusion that a tax decrease will increase state revenue.

35

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Implausible Estimates by Historical ,H (Or Any State’s) Standards For a 1.7 price decline to generate an additional 14.6 million packs sold (an 11.4 percent increase) the price elasticity of demand for cigarettes (including evasion, smuggling etc.) would have to be about -6.5, indicating that a 10 percent decline in price would lead to a 65 percent increase in sales. An increase of 14.6 million pacts sold in NH would represent the third largest increase in sales in NH history (and the second largest on a percentage basis) in the past 30 years. This would be an extraordinary sales increase from just a $0.10 or 1.7 percent price decline. Especially with no specific explanation of how that price decline affects prices relative to other states or any models that incorporate NH prices relative to other states. The authors offer no explanation for this use of dramatically higher sales gains estimates other than to note in footnote #1 that: “Statistical models using regression analysis were utilized to project pack sales based on historical activity. Projections of pack sales beyond the statistical model utilize alternative methods.”

Why were different methods used? What were the methods? The use of dramatically different estimates than those derived from their statistical modeling invites concerns about manipulation of results in order to produce findings of substantial revenue gains in response to an excise tax decrease. Reporting dramatic and counterintuitive results that a decrease in tax rates will increase state revenues demands some empirical support and evidence, especially when it appears to contradict other analyses in the same report.

Beyond these broad concerns about reporting, transparency of methods and inconsistency of results, very specific issues become clear upon closer review of the report: •

•

Using per capita cigarette sales to estimate revenues is problematic. Per capita revenues are affected not only by the volume of cigarette sales in a state, but also changes in population. Per capita sales can, and have, declined when population grows at a faster rate than sales. More practically, the State of NH and policymakers cannot make fiscal decisions based on changes in per capita revenues. It is useful as a comparative measure between geographies but not as a revenue forecasting measure.

The report speaks at length to the importance of NH being price competitive with other states in determining the volume of cigarette sales in the state, however, the model used by the report’s authors contains no variable that captures the relative price of NH cigarettes (and how excise taxes affect it) compared to neighboring states. The model estimates changes in cigarette sales only as a function of the price of cigarettes in NH (actually not even in NH itself – see below). In the author’s model, a doubling of the price of cigarettes in Massachusetts would have no impact on NH sales. In contrast, the model used in this report documents the

36

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

•

•

•

•

•

importance of relative cigarette prices and uses it in its estimation of the sales and revenue impacts of changes in cigarette prices.

The model used in the report, as reported, is not estimated using unique NH data, and thus does not represent NH’s unique response to price and other changes in variables affecting sales of cigarettes in the state. The authors of the Grocer’s Association report develop (but do not fully report) elasticity estimates based on pooled data from four New England states. This type of “pooled regression” increases the number of cases (or data) that can be used to estimate relationships between variables, in this case, the price of and demand for cigarettes. However, as specified in the report, their model does not include any “fixed effects” or variables that allow each state’s unique price elasticity to be determined. NH clearly has different circumstances along its borders that result in a different response to cigarette prices and price differentials between states than does Vermont or Mane or Massachusetts. Each state is subject to different border effects and incentives that can increase or decrease combined price and cross border elasticities. The model presented in the report, however, produces estimates of elasticity based on pooled data of all four states with the only “fixed effects” being based on individual years of data, ans no fixed effects to differentiate the price elasticity of demand for cigarettes in each state.

The report assumes that all price changes that have and will occur are a function of changes in excise tax rates. As we have shown in this report, industry price increases have exceeded excise tax increases in NH over the past decade.

The report states in footnotes that the author’s estimates represent the “maximum potential impacts” of an excise tax decrease. The report does not, however, offer a “best point forecast” (or the most likely to occur) so readers have no idea of how probable such a revenue outcome is likely to be. Is the probability that the “maximum potential revenue increase” will occur 5 percent, 10 percent, 0 percent? Should policymakers accept a maximum estimated revenue impacts (based on no reported statistical or empirical evidence) or the most probable estimate of revenue impacts? In addition, the authors provide no discussion of the factors that would result in a result different from their forecast. This would give lawmakers a better understanding of the dynamics that would lead to the estimated outcome as well as allow them to better asses their probability of occurrence.

The report relies extensively on secondary and tertiary sources of information to support claims. Newspaper articles, advocacy organizations and other indirect reports appear to substitute for direct data analysis and empirical evidence to support the report’s findings, claims and conclusion.

The report repeatedly uses the terms cigarette tax revenues “disappointed” or “underperformed” or “fell below estimates”, apparently to indirectly imply that cigarette tax increases resulted in a decline in revenues. Even a

37

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

•

•

cursory review of NH’s cigarette tax collection following excise tax increases reveals (see Figure 1 of this report) that revenues have never fallen after a cigarette tax increase in NH (although revenue has come in both above and below what was forecast as a result of excise tax changes – a fact that was noted by the authors).

The report presents no direct or indirect empirical evidence of a relationship between cigarette sales and other tax revenues (meals and rentals, gasoline, etc.), but rather relies on a series of undocumented assumptions to estimate revenue gains.

The authors use retail “markup” or margin as synonymous with profit in calculating impacts on retailers and for estimating business tax collections.

Gross margins are not a measure of reported profits. In addition, as noted above, the report uses increased sales estimates of dramatically different magnitudes

The most fundamental problem with the analysis contained in the NH Grocers Association report is that is simply produces results that are implausible by historical or any other evidence. Table 2 present historical data on the largest increases and largest decreases in cigarette sales in the state of NH over the past 30 years. This table can help policymakers understand the circumstances that are associated with large changes in cigarettes sales in NH, and to evaluate whether the circumstances in the proposed excise tax decrease follow the pattern characteristic of large increases in cigarette sales in the state.

Annual cigarette sales have increased only nine times in NH during the last 30 years. One fact that immediately stands out in the table is that the two largest increases in cigarette sales in NH occurred during years when the price of cigarettes increased. The 22 million pack sales increase in 1997 occurred in a year when average prices rose by 4.7 percent. The 18.5 million pack increase that occurred in 2003 was accompanied by a 1.4 percent price increase. Clearly the table shows the limitations of estimating changes in sales in NH simply on the basis of price changes, whether they occur as a result of industry price increases/decreases or excise tax increases/decreases. The other key factors apparent in the data are that each large increase in sales occurred at a time when gasoline prices were below $2.00 per gallon, the price of NH cigarettes relative to cigarettes in Massachusetts was relatively low, and prices in Massachusetts and or Maine rose significantly during in the year.

The largest sales decline occurred during years that were characterized by one or more factors: • High NH prices relative to Massachusetts.

• Substantial price increases (by both industry and government via excise taxes).

• Both high gasoline prices and large (20% or more over the prior year) and price increases. Gasoline prices appears to be exerting more of an influence as prices have gotten higher (supported by our econometric models that included gasoline prices in estimating cigarette sales).

38

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Finally, in more than one-half of the years in which NH experienced its largest decline in cigarette sales, the nation was in recession. This finding alone point to the importance of travel and tourism visits to the state in generating revenues, including from cigarette sales. It also suggests, as did our modeling of state revenue responses to cigarette sales, that the direction of causality in cigarette sales is that cigarettes sales are as much a by product of visits to the state as they are generator of visits.

Collectively, these data highlight the limits of simple axioms about how cigarette sales and tax revenues will respond to tax and price cuts, and they urge caution in accepting revenue estimates based on static, undocumented, or simplistic models.

39

Table 2 Largest Increases and Decreases in Cigarette Sales in ,H Over 30 Years

Year 1997 2003 1994 2004 1981 1993 2009 1995 1996

1991 2005 1984 1985 2001 1990 2000 2008 2010

Change.

From Prior Year (Million Packs) 22 18.5 8 6.9 6.2 5.8 4.1 3.3 1.5

-8.6 -11 -11.9 -12.2 -12.2 -16.7 -21 -23.8 -24.8

% Change in Sales

Cigarette Price/Pack

Change Fed./State Taxes

12.2% 11.2% 4.8% 3.7% 2.8% 3.6% 2.7% 1.9% 0.8%

$1.77 $3.58 $1.58 $3.57 $0.58 $1.81 $4.42 $1.64 $1.67

0 0 0 0 0 4 25 0 0

-5.0% -5.8% -5.4% -5.8% -6.8% -8.9% -10.4% -13.7% -16.2%

$1.54 $3.52 $0.91 $0.89 $3.22 $1.36 $3.14 $4.24 $5.88

4 0 5 0 0 8 25 28 107

Total Price. ,H Change Price % ,H From Price Industry Change (Cents) (Cents) Change Largest Sales Increases 8 8 4.7% 4.8 4.8 1.4% -2.3 -23.3 -12.9% -7 -0.7 -0.2% 1 3.1 5.6% 12.7 16.7 10.2% -6.7 18.3 4.3% 6.1 6.1 3.9% 4.7 4.7 2.9% Largest Sales Decreases 14 18 -5.4 -5.4 10.8 15.8 -1.3 -1.3 7.6 7.6 2 10 66.1 91.1 19.6 47.6 38.5 145.5

13.2% -1.5% 21.2% -1.4% 2.4% 7.9% 40.9% 12.6% 32.9%

Mass.

Price Change (Cents)

,H Price as a % of Mass.

37 84.9 10.3 31 2.6 4.7 123.5 14.7 2

10.9 -12.5 12.7 6.9 32 3.8 70.1 12.9 89.6

Gas Price

Gas Price % Change

Maine Price Change

72.0% 74.0% 82.7% 69.3% 81.7% 100.0% 69.4% 79.6% 81.3%

$1.24 $1.57 $1.15 $1.84 NA $1.12 $2.33 $1.18 $1.24

-0.1% 21.8% -2.1% 22.6% NA -7.2% -31.0% 5.4% 7.2%

3.3 25 -14.3 10.5 3.9 4.9 8.9 6.6 2

94.5% 70.0% 90.1% 82.4% 83.9% 89.5% 89.2% 82.7% 81.0%

$1.23 $2.22 $1.14 $1.17 $1.45 $1.20 $1.52 $3.20 $2.76

-5.0% 25.8% NA 2.9% -6.8% 15.4% 45.5% 20.0% 22.1%

5.7 -22.4 12.9 4.4 22.7 15.7 62.7 24.1 63.1

39

IX. Conclusions Rhetoric, anecdote and often hyperbole have dominated the policy debates surrounding the impacts of changes in cigarette excise tax rates in NH, as they have in most states.

This study adds empirical evidence to the debate by employing standard tools of economic analysis as well as methods derived from the extensive national research on the economics of cigarette taxation.

Our study quantifies the degree to which cigarette sales in NH are affected by key price variables, demonstrates how cigarette tax revenues respond to changing levels of taxation, and perhaps most importantly, we clarify the impact that cigarette sales in NH have on employment in the state.

Results from our analyses indicate that a $0.10 decrease in NH’s cigarette tax will result in a 1.7 percent reduction in prices and a 1.6 percent increase in cigarette sales in the state. Combined, these changes result in a decline in cigarette tax revenue of $9 million for the state. We also demonstrate that the risk to the state of losing more cigarette tax revenue are significant because of the strong economic incentives the cigarette industry will have to raise prices in response to the excise tax cut.

We conclude that cigarette sales do not significantly affect other revenue sources in the state and that the apparent relationship that exists between cigarette sales and some revenue sources is an artifact of the relationship each has to another variable - travel and tourism-related visits to the state. Cross-border shopping for lower-priced cigarettes in NH is responsible for a significant portion of NH’s high level of cigarette sales per capita.

But a detailed analysis of monthly cigarette sales and several sources of state tax revenue indicates that travel and tourism visits to the state are responsible for a large portion of the increase in cigarette sales in NH that are attributed to cross-border cigarette consumers seeking lower prices in New Hampshire. In addition, consumers seeking lower-priced cigarettes do not increase meals and rental tax and other state revenues.

Finally, we review one recent analysis of a proposed cigarette excise tax reduction and find inconsistencies and shortcomings in its methodology that lead it to produce demonstrably implausible results that suggest drama tic increases in cigarette sales in NH in response to a $0.10 decrease in the states excise tax.

40

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

References Chaloupka, K., & Warner, K. E., (1999). The Economics of Smoking. Cambridge, MA; National Bureau of Economic Research, Working Paper 7047 (http://www.nber.org/papers/w/7047).

Cutler, M, Gruber, J., et. al , (2000). The Economic Impacts of The Tobacco Settlement, .

Cambridge, MA; National Bureau of Economic Research, Working Paper (http://www.nber.org/papers).

Emery, S et al., “Was There Significant Tax Evasion After the 1999 50 Cent Per Pack Cigarette Tax Increase in California?,� Tobacco Control 11: 130-34, June 2002, (http://tc.bmjjournals.com/cgi/reprint/11/2/130.pdf).

Farrelly, M., Nimsch, C. (2003), Impacts of Cigarette Excise Tax Increases in Low-Tax Southern States on Cigarette Sales, Cigarette Excise Tax Revenue, Tax Evasion, and Economic Activity. Tobacco Technical Assistance Consortium, Report.

Farrelly, M., Nimsch, C., James, J. (2003), State Cigarette Excise Taxes: Implications for Revenue and Tax Evasion, Tobacco Technical Assistance Consortium, RTI International Report. (http://www.rti.org/pubs/8742_Excise_Taxes_FR_5-03.pdf).

Farrelly, M., Pechacek, T., & Chaloupka, F. (2001). The Impact of Tobacco Control Expenditures on Aggregate Cigarette Sales: 1981-1998. Cambridge, MA; National Bureau of Economic Research, Working Paper 8691 (http://www.nber.org/papers/w/8691 ).

Gruber, J., Sen, A., & Stabile, M., (2003), Estimating Price Elasticities When There is Smuggling: The Sensitivity of Smoking to Price in Canada, Journal of Health Economics, 22: 821-842.

Minnesota Implan Group. Regional Input-Output Modeling System, Model of H and its 10 Counties. (www.implan.com).

Orzechowski and Walker, The Tax Burden on Tobacco, Arlington, VA. Various years.

Ohsfeldt, R., Boyle, R., & Capilouto, E., (1998). Tobacco Taxes, Smoking Restrictions, and Tobacco Use. Cambridge, MA; National Bureau of Economic Research, Working Paper 6486 (http://www.nber.org/papers/w/6486).

Tasto, M., Randolph, G. and Keip, W., (2011), An Analysis of the Impact of a Reduction and an Increase in the ew Hampshire Cigarette Excise Tax, NH Grocers Association and Southern NH University.

41

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

US Department of Commerce, Bureau of Census. County Business Patterns, various years. (http://www.census.gov/epcd/cbp/view/cbpview.html).

US Department of Commerce, Bureau of Economic Analysis, Regional Economic Information System. State and County Employment, Income and Other Economic Data (files CA13,CA25, CA34), (http://www.bea.gov/bea/regional/reis/).

US Department of Labor. Consumer Expenditure Survey, 2001. (http://www.bls.gov/cex/home.htm).

Warner, K. E., (1986). Smoking and Health Implications of a Change in the Federal Cigarette Excise Tax, Journal of the American Medical Association, 255(8): 1028-32.

Warner, K. E., & Fulton, G., (1994). The Economic Implications of Tobacco Product Sales in a on-Tobacco State, Journal of the American Medical Association, 271(10): 771-776.

42

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Appendix A ,H Cigarette Sales Model Model Summary Std. Error Adjusted R of the Model R R Square Square Estimate 1 .951 .904 .892 7.5638 a Predictors: (Constant), NHPRICE, NH%PRICE, NHSALESLAG, TIME TREND b Dependent Variable: NHSALES

NHSALES = Total annual packages of cigarettes sold in NH NHPrice = The average retail price (including taxes) of a package of cigarettes in NH NH%PRICE = The average price of a pack of cigarettes in NH as a % of the average price in MA NHSALESLAG = Total packages of cigarettes sold in NH in prior year TIMETREND = A time trend variable to control for longer –term trends in NH cigarette sales over time that are not expressly accounted for in the model ANOVA Model

Sum of Squares 1 Regression 17790.6 Residual 1887.9 Total 19678.5

df 4 36 40

Mean Square 4447.66 57.21

F 77.74

Sig. .000

Coefficients Unstandardized Standardized Coefficients Std. Coefficients Model B Error Beta t 1 (Constant) 203.50 33.98 6.00 TIMETREND -.369 .367 -.178 -1.01 NHSALESLAG .529 .09 .499 5.86 NH%PRICE -107.33 21.6 -.329 -4.96 NHPRICE -6.089 3.27 -.323 -1.86 a Dependent Variable: NHSALES

Sig. .000 .321 .000 .000 .071

43

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Appendix B ,H Gasoline Price and Cigarette Sales Model Model Summary Std. Error Adjusted R of the DurbinModel R R Square Square Estimate Watson 1 .946 .894 .875 6.54 1.413 a Predictors: (Constant), NHPrice%, NHLaggedSales, Real Gasoline Price, Real NH Price b Dependent Variable: NHSALES

ANOVA Sum of Mean Squares df Square F Sig. 1 Regression 7951.2 4 1987.802 46.530 .000 Residual 939.9 22 42.721 Total 8891.1 26 a Predictors: (Constant), NHPrice%, NHLaggedSales, Real Gasoline Price, Real NH Price b Dependent Variable: NHSALES Model

Coefficients Unstandardi zed Standardized Coefficients Std. Coefficients Model B Error Beta t 1 (Constant) 126.081 21.71 5.808 NHLagged .718 .090 .671 7.993 Sales -.130 Real .040 -.273 -3.286 Gasoline Price Real NH -5.023E-02 .021 -.237 -2.432 Price NHPrice% -60.631 12.68 -.336 -4.781 a Dependent Variable: NHSALES

Sig. .000 .000

Collinearity Statistics Tolerance

VIF

.681

1.468

.003

.697

1.435

.024

.504

1.984

.000

.973

1.028

NHSALES = Total annual packages of cigarettes sold in NH NHLaggedSales = NH Cigarette sales lagged one year RealNHPrice = The average retail price (including taxes) of a package of cigarettes in N NH%PRICE = The average price of a pack of cigarettes in NH as a % of the average price in MA REAL NH Price = The real (inflation adjusted) price of gasoline in NH. **Note NH gasoline prices only available from 1984 on from the U.S. Energy Information Agency

44

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Appendix C Cigarette Sales and Meals and Rentals Revenues (Base Rooms & Rentals Sales) Model Summary Adjusted R Std. Error of R Square Square the Estimate 1 .989 .979 .977 70464055.3 a Predictors: (Constant), RLNHPCI, NHUNEMP, CIGARETTE SALES b Dependent Variable: RLMEALBA Model

R

ANOVA Model

Sum of Squares 1 Regression724504587854 6890000.

Residuall158885859071 152900.

Mean Square 3 24150152 92848962 000.0 32 49651830 95973530.

0 35

df

F 486.390

Sig. .000

Total740393173761 8040000.000 a Predictors: (Constant), RLNHPCI, UNEMP, CIGARETTE SALES b Dependent Variable: RLMEALBA

Coefficients Unstandardi zed Standardized Coefficients Std. Coefficients Model B Error Beta t 1 (Constant) - 3188898 -1.504 479607132.

43.8 7 CIGARETTE -.9 .892 -.050 -.986 SALES - 1043011 -.020 -.570 594614478.

686.1 UNEMP 4 RLNHPCI 78894.3 4561.6 .943 17.3 a Dependent Variable: RLMEALBASE

Sig. .142

Collinearity Statistics Tolerance

VIF

.331

.264

3.782

.573

.561

1.783

.000

.226

4.432

45

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Appendix C cont.

Gasoline Sales and Cigarette Sales Model Summary Standard Error of Adjusted R the Model R R Square Square Estimate 1 .945 .893 .879 138.01 a Predictors: (Constant), RLGASPRI, CIGARETTE SALES, RLNHPCI b Dependent Variable: GASSALES

ANOVA Sum of Mean Squares df Square F Sig. Regression 3509626.6 3 1169875.5 61.47 .000 Residual 419058.4 22 19048.1 Total 3928685.1 25 a Predictors: (Constant), RLGASPRICE, CIGARETTE SALES, RLNHPCI b Dependent Variable: GASSALES Model

Coefficients Unstandard ized Standardized Coefficients Std. Coefficients Model B Error Beta t 1 (Constant) -1073.502 486.11 -2.21 CIGARETTE -2.754E-06 -.110 -1.45 .000 SALES RLNHPCI .104 .008 .960 12.44 RLGASPRCEI -2.05 .813 -.194 -2.53 a Dependent Variable: GASSALES

Sig. .038 .160 .000 .019

Collinearity Statistics Tolerance

VIF

.843

1.187

.813 .823

1.230 1.216

46

The Fiscal and Economic Impacts of Decreasing The Cigarette Tax in ew Hampshire

Appendix C cont.

Cigarette Sales and BPT Revenue (Base Business Profits) Model Summary Std. Error of Adjusted R the Estimate Model R R Square Square 1 .815 .664 .631 370573094.8 a Predictors: (Constant), UNEMP, CIGARETTE SALES, RLNHINC b Dependent Variable: RLBPTBASE

ANOVA Sum of Mean Squares df Square 1 Regression 8400788 3 28002627 3741049 91368299 00000.0 000.0 Residual 4257056 31 13732441 9772835 86220503 60000.0 00.0 Total 1265784 34 5351388 460000.

0 a Predictors: (Constant), UNEMP, CIGARETT, RLNHINC b Dependent Variable: RLBPTBASE Model

F 20.392

Sig. .000

Coefficients Unstandard ized Standardized Coefficients Std. Coefficients Model B Error Beta 1 (Constant) 341420412 135890 2.8 7826.50 6 CIGARETTE -6.45 4.676 -.254 SALES RLNHINC 21.88 11.963 .365 UNEMP - 507778 -.438 175625338 2119.3 88.2 a Dependent Variable: RLBPTBAS

Collinearity Statistics Tolerance

VIF

t 2.52

Sig. .017

-1.38

.178

.320

3.127

1.83 -3.46

.077 .002

.272 .677

3.670 1.478

47