By Clea Benson, CQ Staff

Ten years ago, Congress created the State Children’s Health Insurance Program and funded it with a 15-cent rise in the federal tobacco tax.

Now that the program is up for reauthorization, Democrats are pushing to expand it to cover more children in low-income working families who earn too much to qualify for Medicaid. Most of the debate has been over the scope of this expansion. What has been largely overlooked is the proposed method of financing: an increase in the tax on each pack of cigarettes by 61 cents, which would raise an estimated $35.7 billion over five years.

Although tobacco helped pay for this program from the beginning, a new wrinkle has arisen. In the intervening years, levies on tobacco have also become increasingly popular among the states. The average state excise tax on cigarettes has more than doubled in inflation-adjusted terms, to $1.07 per pack from 48 cents since 1997. And states are using the money to pay for a broad array of needs beyond the health-related programs that often benefited in the past from tobacco taxes.

Economists, including those at the Congressional Budget Office (CBO), say making it more expensive to smoke by adding a federal levy will definitely dampen tobacco sales enough to cut into state tax receipts at a time when they can ill afford to lose the money.

Tobacco companies and anti-tax groups are doing their best to raise the issue. They also point out that revenue from taxing tobacco are all but guaranteed to decline over time, since part of the point is to discourage youth from beginning a lifelong habit by raising the cost. Therefore, those tax opponents reason, the levy is hardly a reliable way to finance a permanent program that will probably grow along with the U.S. population.

President Bush, who already vetoed one SCHIP bill in part because it contained new taxes, stands ready to take the same action on the pending bill. Democrats are currently working to find enough Republican votes for a veto override in the House.

But, so far, no one is talking about an alternative revenue source, primarily because state officials are more worried about getting SCHIP reauthorized than they are about any potential hit to their treasuries. The National Governors Association, the National Conference of State Legislatures and other groups that represent state interests aren’t taking a position on the tobacco tax.

Ohio Gov. Ted Strickland , a Democrat, said recently that the children’s health program was so vital that the state would just have to grow its economy to make up for any financial loss created by an expansion.

At the same time, many states are continuing to consider still further increases in their own tobacco taxes, possibly causing tobacco sales to decline still more, especially in high-tax states.

“If a state’s looking for a revenue source to balance its budget or fund a health-care priority, more and more a cigarette tax is part of that mix,” said Bert Waisanen, a fiscal analyst at the National Conference of State Legislatures. “In the last five years, for states that have been looking for new revenues, it’s been a common source.”

‘Sin Tax’

Since 2002, 43 states have raised tobacco taxes a total of 70 times, according to Sujit M. CanagaRetna, a budget expert at the Council of State Governments. In part, states need to keep raising their tobacco tax rates to maintain purchasing power eroded over time by inflation and the decline in smoking.

But recent increases also show a growing willingness among states to use tobacco levies as a way to solve broader budget problems, CanagaRetna said. “During the early part of the decade when states faced the worst fiscal downturn in 60 years, they were really grappling with all kinds of ways to raise revenues when raising taxes was still very toxic,” he said. “But, on the other hand, raising a host of these sin taxes turned out to be very successful.”

CBO estimates that a 50-cent rise in the federal tax on tobacco would raise almost $7 billion annually for the federal government and cost state and local governments about $1 billion because of the dampening of demand. That’s out of about $14 billion that states currently collect in tobacco taxes and from settlements they got from lawsuits against the industry, which are pegged to smoking rates. Smoking tends to decline about 5 percent for every 10 percent increase in price, according to CBO estimates.

In the states, reduced receipts linked to a drop in smoking already have had a very real impact on spending.

In California, for example, voters in 1988 approved Proposition 99, which raised the state cigarette tax to 25 cents per pack and earmarked the extra money for smoking-prevention and health programs. As smoking has dropped off, and other taxes on tobacco have been added (the total California cigarette tax is now 87 cents per pack), Proposition 99 revenue has dwindled by almost 70 percent in inflation-adjusted dollars.

The Rise and Fall of Tobacco and Its Taxes: Click Here to View Chart

That decline has affected some programs. Hospitals in rural areas once received tobacco tax money to help offset the cost of treating indigent patients, but haven’t received any of that funding since 2001. The state’s smoking-prevention budget also has shrunk.

The impact of a federal tax increase is likely to reverberate differently among the states, which have widely varying cigarette levies, ranging from 7 cents per pack in South Carolina to $2.58 in New Jersey. Moreover, some state budgets rely more heavily on tobacco revenue than others. At the top of the list is New Hampshire, which finances about 7 percent of its overall spending with tobacco levies.

Tobacco companies themselves have been offsetting some of the impact of price increases in recent years by spending billions on marketing programs that offer discounts to loyal customers. That helps explain why, despite the zeal among states to increase taxes, the decline in smoking has slowed over the past three years.

So far, all of the recent tax increases at the state level have resulted in near-term revenue gains, even though overall tobacco sales have declined. Supporters and opponents of raising the federal tax disagree on whether the price of tobacco products is reaching a tipping point in some states beyond which it will be impossible to raise taxes without driving down sales so far that there won’t be net increase in revenue.

CanagaRetna, whose organization doesn’t have a position on whether raising tobacco taxes is good policy or bad, said data suggest there is probably room for states and the federal government to keep raising taxes for now.

The conservative Heritage Foundation, meanwhile, recently released a study predicting that smoking would decrease so much as a result of the proposed increase in the federal tax that 22.5 million people would have to take up smoking to finance SCHIP through 2017.

But that projection was dismissed as “crazy” by Eric Lindblom, director of policy research at the Campaign for Tobacco-Free Kids. “They’re just assuming unprecedented, incredible smoking declines year after year,” Lindblom said. “We wish that were true.”

‘Drives Down Health Costs’

Supporters of the proposed SCHIP expansion say arguments against raising the tobacco tax overlook the public benefits of a decline in smoking. And they argue that a decline in cigarette sales will reduce spending on medical services in the long run.

In California, lawmakers are considering a $2 per-pack tobacco tax increase to help fund a complete overhaul of the state’s health care system, on top of whatever new levies Congress may enact.

Using a tobacco tax to pay for health costs is “certainly not a viable idea for perpetuity, but it does have a triple impact,” said Jim Keddy, director of PICO California, a coalition of faith-based organizations. “It generates money for children’s health in the short term, and in the long term it reduces smoking among young people, and it drives down health costs.”

Lindblom argues that tobacco taxes are a stable source of revenue compared with taxes on income or property that are pegged to the economy and more volatile as a result.

But tax opponents say raising tobacco levies to pay for children’s health insurance is only the beginning. As revenues decline and the program grows, they predict lawmakers will look at other taxes to pay for it. The original SCHIP program was capped at $40 billion over 10 years, but with program expansions and a growing population, states have bumped against that ceiling and want more money.

“The politicians who pass these tax increases on cigarettes know perfectly well that it’s a declining revenue source,” said Grover Norquist, president of Americans for Tax Reform. “A cigarette tax today is an income tax, a sales tax, or a property tax five or 10 years down the road.”

FOR FURTHER READING: Importance of SCHIP program to the states, CQ Weekly, p. 639; veto of first SCHIP reauthorization (HR 976), p. 2396; passage of second SCHIP reauthorization (HR 3963), p. 3337.