BILL ANALYSIS                                                                                                                                                                                                    Ó




                   Senate Appropriations Committee Fiscal Summary
                            Senator Kevin de León, Chair


          SB 768 (de León) - Cigarette and Tobacco Products Taxes:  
          California Tobacco Tax Act of 2014
          
          Amended: May 14, 2013           Policy Vote: G&F 5-2, Health 6-2
          Urgency: No                     Mandate: Yes
          Hearing Date: May 20, 2013      Consultant: Robert Ingenito
          
          This bill meets the criteria for referral to the Suspense File.


          Bill Summary: SB 768 would impose an additional excise tax of  
          $2.00 per package of 20 cigarettes. The bill would also impose a  
          one-time "floor stock tax" on the cigarettes held or stored by  
          dealers and wholesalers.

          Fiscal Impact: The Board of Equalization (BOE) estimates that  
          this bill would result in a net cigarette tax revenue gain  
          (nearly all of which would be special funds) of $355 million in  
          2013-14, and $1.4 billion in 2014-15. In addition, 2014-15 sales  
          and use tax revenues would increase by $51 million, resulting  
          from the higher excise tax.

          Additionally, though this measure does not directly increase the  
          tobacco products tax, current law triggers an automatic tobacco  
          products tax increase whenever the tax imposed on cigarettes is  
          increased.  Specifically, current law requires the BOE to  
          annually determine the tobacco products tax rate at a rate  
          equivalent to the combined rate of all taxes imposed on  
          cigarettes. Thus, when the cigarette tax is increased, the  
          tobacco products tax rate increases as well. BOE estimates the  
          increase to be $86 million in 2014-15.

          BOE administrative costs related to this bill are substantial,  
          likely about $10 million annually. These costs include: taxpayer  
          notification, tax return design, computer programming, cigarette  
          tax stamp design and denomination changes, and compliance and  
          audit efforts to ensure proper reporting, and floor stock tax  
          administration. Furthermore, the bill requires enhanced efforts  
          to ensure proper floor stock tax reporting and collection,  
          greater compliance efforts for additional billings and  
          delinquencies, and an increase in BOE program and investigative  
          staff presence due to increased tax evasion.








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          The bill would also result in increased administrative costs to  
          various state departments to administer the new revenues from  
          the measure. The bill caps all administrative costs at two  
          percent of revenues, roughly $30 million annually based on BOE's  
          figures.

          Background: Existing federal law imposes a tax of $1.01 per pack  
          of 20 cigarettes with the majority of the funds being used to  
          fund children's health programs.  The federal cigarette tax rose  
          by 62 cents in 2009 to fund the "S-Chip" federal children's  
          health programs.  Existing state law imposes a tax on  
          distributors of cigarettes and tobacco products which fund a  
          variety of programs and services including: health education,  
          research, hospital care, fire prevention, environmental  
          conservation, breast cancer research and early detection  
          services, and early childhood development programs.  The excise  
          tax on cigarettes is imposed at a total rate of 87 cents per  
          pack of 20 cigarettes, allocated as follows:
                 10 cents to the General Fund.
                 25 cents to the Cigarette and Tobacco Products Surtax  
               Fund (created by Proposition 99 in 1988).
                 2 cents to the Breast Cancer Fund (created by AB 478,  
               Chapter 660 of 1993).
                 50 cents to the California Children and Families Trust  
               Fund (created by Proposition 10 in 1998).


          The tobacco products tax is imposed at a rate that is based on  
          the combined rate of tax imposed on cigarettes, as determined by  
          BOE.  The 2012-13 tobacco products rate is 30.68 percent.  
          Revenue from the tax imposed on tobacco products is split  
          between the Proposition 99 and Proposition 10 funds.

          California tax-paid cigarette distributions have decreased  
          dramatically over the past 30 years, both before and after  
          passage of Proposition 10. Consequently, revenues for all funds  
          supported by cigarette taxes have declined as well. Based on  
          outcomes from similar tax increases, there is strong evidence  
          that the Proposition 10 tax increase results in greater declines  
          in annual cigarette and tobacco sales than would have been the  
          case had the Proposition not passed. Current law, as added by  
          Proposition 10, requires BOE to determine the effect of  
          Proposition 10 on the consumption of cigarettes and tobacco  








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          products and directs that a transfer of funds to Proposition 99  
          and Breast Cancer programs be made to backfill for revenue  
          losses to those programs resulting from consumption changes  
          triggered by Proposition 10. The intent of the backfill is to  
          keep the funding levels of certain Proposition 99 and breast  
          cancer programs from declining any more than they would have  
          decreased without the Proposition 10 tax increase. These  
          determinations do not affect the amount of taxes paid by  
          taxpayers. The Proposition 10 backfill determination is strictly  
          an issue of the magnitude of funds allocation from one set of  
          funds to another.

          Proposed Law: SB 768 would impose an additional excise tax of  
          $2.00 per package of 20 cigarettes, and indirectly increase the  
          tax on other tobacco products.  The bill would also impose a  
          one-time "floor stock tax" on the cigarettes held or stored by  
          dealers and wholesalers.  Except for payment of refunds, the  
          bill would require BOE to deposit all revenues into the Tobacco  
          Tax Fund, which this bill would create. The bill would require  
          the Tobacco Tax Fund monies to be transferred in unspecified  
          percentages to the:

                 Tobacco Prevention and Education Account for transfer to  
               the State Department of Public Health (DPH), State  
               Department of Education, and the University of California.
                 Tobacco Disease Related Health Care Account for transfer  
               to the State Department of Health Care Services to improve  
               quality and access to specified health care programs.
                 Tobacco Law Enforcement Account for transfer to the BOE,  
               Department of Justice, and the Department of Public Health  
               for the purpose of "supplementing funding for the  
               enforcement of laws that regulate the distribution and sale  
               of cigarettes and other tobacco products, including, but  
               not limited to, laws that prohibit cigarette smuggling,  
               counterfeiting, selling untaxed tobacco, selling tobacco  
               without a proper license and selling tobacco to minors, and  
               enforcing tobacco-related laws, court judgments, and  
               settlements."


          Staff Comments: According to BOE estimates, this bill is  
          expected to raise total of approximately $1.4 billion in  
          revenues related to the excise tax increase of $2.00 per pack of  
          cigarettes. The assumed increase in the retail price of  








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          cigarettes and tobacco products as a result of this bill would  
          also have an impact on sales and use tax revenues.  State and  
          local sales and use tax revenues are expected to increase by $51  
          million in 2014-15, of which $27 million is General Fund.  

          Furthermore, SB 768 would impose a one-time "floor stock" tax on  
          existing inventories of cigarette dealers, wholesalers, and  
          distributors in an amount equal to the difference between the  
          old tax rate and the new tax rate.  This is intended to equalize  
          the excise tax paid by these entities on their inventory (which  
          was purchased before the effective date of the tax increase) and  
          those products purchased after the effective date.  The floor  
          stock tax mitigates the windfall profits that would occur  
          otherwise. The floor stock tax is estimated to generate  
          approximately $95 million. BOE would incur additional  
          administrative costs associated with the administration and  
          enforcement of the floor stock tax, but these costs would be  
          offset by the proceeds from the tax.

          BOE would incur non-absorbable costs related to the  
          administration and collection of the additional cigarette and  
          tobacco products tax proposed by this measure.  These costs  
          would be related to notifying taxpayers, developing returns,  
          programming computers, developing and carrying out compliance  
          and audit efforts to ensure proper reporting, and administering  
          a floor stock tax.  BOE identified preliminary costs associated  
          with a similar measure in 2009 to be estimated at $11.4 million  
          for fiscal year 2009-10 and $8.8 million for fiscal year  
          2010-11, and each fiscal year thereafter.

          This bill requires BOE to annually determine the effects of its  
          provisions on the consumption of cigarettes and tobacco products  
          and determine the extent to which there has been a decrease in  
          consumption as a direct result of the additional tax imposed.   
          If there is a negative impact, SB 768 would provide for a  
          backfill similar to the one in current law.

          BOE indicates that 951 million tax-paid cigarettes, were  
          distributed in 2011-12, and forecasts that the number will  
          decline to 724 million packs by 2014-15. The decline reflects  
          both the long-term decline in cigarette consumption that has  
          occurred over the last 30 years, and well as reduced demand in  
          response to this bill's $2.00 per pack increase. Finally, BOE  
          research suggests that a tax rate increase as large as the one  








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          imposed by this bill is likely to cause both a decrease in  
          actual consumption and an increase in tax evasion. Staff notes,  
          however, that the bill also provides revenue for increased  
          enforcement efforts, which should partially mitigate the  
          decreases due to tax evasion.