LAO Issues Report on Taxation of Electronic Cigarettes

The Legislative Analyst’s Office (LAO) published a report this week exploring the taxation of electronic cigarettes as proposed by Governor Gavin Newsom’s FY 2020-21 Budget. The report details the current taxes levied on electronic cigarette products, analyzes the Governor’s proposal, and poses several areas for consideration by the Legislature as its budget subcommittees begin their work over the coming weeks.

In assessing the current landscape related to electronic cigarettes, the LAO provides background on electronic cigarette usage, health concerns (including the recent EVALI outbreak), and overall tobacco utilization trends and rates. The LAO assesses the current cigarette and electronic cigarette policies related to taxation, stamps, and federal and state regulatory actions. California currently levies $2.87 per pack excise tax on combustible cigarettes. Electronic cigarettes, on the other hand, are currently taxed at 59 percent of the wholesale price in California. A number of other states similarly impose a tax as a percentage of the wholesale price, while others base taxes on a percentage of the retail price, volume-based electronic cigarette liquid, or cartridge-based liquid.

The LAO analyzes the Newsom Administration’s proposal to impose a new tax on electronic cigarettes with the goal of reducing youth use of electronic cigarettes. Based on the LAO’s review, it is anticipated that the proposed tax would reduce both youth and adult electronic cigarette substantially; however, the tax would also likely increase adult combustible cigarette smoking.

The Governor’s proposed tax would be in addition to existing taxes on the products and would be $1 for every 20 milligrams of nicotine in a product. The exact tax of the product would be established by 1) rounding up the total amount of nicotine to the next highest multiple of 20 milligrams, and 2) assessing a $1 tax per 20 milligrams. For example, a tax on an item containing 92 milligrams of nicotine – roughly the amount in a four pack of three percent nicotine JUUL pods – would be $5.

The LAO discusses the structure of the proposed tax and indicates that the Newsom Administration has not presented a compelling case in estimating that its proposed tax would result in roughly the same state tax rate on nicotine intake, regardless of whether the intake comes from electronic cigarettes or conventional cigarettes. Ultimately, the LAO recommends that if the Legislature agrees with the Newsom Administration focus on reducing youth electronic cigarette use, it should consider alternative nicotine-based taxes that place higher rates on products that tend to encourage or enable youth use.

As the Legislature begins its consideration of the proposed tax, the LAO outlines several key questions, including:

• How harmful are electronic cigarettes?
• To what extent to vapers’ choices account for these harms?
• How would the tax rate affect electronic cigarette use?
• How would the tax rate affect other outcomes, such as cigarette smoking?
• How would the tax rate affect compliance with the tax?
• How would the tax interact with other state and federal policies?

The LAO goes on to further recommend that the Legislature index the tax rate to inflation to keep its economic value steady over time and that the Legislature revisit the rate frequently in coming years. The LAO discusses the proposed revenue allocation and recommends that the revenue allocation should prioritize flexibility, primarily through depositing revenues in the General Fund. Lastly, the LAO discusses the Governor’s proposed tax stamp proposal for electronic cigarettes but finds the Newsom Administration does not appear to have considered the complexity of such an approach enough to justify its requested appropriation of $8 million.

The full LAO report on electronic cigarette taxation is available here.