The Minnesota Legislature has produced two proposals that reveal our ambiguous feelings about tobacco and gambling.
We still disapprove of gambling. We increasingly disapprove of smoking. But recognizing that some people want to gamble or smoke just as some want to drink alcohol, as long as such consumption is going to occur, we want to make some money on it.
Governments have long taxed “vices” or distributed them through state monopolies; each accomplishes the same goal: bringing in revenue.
There are three arguments to support such revenue-generating practices.
The first is the traditional moral argument that gambling, smoking and drinking are sinful and harmful to society. Ideally, in this point of view, such activities should be banned. But moderate indulgence in these vices brings little apparent harm to individuals or society. Besides, banning is difficult.
The second is the pragmatic argument that alcohol, tobacco and gambling are good things to tax because such taxes are relatively easy to administer and don’t seem to affect demand for products. In economists’ jargon, demand for these vices is inelastic.
The third is the “Pigouvian” argument, the most sophisticated in economic terms. Economist Arthur C. Pigou a century ago argued that free markets will overproduce any economic good or service that involves external costs, such as pollution, illness or danger. He recommended taxes equal to the external cost of producing or consuming such goods. Consumers would get the “right” price signals and the goods would be used at a level where their benefits to society exceed their costs.
These three arguments are jumbled in the Legislature and in public discussions of tobacco and gambling.
Pragmatism dominated when Minnesota set cigarette taxes a few decades ago. The idea was to raise some money without appearing unfair to the people who smoked.
This week’s proposal by DFL leaders to triple cigarette taxes mixes Pigouvian “Let’s provide an incentive to reduce this external cost activity” and moral “We should punish people who smoke” arguments. Smokers no longer are seen as a voting group with any power and few argue that higher taxes on them might be unfair. Gov. Tim Pawlenty and others argue against tax increases but say little in defense of smokers.
Yet, smokers already pay sharply higher retail prices for cigarettes since tobacco companies raised prices to fund multibillion dollar liability settlements negotiated in the 1990s. Most studies show that smokers now pay prices that more than equal the total social cost of their activity. So the Pigouvian argument really doesn’t hold anymore.
Gambling is even more muddled. In 20 years, Minnesota has done a complete flip-flop on it. We used to suppress all gambling.
Today, the state government runs a lottery and taxes nonreservation gaming.
There really isn’t any rhyme, reason or logic to this. The state lottery and reservation casinos advertise on television, yet cigarettes and distilled spirits makers and distributors can’t. Charitable gambling lobby groups sponsor programs on public radio yet police crack down on private bookies.
Some skeptical economists interpret all of this as monopolistic activity by government that keeps the public from getting as good a deal (payout ratios) for their gaming dollar as they might if the gambling sector were opened up to more competition.
Yes, there still are some state constitutional issues, but these could be amended away if fair treatment of consumers were an issue, rather than expediency and securing funds for the state coffers.
As an economist, it is hard to see any fairness or efficiency argument for either the higher cigarette tax or the “racino” proposed for Canterbury Park. But given how expediency dominates careful weighing of the issues in the budget crisis environment, we probably will end up with both.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.