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. SB 768 (de León) Page 1 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 SB 768 (de León) Page 2 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 SB 768 (de León) Page 3 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 SB 768 (de León) Page 4 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.