economic analysis of minnesota tobacco tax increase

8/10/2019 Economic Analysis of Minnesota Tobacco Tax Increase

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The Economic Consequences of the Recent Cigarette Tax IncreaseIn Minnesota

By

John Dunham and Associates

Brooklyn, New York

Orzechowski & Walker

Arlington, Virginia

June 13, 2014

Funded by Altria Client Services Inc. (on behalf of Philip Morris USA, U.S. Smokeless Tobacco Companyand John Middleton), RAI Services Co., Lorillard Tobacco Co., Minnesota Wholesale Marketers Association,

Kwik Trip, Inc., Holiday Stationstores, Inc., Farner-Bocken Company and Core-Mark International

Supported by The Minnesota Retailers Association and The Minnesota Petroleum Marketers Association


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EXECUTIVE SUMMARY

The Economic Consequences of the Recent Cigarette Tax IncreaseIn Minnesota

The State of Minnesota recently passed a 130 percent increase in the cigarette excise tax. Theexcise tax increase has shifted taxable sales to neighboring low-tax jurisdictions, and a provisionthat would increase the rate annually would further this disturbing trend Legislation thatdiscriminates against cigarette sales in draconian ways simply impacts local tobacco retailers andcan have damaging consequences for the Minnesota economy:

Cigarette sales account for nearly 40% of in-store sales for many local retailers.1

Currently about 6,200 Minnesota retailers sell cigarettes.2 The average store sells 38,000packs per year. In many cases, profits from cigarettes keep the doors open and allowstore owners to employ local residents.

Border communities are seeing per capita sales losses of 27% to 42%, depending onthe border. Sales losses for Minnesota retailers situated near the Iowa, North Dakota,South Dakota, and Wisconsin borders have been devastating. Per capita sales inMinnesota counties bordering North Dakota are now just 13 percent of those inneighboring communities. Per capita sales in Minnesotas border regions as a wholehave fallen by 30.1 percent in the aftermath of the tax increase; this drop in sales is 50percent larger than the estimated 19.8 percent reduction statewide.

The cigarette tax increase has put more than 1,100 Minnesotans out of work. In aneconomic environment where nearly 141,100 people are trying to find jobs,3 higher

cigarette taxes in Minnesota have already put more than 1,100 people out of work. Thebulk of these jobs are with local retail establishments particularly convenience stores.These stores employ about 4,810 people due to the sales of cigarettes. Wholesalersprovide another 380 jobs, and firms that supply these businesses about 660 jobs. Theseare real people, with real jobs, living in communities throughout the state.

Prior to the tax increase the Tax Foundation estimated that 22.4% of all cigarettesconsumed in Minnesota were purchased from other states, Native American smokeshops, or other, non-Minnesota sources.4 The tax increase only makes this problemworse. The combined excise and sales tax rate in the state is now among the highest inthe country, and the evidence shows that this has driven consumers to retail shops in thebordering states of North and South Dakota. After the tax increase, retailers in Iowa andWisconsin saw significant growth in sales at the expense of both Minnesota stores andtaxpayers.

1 Wong, Venessa, In Convenience Stores: More Food, Fewer Cigarettes, Bloomberg Businessweek, January17, 2013. The figure is specific to convenience stores and reflects the national average.

2 6,200 stores based on in-store scanner data provided by Altria Client Services, Inc. In its fiscal note, theState of Minnesota estimated that there were about 9,000 retailers. See:Analysis of H.F. 91 (Lenczewski),As Amended in House Tax Committee, Analysis Revised for February 2013 Forecast, MinnesotaDepartment of Revenue, March 12, 2013.

3 Bureau of Labor Statistics, Regional and State Employment and Unemployment Summary, April 2014,http://www.bls.gov/news.release/laus.nr0.htm.

4 Henchman, Joseph and Scott Drenkard,Cigarette Taxes and Cigarette Smuggling by State, Fiscal Fact 241,

The Tax Foundation, March 2014.


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Minnesotas tobacco retailers may have lost as much as $38.46 million in non-tobacco sales as a result of the tax.Management Science Associates, Inc., a firm that

collects extensive data from wholesalers and retailers, estimates that on average, forevery $8.33 in cigarettes purchased, buyers purchase $6.87 in non-tobacco products.5

That would suggest that Minnesota retailers have lost as much as $38.46 million in salesof sundry products things like gasoline, food, beverages, candy, salty snacks, andlottery tickets due to the tax increase.6

The proposed taxacceleratorwill only make matters worse, as it will raise taxes byabout 10-cents per pack each and every year. Over time, this perverse tax increasewill cost more and more jobs.

5 Presentation by Don Burke, Senior Vice President, Management Science Associates, Inc., at the Federationof Tax Administrators Annual Meeting (Tobacco Tax Section), Albuquerque, New Mexico, August 13,2013.

6 An estimated 11.43 million packs were lost to increased purchases in other states. Taking these lost tax-paid sales times an estimated price per pack of $4.08 is equal to $46.63 million. Dividing this by $8.33 and

multiplying by $6.87 provides an estimate of lost sundry sales.


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The Economic Consequences of the Recent Cigarette Tax Increase

In Minnesota

Introduction

Minnesotas excise tax on cigarettes increased on July 1, 2013, as part of a major package of taxincreases in the state. This legislation, the Minnesota Omnibus Tax Bill, was signed into law onMay 23, 2013.7 The state eliminated the 75-cents per pack health impact fee and raised theexcise tax from 48-cents per pack to $2.83 per pack. The wholesaler fee - levied in lieu of a retailsales tax - rose as well, going from 36.2-cents per pack to 49.3-cents per pack. In January, thatrate, which is adjusted annually, rose to 51.2 cents per pack. Going forward, the cigarette excisetax will be subject to annual indexation.

Table 1Minnesota State Cigarette Tax Rates8

Combined, the cigarette excise tax and wholesaler fee is $3.342 per pack.9 The tax increasemakes the overall excise and state sales tax in Minnesota the 7th highest in the country, andsignificantly higher than any of the states surrounding it, as well as in the Canadian province ofOntario.10 Table 2 on the following page compares the tax rate in Minnesota with other states.

This relatively high tax rate encourages consumers to purchase cigarettes as well as otherproducts from retailers located in:

Lower-tax surrounding states,

7 The bill also changed the taxation of little cigars and increased the tax on other tobacco products (OTP)from 70 percent to 95 percent of wholesale value. Before July 1, 2013, little cigars were taxed as OTP andsubject to the 70 percent rate. They are now taxed like cigarettes. In addition, little cigars weighing morethan 3 lbs. per 1,000 and less than 4.5 lbs. per thousand are taxed at $5.66 per pack. While data on littlecigar sales in Minnesota following the tax increase are not available, it follows that some of the sales nowbeing recorded as cigarettes actually represent little cigars.

8 Cigarettes in Minnesota are not subject to the state retail sales tax. Instead, wholesalers pay a tax in lieu ofthe sales tax. That rate adjusts annually (on Jan. 1 of each year)

9 This is the tax rate for cigarettes produced by companies that have signed a Tobacco Settlement Agreementwith the state. Products produced by these firms account for the vast majority of cigarettes sold in the state.For cigarettes produced by companies without a settlement agreement, a non-settlement fee of 50-centsper pack is assessed making the total tax rate $3.843 per pack.

10 The cigarette tax rate in Ontario is equivalent to $2.47 per 20-unit pack. The federal tax in Canada is $1.70

per pack of 20.

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Non-taxed Native American reservations,

Non-taxed military commissaries and post exchanges,

Duty free shops, Over the Internet, and

Black market sources.

While in some cases, these sales may be illegal and require the consumer to pay cigarette usetaxes, enforcement can be difficult.11 In addition, Minnesota law allows consumers the ability tolegally evade the tax up to a point.12

Table 2Comparative State Cigarette and General Excise Taxes Per Pack

More ominously, high cigarette tax rates create a target of opportunity for the organizedsmuggling of cigarettes. One of the more common forms of the illicit trade in cigarettes in theU.S. involves interstate smuggling of cigarettes in bulk from low-tax states to high-states. Thesetransactions are attractive to criminal enterprises because: Cigarettes are sold legally, which

11 A 2009 report prepared for the Minnesota Department of Revenue found that few residents file a cigaretteuse form on out-of-state purchases. See Blumenthal, Marsha, Cigarette Tax Evasion in Minnesota, October18, 2009.

12 Minnesota law allows a consumer to legally bring into the state up to 200 cigarettes (one carton) per monthfrom a lower-taxed state provided they are personally carried into Minnesota by the consumer. See 2013

Minnesota Statutes 297F.06 Subd. 3.

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makes it relatively easy to find supply and to distribute; taxes are a major component of price,and thus, the wide disparity in tax rates between states creates profit opportunities; and criminalpenalties are relatively modest, especially when compared to the smuggling of other illicit

goods.13 The gross profit potential on a pack of cigarettes purchased in Missouri, where thecombined excise and sale tax is 35-cents per pack, and sold in Minnesota is nearly $3.00 perpack. For a large van carrying 5,000 cartons, thats a profit of $150,000 on a single trip.

This paper examines the effects of the recent tax increases in terms of overall taxable sales in thestate, and the impact of high cigarette taxes on current and future state revenues. It alsoexamines how high cigarette taxes have impacted retail employment in the state, particularlyalong border areas. It is based on models developed by John Dunham and Associates (JDA) andOrzechowski & Walker for Altria Client Services, Inc., and Reynolds American ServicesCompany.

The Economic Impact of Tobacco Sales in Minnesota

Even though Minnesota is not considered a tobacco state, the sale of cigarettes is an importantpart of the states economy. Cigarettes are part of the product mix sold by many different typesof retailers, including convenience stores, grocers, gas stations, and of course tobacco outlets.While cigarettes rarely constitute 100 percent of sales for any given store, they account for asignificant amount of both revenues and profits, and in many cases these small businesses needthese profits in order to keep the doors open and employ local residents. As Figure 1 belowshows, retailers that sell at least some cigarettes are located throughout the entire state.

Figure 1

Retail Cigarette Outlets in Minnesota and Surrounding States

Currently there are over 6,200 stores in the state that sell cigarettes. 14 These range from tobaccoonly stores, to small neighborhood grocers and newsstands. All told, in Calendar Year 2012,

13 U.S. Government Accountability Office,Illicit Tobacco: Various Schemes are Used to Evade Taxes andFees, GAO-11-313, March 2011.

14 Based on in-store scanner data provided by Altria Client Services, Inc. In its fiscal note, the State ofMinnesota estimated that there were about 9,000 retailers. See:Analysis of H.F. 91 (Lenczewski), AsAmended i n House Tax Committee, Analysis Revised for February 2013 Forecast, Minnesota Department

of Revenue, March 12, 2013.


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these stores sold a total of 234.6 million taxed packs of cigarettes, 15 or an average of about38,000 packs per store, with convenience stores selling the bulk of them.16

Table 3Economic Impact of Cigarette Sales in Minnesota

Since retail employment is directly and linearly correlated with sales, jobs in individual storesare closely tied to the volume of cigarette sales. Estimates for the percentage of sales in each ofthe store types accounted for by cigarettes in Minnesota are available from the US Department ofCommerce.17 These percentages are applied to the number of jobs in each of the 6,200 stores tocalculate an estimate of the number of retail jobs dependent on cigarette sales throughoutMinnesota.

Based on this analysis, prior to the 130 percent cigarette tax increase, 18 about 4,800 retail jobsdirectly depended on the sale of cigarettes in the State of Minnesota. In addition, the jobs of 380people depend on cigarette wholesaling operations in the state. An additional 11 people work forvarious offices of cigarette manufacturing firms located in Minnesota.19 This means that justover 5,200 jobs in Minnesota are directly dependent on the sale of cigarettes. These workersearn approximately $154.0 million in wages and benefits.20

As Table 3 above shows, an additional 660 jobs in firms supplying goods and services tocigarette retailers, wholesalers and manufacturers in Minnesota are dependent on cigarette sales.

15 Monthly tax-paid sales data was collected by Orzechowski and Walker from the State of Minnesota.16 This is an average across all store types and does not necessarily represent an individual store. For example

a restaurant or tavern selling cigarettes may sell only a few packs a day, while a large convenience storemay sell hundreds. In fact, according to the US Department of Commerce, Bureau of the Census, about72.6 percent of the cigarettes sold in Minnesota are sold in convenience stores, and cigarette sales represent19 percent of overall c-store sales. See:Retail Trade: Subject Series - Product Lines: Product LinesStatistics by Kind of Business for the United States and States: 2007, 2007 Economic Census on AmericanFact Finder, at www.census.gov

17 US Department of Commerce, Bureau of the Census, Census of Retail Trade, Subject Series - ProductLines: Product Lines Statistics by Kind of Business for the United States and States: 2007, on-line at:http://factfinder2.census.gov/faces/nav/jsf/pages/searchresults.xhtml?refresh=t

18 This is the percent change in the excise tax rate only, not including the increase in sales taxes.19 Data from Dun and Bradstreets Hoovers database.

20 Wage per employee figures are based on IMPLAN input-output tables for Minnesota, 2012.

Jobs Wages Output

Direct 5,206 153,977,534$ 357,521,538$Manufacture 11 1,254,971$ 31,322,781$Wholesale 380 34,533,966$ 81,493,320$Retail 4,815 118,188,598$ 244,705,437$

Supplier 660 35,226,234$ 97,801,940$Induced 954 43,135,754$ 126,228,587$Total 6,820 232,339,521$ 581,552,064$

TaxesState and Local 52,949,725$Federal 50,411,337$


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A further 950 people have jobs that are induced by the re-spending of the $189 million of wagesof direct and supplier employees.

All told, about 6,800 people have jobs dependent on the sale of cigarettes in Minnesota, and thiscreates nearly $581.6 million in economic activity. In addition, as much as $52.95 million inbusiness and personal taxes are paid to Minnesota and its localities by businesses and individualsdue to the sale of cigarettes. This does not include the nearly $371.7 million in excise taxes paidto the state by cigarette consumers.

The Impact of the 130 Percent Tax Increase on Jobs and Economic Activity in Minnesota

Since tobacco is taxed at different rates in different states, consumers in a given jurisdiction cantake advantage of a wide range of prices. Not only can consumers in Minnesota purchasecigarettes from local retailers like convenience stores, grocery stores or tobacco outlets, but they

can also purchase the same exact product from similar stores in neighboring states, or from dutyfree stores on ships, in airports or along the Canadian border. Consumers can also ordercigarettes from vendors overseas via the Internet. These vendors typically sell counterfeitversions of premium brands and use the U.S. mail or private shippers to get them directly toconsumers. Consumers also have access to cigarettes sold in Native American smoke shopslocated on one of the 11 reservations in the state, or on military commissaries and postexchanges. While many of these sales may ultimately avoid payment of appropriate excisetaxes, and residents are required by law to remit these taxes to the Department of Revenue,widespread tax avoidance is common, either intentionally or unintentionally.

Based on monthly tax-stamp sales data from the Minnesota Department of Revenue, average

sales per month are indeed down by about 4.7 million packs in the 10 months after the taxincrease was imposed. This, however, includes sales of little cigars that, following the taxincrease in July of 2013, are taxed as cigarettes. These little cigars represent a very small part ofthe overall tobacco market, and based on data from 2012 probably account for no more thanabout 16,500 packs per month, or fewer than 200,000 packs per year.21

Overall, cigarette sales in Minnesota had been trending downward for some time, but even so, ifone includes the estimated little cigars, sales are running at about 19.8 percent below trend.Annualizing the 19.8 percent sales reduction suggests that overall, taxable cigarette sales inMinnesota will fall by about 42.3 million packs as a result of the tax increase.

A drop in sales this large affects not only the stores bottom line, but jobs.The tax is estimatedto have cost Minnesota as many as 1,025 lost tobacco retailing jobs, and 1,400 total jobs.These sales and job losses will flow through the supplier chain impacting wholesalers as well as

21Tax Burden on Other Tobacco Products: 2012, Orzechowski & Walker and John Dunham and Associates.The influence of little cigars on the cigarette data could be larger impact than we can estimate. This isbecause Minnesotas definition of little cigars includes many cigars that for purposes of federal taxation,are popular large cigars. Because of the lack of data on cigars between 3 lb. and 4.5 lb. per 1,000, wecannot quantify this effect. The state estimates that about 18,500 packs of little cigars would be sold in2014. However, given that Minnesota taxes them at draconian rates - $5.66 per pack of 20 it is likely thatfew little cigars will be sold in the state. See: Analysis of S.F. 2910 (Skoe)/H.F. 3303 (Anzelc), Minnesota

Department of Revenue, April 1, 2014.


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companies that supply goods and services to retailers and wholesalers. 22 All told, this taxincrease is estimated to cost the state of Minnesota about $110.9 million in overall economicactivity and about $10.7 million in business and personal taxes (not including changes to excise

tax revenues). The economic impact of the 130 percent tax increase is detailed on Table 4,below.

Table 4Economic Cost of Cigarette Tax Increase in Minnesota

The Cross-Border Impact of High Cigarette Taxes in Minnesota

The substantial reduction in tax-paid cigarettes is largely due to the fact that consumers have somany different and less expensive alternative sources to purchase cigarettes and other

tobacco products. Taxable sales recorded in Minnesota cannot fully reflect actual demand.Consumers might order cigarettes from vendors overseas via the Internet. These vendorstypically sell counterfeit versions of premium brands and use the U.S. mail or private shippers toget them directly to consumers. Consumers also have access to cigarettes sold in NativeAmerican smoke shops located on one of the 11 reservations in the state, or on militarycommissaries and post exchanges. While many of these sales may ultimately avoid payment ofappropriate excise taxes, and residents are required by law to remit these taxes to the Departmentof Revenue, widespread tax avoidance is common, either intentionally or unintentionally.

One major way that consumers can respond to higher state cigarette excise taxes is to simplydrive across state lines and purchase products in other jurisdictions with lower tax rates. In the

case of Minnesota, following the 130 percent tax increase, retailers in the surrounding states ofIowa, North Dakota, South Dakota and Wisconsin are able to sell exactly the same product atlower prices. For consumers in border regions, it is hard to resist driving just a few miles to savetens or even hundreds of dollars.

Based on actual store level sales data, it appears as if Minnesota consumers are doing just that.As the map in Figure 2 on the following page shows, there appears to be a hollowing outofcigarette sales in border counties, with particularly large impacts occurring along the border ofIowa and the Dakotas.

22 Note that it is assumed that manufacturers sales offices and other operations in Minnesota are not impacted

by changes in local sales, and that these are rather determined by national trends.

Jobs Wages Output

Direct 1,100 31,978,861$ 68,186,108$Manufacture - -$ -$Wholesale 75 6,825,875$ 16,107,714$Retail 1,025 25,152,986$ 52,078,394$

Supplier 126 6,718,308$ 18,652,677$Induced 182 8,226,803$ 24,074,175$

Total 1,408 46,923,972$ 110,912,960$

TaxesState and Local 10,753,956$

Federal 10,052,534$


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In fact, based on the store level data,per capita sales in Minnesotas border regions fell by30.1 percent, 50 percent more than the 19.8 percent estimated reduction statewide. Prior tothe tax increase, the high relative excise rates in Minnesota encouraged cross border shopping.

Particularly on the border areas with North Dakota, but also along the Iowa and South Dakotaborders, per capita cigarette sales in Minnesota counties were lower than per capita averages inthe other jurisdictions. Only with Wisconsin, did Minnesota sell more cigarettes per capita inborder counties, and this likely reflects that fact that the major population centers of Minneapolisand St. Paul are located very close to the border.

Figure 2Per Capita Cigarette Sales Change Following Tax Increase

The tax increase exacerbated this bleak cross border trend. Following the tax increase, sales inMinnesotas border counties completely collapsed, down by about 42 percent along theNorth Dakota and Iowa borders, but also down by 35percent along the border with South Dakota and by 27percent along the Wisconsin border. Per capita sales inMinnesota counties bordering North Dakota are now just 13percent of those in neighboring communities. And this is

not just because the population centers of Fargo and GrandForks, North Dakota are along the border. Low per capitasales extend all along the North and South Dakota borderareas.

The most dramatic changes have occurred along the borderwith Iowa. Prior to the tax, per capita sales in Minnesotacounties that bordered Iowa were higher than in theHawkeye state. However, following a 41.7 percent declinein per capita sales, after the tax increase, sales in Minnesotaborder areas were about half those in Iowa.

Cigarette sales at Minnesotaconvenience stores are plummeting with higher taxes sending manysmokers to North Dakota to stock upon tobacco.

"Our highest is $9.50 or somethinglike that, it's expensive cigarettes," saidRodney Helming, owner of the OasisConvenience Store in Moorhead,Minnesota, a store less than a mileaway from North Dakotas border.

"Cigarette sales dropped 75%, we usedto do 300 cartons a week, now we buy70 to 80 a week," he said.

- NACS Online, January 2014


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The Wisconsin border area presents an interesting case as prior to the tax increase Minnesotawas a net exporter to the Badger state. Shoppers in Wisconsin took advantage of lower prices inMinnesota and frequented retailers on that side of the border. This has changed after the tax

increase, as Wisconsin retailers now have a price advantage to those in Minnesota. Because ofthis the direction of cross-border sales has been shifting, and overall taxable cigarette sales inWisconsin have grown by about 8 percent in the 6 months following Minnesotas tax increase.Over time, as Minnesotas cigarette tax continues to increase (see below), Wisconsin basedretailers will enjoy a larger and larger price differential and retailers along that border couldbegin to face business conditions similar to those on the western border of the state.

Detailed maps for specific border areas showing changes in sales by store are found in theAppendix to this report.

Table 5

Change in Quarterly Per Capita Cigarette Sales in Border Counties

The Impact of Lost Cigarette Sales on Sales of Other Products at Retail

Stores that sell cigarettes generally sell other products. In the case of grocery stores andsupermarkets, cigarettes account for just 2 percent of revenue. However, the impact onconvenience stores where the vast majority ofcigarettes are sold is much larger. Cigarettesprovide as much as 19 percent of total sales for C-stores. The impact is larger when gasoline isexcluded; according to the National Association ofConvenience Stores, 38 percent of in-store salescome from cigarettes.23

When shoppers are traveling across state linesto take advantage of lower cigarette prices inNorth Dakota or Iowa, they may actually shiftentire shopping trips to the other state.

In other words, tobacco retailers in Minnesotamight not just be losing cigarette sales whenconsumers cross borders. They are also likely losing sales of gasoline, beverages, milk, candy,beer, coffee, salty snacks and lottery tickets the items most commonly bought along with

23 Wong, Venessa,In Convenience Stores: More Food, Fewer Cigarettes, Bloomberg Businessweek, January

17, 2013.

7$8&9$ :#,9$(%$ ;8'$9 :#,9$(%$


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cigarettes.24 Actual data on how consumers shift other purchases when traveling across states forcigarettes is difficult to obtain; however, in a presentation to the Federation of TaxAdministrators, Mr. Don Burke, Senior Vice President of Management Science Associates, Inc.,

a firm that collects extensive data from wholesalers and retailers, indicated that on average forevery $8.33 in cigarettes purchased, buyers bought $6.87 in non-tobacco products.25 That wouldsuggest that Minnesota retailers may have lost as much as $38.46 million in sales of sundryproducts due to the tax increase.26 Depending on the product mix for these cross borderconsumers, Minnesota is also likely losing sales tax, gas tax, alcoholic beverage taxes, andlottery revenues to neighboring states as well.

The Impact of Annually Indexing the Cigarette Tax for Inflation

Unfortunately for retailers, the 130 percent increase is not the end of the pain. Annually, thecigarette tax will be indexed so that it will rise as cigarette prices rise. How high the tax is raised

will be based on the annual adjustment in the wholesale sales tax on cigarettes. The calculationfor the wholesale sales tax is made each November and is effective on January 1 of the followingyear. It is based on the increase in the weighted average retail price of cigarettes year-over-year,and has been a feature of cigarette taxation in Minnesota since FY2006.

Table 6Cigarette Price Inflation Compared to the Consumer Price Index

For the cigarette excise tax, the new rate will be equal to the current rate times the percentagechange in the wholesale sales tax. According to the Minnesota Department of Revenue, the tax

rate will increase by about 2 percent per year along with inflation. This may be a low estimate,as cigarette prices tend to rise faster than inflation representing in part all of the regulatoryrestrictions placed on their pricing and sale. As Table 6 shows, even discounting for 2009, theyear when a massive federal tax increase went into effect, the average growth in cigarette prices

24 Presentation by Don Burke, Senior Vice President, Management Science Associates, Inc., at the Federationof Tax Administrators Annual Meeting (Tobacco Tax Section), Albuquerque, New Mexico, August 13,2013.

25 Ibid.26 An estimated 11.43 million packs lost to increased purchases in other states. Taking these lost tax-paid

sales times an estimated price per pack of $4.08 is equal to $46.63 million. Dividing this by $8.33 and

multiplying by $6.87 provides an estimate of lost sundry sales.

Year

Cigarette

Prices General Prices

Cigarette

Gap

2004 2.2% 2.8% -0.5%

2005 3.9% 3.2% 0.7%2006 2.4% 1.8% 0.6%2007 4.4% 3.8% 0.6%2008 5.2% -0.4% 5.6%2009 29.5% 2.3% 27.3%2010 5.3% 1.2% 4.2%2011 2.2% 2.5% -0.3%2012 1.4% 1.3% 0.1%2013 2.6% 1.2% 1.4%


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has been 3.3 percent per year over the past decade. This compares with consumer price inflationof about 2 percent.27

The state of Minnesota estimates that it will generate $2.5 million from this tax acceleratorinFY 2015, increasing to $14.8 million by FY 2017 based on an elasticity of -0.95 which shouldtake into account volume changes and cross-border sales that will likely occur due to the higherexcise taxes.28

Based on JDAs model of the Minnesota cigarette market, the tax increase would be equal toabout 9.3-cents in the first year, rising to just under 10-cents per pack three years out.29 Theincrease in the wholesale sales tax is not included as sales taxes generally rise along with priceinflation so there would be no differential impact on the market from that increase.

Table 7

Economic Impact of Tax Accelerator

Based on JDAs model, the increase will lead to a reduction of as many as 938,000 packs ofadditional sales by Fiscal Year 2017, and there would be additional job losses as a result of the

Accelerator, primarily in retail outlets like convenience stores or food shops that sell tobaccoproducts. Overall, the states economy would be nearly $2.3 million smaller as a result of thistax accelerator, a figure that will only increase as prices continue to rise. Table 7 outlines theeconomic effects of the excise tax accelerator.

The figures in Table 7 represent economic impacts and do not account for State revenues fromthe accelerator, which are currently forecast to raise $2.5 million in the first year (where it wouldonly be imposed after 6 months), $9.0 million in the second year, and $14.7 million in FY2017.30

These job losses may be understated, as the price for cigarettes in Minnesota has now become

higher than those in Wisconsin. Prior to the last tax increase, consumers in Wisconsin purchaseda large amount of cigarettes from Minnesota based retailers. This has now switched, and werethe excise tax to be increased year over year, the differential would only grow. This would makebusiness conditions for convenience stores, gasoline stations, and other retailers who rely ontobacco sales in border counties like Carlton, Dakota, Houston, Washington and Winona, evenworse.

27 Bureau of Labor Statistics, Consumer Price Index Database, at: www.bls.gov/cpi/28 The revenue increase in 2014 assumes that the higher tax is imposed over just half of the year. Analysis of

S.F. 2910 (Skoe)/H.F. 3303 (Anzelc), Minnesota Department of Revenue, April 1, 2014.29 Note that the tax increase would take effect half way through FY 2015; therefore the impact has been cut

by half in the table.

30 Analysis of S.F. 2910 (Skoe)/H.F. 3303 (Anzelc), Minnesota Department of Revenue, April 1, 2014.

FY 2014 FY 2015 FY 2016 FY 2017

Excise Tax Rate $2.830 $2.923 $3.020 $3.120

Pack Sales Change - (45,400) (369,190) (938,285)Lost Jobs - (2) (13) (34)Lost Wages - ($48,036) ($390,633) ($992,783)Lost Economic Output - ($111,280) ($904,933) ($2,299,862)


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showing increased revenues in the absence of cigarette tax increases; this is in an environment offalling cigarette sales nationally. In other words, rather than benefitting the economy ofMinnesota, this tax increase is generating new business in the regional marketplace at the

expense of Minnesota retailers, workers and taxpayers.

As Table 8 shows, even with the loss of sales following the tax increase in July of 2013,Minnesota is generating significant additional tax revenues for border taxes, particularly forNorth and South Dakota. In the case of Minnesota, the average month-to-month change inrevenues for the months following the tax increase has been 52 percent, reflecting both higherper unit revenues and substantial sales reductions.

It should also be remembered that the tax increase happened just recently, and there are only afew months of data reported since that time. As consumers outside of the border countiesbecome more aware of the ability to purchase cigarettes from less expensive outlets in Iowa,

North Dakota and now even Wisconsin, taxable sales in Minnesota may fall further. Consumersalong the border with North Dakota have long realized that savings can be had by purchasingtobacco in that jurisdiction. Now, Minnesotas large population centers of Minneapolis and St.Paul are within a short drive of cheaper tobacco products in Wisconsin. In fact, that staterecognizes that it is benefitting from Minnesota shoppers, who now travel a short distance tostores in border regions of the Badger State to purchase their tobacco products.35

These cross border sales can grow exponentially over time. For example, New York City has thehighest cigarette excise taxes in the country, and research has shown that nearly two-thirds oftobacco sales are already made on the black market or from retailers located in other states. 36 Itmay be that Minnesota currently lacks a black market infrastructure; however, given the profit

potential from illicit trade, that is likely to change.

35 Letter from Robert Lang, Director of the Legislative Fiscal Bureau to Representative John Nygren, andSenator Alberta Darling, outlining the status of the States general fund. January 16, 2014

36 See: John Dunham and Associates, An Examination of Cigarette Sales in New York State By Source: 2011,Prepared for the New York Association of Convenience Stores, October 10, 2012. On line at:www.nyacs.org/documents/JohnDunhamCigTaxEvasionReportOct2012.pdfAlso see: LaFaive, Michaeland Todd Nesbit,Cigarette Smuggling Remains High in Michigan, Elsewhere, Mackinac Center for PublicPolicy, Viewpoint on Public Issues, February 4, 2013, at: www.mackinac.org/18219. Another recentanalysis examined certain neighborhoods in the Bronx and concluded that over 76 percent of discardedcigarette packs in that area did not have proper tax indicia. See: Kurti, Marin, et. al.,The illegal cigarettemarket in a socioeconomically deprived inner-city area: the case of the South Bronx, Tobacco Control,

published on-line August 4, 2012.


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Methodology Data and Sources

This analysis is based on a number of mathematical models, and as with all models, this one is

only a representation of reality. The model used to project the economic impact of lost sales is amulti-state demand model. Since consumers have so many different and less expensive alternative sources to purchase cigarettes and other tobacco products, the taxable sales recordedin Minnesota cannot fully reflect actual demand. In particular, since many of these alternativetransactions are illegal, they are not recorded in official records, making actual data onalternative transactions impossible to obtain. Therefore, a model has to be constructed todetermine actual cigarette demand in the state.37

Given the degree of price differentiation of products available, every consumer faces multiplechoices regarding where and how to purchase cigarettes. This model addresses that and estimatesthe probability attached to each of the possible decisions.

37 The model used in this analysis is a multi-segment demand model. This model is similar to those that JDAhas constructed to model the national cigarette, moist snuff, cigar, beer, wine, spirits, and aviation fuel -industries all of which have similar tax structures. This model examines cross border sales of cigarettesamong the 50 states and the District of Columbia, as well as certain untaxed sales, mainly motivated byprice differentials resulting from different tax rates. The model estimates in-state demand of own-statetaxed sales of cigarettes and exports to and imports from other states. The general methodology is a two-stage estimation of the demand equation linked to a non-linear programming model of the import andexport patterns. Taxable sales were obtained from The Tax Burden on Tobacco: 2012. Price per pack wasobtained from The Tax Burden on Tobacco 2012. The prices are adjusted for state sales tax. PopulationEstimates, Race and Hispanic Origin from the Bureau of the Census. State-to-state centroid distance data

were obtained from Caliper Corp.


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About John Dunham and Associates

John Dunham and Associates (JDA) is a leading New York City based economic consulting firm

specializing in the economics of fast moving issues. JDA is an expert at translating complexeconomic concepts into clear, easily understandable messages that can be transmitted to anyaudience. Our companys clients include a wide variety of businesses and organizations,including some of the largest Fortune 500 companies in America, such as:

Altria

Diageo

Feld Entertainment

Forbes Media

MillerCoors

Verizon Wegmans Stores

John Dunham is a professional economist with over 25 years of experience. He holds a Masterof Arts degree in Economics from the New School for Social Research as well as a Masters ofBusiness Administration from Columbia University. He also has a professional certificate inLogistics from New York University. Mr. Dunham has worked as a manager and an analyst inboth the public and private sectors. He has experience in conducting cost-benefit modeling,industry analysis, transportation analysis, economic research, and tax and fiscal analysis. As asenior economist for Philip Morris, he developed tax analysis programs, increased cost-centerproductivity, and created economic research operations. He has presented testimony on

economic and technical issues in federal court and before federal and state agencies.

Prior to Phillip Morris John was an economist with the Port Authority of New York and NewJersey, the Philadelphia Regional Port Authority and the City of New York.

About Orzechowski & Walker

Orzechowski and Walker (O&W) is an economic and policy research and analysis firm based inArlington, VA. O&W specialize in clear and concise analysis of legislative and regulatory issuesat the federal, state, and local level. O&W have worked with a variety of business, public policy,public relations, and tax organizations, including Fortune 500 companies and major trade

associations.

O&W have more than 35 years combined experience studying cigarette and other tobaccoproduct taxes. O&W produce The Tax Burden on Tobacco, an annual, authoritative compendiumof federal, state, and local tobacco tax data. The Tax Burden is used by tobacco companies, statedepartments of revenue and other government entities, public health groups, and financialresearch firms, alike.


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Appendix

1: Cross Border Examples2: Impact of Proposed Couponing Ban


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Albert Lea Minnesota Border Area

Percent Change in Sales By Zip Code Following Tax Increase

Quarterly sales in Freeborn County Minnesota averaged 263.2 cigarettes per capita prior to the130 percent jump in tobacco tax rates. They fell 38.3 percent to just 162.4 cigarettes per quarterfollowing the tax increase.

On the other hand, quarterly cigarette sales in stores located in Worth County Iowa averaged238.7 cigarettes per capita prior to the increase, and 416.1 after the tax went into effect inMinnesota. This was a 74.3 percent increase in quarterly per capita cigarette sales and reflectscross border movement out of Albert Lea area stores.


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Duluth Minnesota Border Area


Quarterly sales in St. Louis County Minnesota averaged 325.7 cigarettes per capita prior to the130 percent jump in tobacco tax rates. They fell 22.9 percent to just 251.0 cigarettes per quarterfollowing the tax increase.

On the other hand, quarterly cigarette sales in stores located in Douglas County Wisconsinaveraged 195.6 cigarettes per capita prior to the increase, and 309.2 after the tax went into effectin Minnesota. This was a 58.1 percent increase in quarterly per capita cigarette sales and reflectscross border movement out of Duluth area stores.


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Fargo North Dakota Border Area


Quarterly sales in Clay County Minnesota averaged 99.2 cigarettes per capita prior to the 130percent jump in tobacco tax rates. They fell 51.1 percent to just 48.5 cigarettes per quarterfollowing the tax increase.

On the other hand, quarterly cigarette sales in stores located in Cass County North Dakotaaveraged 384.3 cigarettes per capita prior to the increase, and 498.4 after the tax went into effectin Minnesota. This was a 29.7 percent increase in quarterly per capita cigarette sales and reflectscross border movement into Fargo area stores.


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Grand Forks North Dakota Border Area


Quarterly sales in Polk County Minnesota averaged 166.8 cigarettes per capita prior to the 130percent jump in tobacco tax rates. They fell 36.4 percent to just 106.0 cigarettes per quarterfollowing the tax increase.

On the other hand, quarterly cigarette sales in stores located in Grand Forks County NorthDakota averaged 402.9 cigarettes per capita prior to the increase, and 499.2 after the tax wentinto effect in Minnesota. This was a 23.9 percent increase in quarterly per capita cigarette salesand reflects cross border movement into Grand Forks area stores.


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Hudson Wisconsin Border Area


Quarterly sales in Washington County Minnesota averaged 198.0 cigarettes per capita prior tothe 130 percent jump in tobacco tax rates. They fell 30.9 percent to just 136.8 cigarettes perquarter following the tax increase.

On the other hand, quarterly cigarette sales in stores located in St. Croix County Wisconsinaveraged 149.5 cigarettes per capita prior to the increase, and 226.6 after the tax went into effectin Minnesota. This was a 51.6 percent increase in quarterly per capita cigarette sales and reflectscross border movement into Hudson area stores.


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Jackson Minnesota Border Area


Quarterly sales in Jackson County Minnesota averaged 220.8 cigarettes per capita prior to the130 percent jump in tobacco tax rates. They fell 32.1 percent to just 150.0 cigarettes per quarterfollowing the tax increase.

On the other hand, quarterly cigarette sales in stores located in Dickinson County Iowa averaged317.0 cigarettes per capita prior to the increase, and 416.4 after the tax went into effect inMinnesota. This was a 31.3 percent increase in quarterly per capita cigarette sales and reflectscross border movement out of Jackson area stores.


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La Crosse Wisconsin Border Area


Quarterly sales in Houston County Minnesota averaged 698.9 cigarettes per capita prior to the130 percent jump in tobacco tax rates. They fell 65.7 percent to just 239.7 cigarettes per quarterfollowing the tax increase.

On the other hand, quarterly cigarette sales in stores located in La Crosse County Wisconsinaveraged 148.8 cigarettes per capita prior to the increase, and 196.1 after the tax went into effectin Minnesota. This was a 31.7 percent increase in quarterly per capita cigarette sales and reflectscross border movement into La Crosse area stores.


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Sioux Falls South Dakota Border Area


Quarterly sales in Rock County Minnesota averaged 186.8 cigarettes per capita prior to the 130percent jump in tobacco tax rates. They fell 41.1 percent to just 109.6 cigarettes per quarterfollowing the tax increase.

On the other hand, quarterly cigarette sales in stores located in Minnehaha County South Dakotaaveraged 250.7 cigarettes per capita prior to the increase, and 280.5 after the tax went into effectin Minnesota. This was a 11.9 percent increase in quarterly per capita cigarette sales and reflectscross border movement into Sioux Falls area stores.


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Ortonville Minnesota Border Area


Quarterly sales in Big Stone County Minnesota averaged 204.1 cigarettes per capita prior to the130 percent jump in tobacco tax rates. They fell 52.0 percent to just 97.8 cigarettes per quarterfollowing the tax increase.

On the other hand, quarterly cigarette sales in stores located in Grant County South Dakotaaveraged 229.5 cigarettes per capita prior to the increase, and 363.4 after the tax went into effectin Minnesota. This was a 58.4 percent increase in quarterly per capita cigarette sales and reflectscross border movement out of Ortonville area stores.


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The Economic Consequences of a Proposed ban on Cigarette Couponing and Price

Promotions In Minnesota

Executive Summary:

Proposals to restrict tobacco companies from offering discounts to consumers will leadto additional job losses. In 2012 about $121.1 million in coupons and retailer discountswere applied to cigarette purchases in Minnesota. This is equal to approximately 51.6-centsper pack. Banning these discounts would reduce cigarette sales in the state by 16.5 millionpacks, resulting in a loss of about 475 jobs, and over $37.8 million in economic activity inMinnesota.

Bans on coupons and price discounts will reduce tax revenues in the State. A ban oncoupons and price promotions would lead to a reduction of $3.65 million in state and local

business and personal taxes, and would cut excise and sales taxes by $55.2 million. Overall,about 19 percent of the revenues that the state gained from its 130 percent tax increase wouldbe lost if a ban were implemented.


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The Potential Impact of a Proposed Ban on Couponing and Price Promotion

Data on actual promotional allowances paid to Minnesota based retailers are not available;

however, the Federal Trade Commission publishes information on overall promotionalallowances paid to retailers nationally.1 Projecting these data through 2012, suggest thatnationally about $ 7.2 billion in product discounts and coupon payments were made in 2012, ofwhich about $121.1 million were applied to purchases in Minnesota.2 This is equal toapproximately 51.6-cents per pack.

Table 1Economic Impact of Proposed Coupon Ban

This ban would therefore amount to a retail price increase of about 51.6-cents per pack on

average, on top of the already high excise and sales taxes. Similarly to the taxes, price increasesas a result of regulations are passed through to consumers who react by reducing their taxablesales and increasing their cross border purchases.

Based on this projected price increase, it is estimated that overall sales would fall by anadditional 16.5 million packs, resulting in a loss of about 475 jobs, and another $37.8 million inlost economic activity in Minnesota. In addition, state and local business and personal taxeswould fall by over $3.65 million, and excise and wholesale sales taxes would fall by $55.2million, as the state would not benefit from simply harming consumers.

The couponing ban would reduce Minnesota fiscal revenues by about $58.9 million. This

reduction is equal to about 18.6 percent of what the state expected to receive from the 130percent increase in the cigarette tax rate.3

1 See: Federal Trade Commission,Federal Trade Commission Cigarette Report for 2011, 2013.2 Minnesota accounts for roughly 1.67 percent of total taxable pack sales Op. cit. Orzechowski.3

Analysis of H.F. 91 (Lenczewski), As Amended in House Tax Committee, Analysis Revised for February

2013 Forecast, Minnesota Department of Revenue, March 12, 2013.

Jobs Wages Output

Direct (370) (10,887,150)$ (23,253,765)$

Manufacture - -$ -$Wholesale (27) (2,461,826)$ (5,809,423)$Retail (343) (8,425,323)$ (17,444,342)$

Supplier (43) (2,291,170)$ (6,361,193)$Induced (62) (2,805,618)$ (8,210,107)$Total (475) (15,983,937)$ (37,825,064)$

TaxesState and Local (3,650,566)$Federal (3,425,113)$

economic analysis of minnesota tobacco tax increase

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