We fight to preserve tax competition among nations, but the principle’s effects exist within the US among the states, as well. George Scoville writes about the likely outcomes of a decision by Vermont to raise their cigarette taxes by $0.38 while New Hampshire lowers theirs by $0.10:
Prices are information wrapped in incentives, and taxes effectively raise the price of consumer goods. Sure, people might benefit from some tax-funded program — like the roads they take to get to the convenience store to buy their cigarettes — but people aren’t very good when it comes to calculating discount rates (you should click that link if you’re new to economics; I’m not talking about discounted goods or lower prices). And because they’re not good at it, they forgo buying the cigarettes when the tax increase changes the price signal, and this ultimately leads to a decrease in revenues.
…[T]he really interesting dynamic at play here is the potential tax competition in cigarettes between New Hampshire and Vermont. Since the two are so geographically close, I wonder to what extent Vermont smokers would cross state lines to buy their cigarettes in New Hampshire.
Intuition says that, aside from the effects of the price signals Vermont’s new tax will send to consumers, resulting in revenue losses for Vermont, New Hampshire would see a surge in cigarette consumption and tax revenue from Vermont consumers buying their cigarettes across state lines.
His intuition in this case is based on a sound understanding of the principles of tax competition, and an article he quotes – suggesting that states are looking at cutting sin taxes because they haven’t brought in the expected revenue – that supports this view. The question will be whether a net relative change of almost $0.50 in taxes between the neighboring states is strong enough to impact behavior enough to offset the hike itself. I think it may well be.
