Thursday, March 31, 2011
To fill budget gaps, several state legislatures have proposed increasing existing taxes on tobacco and alcohol products. In addition, some states (as well as the federal government) are considering the enactment of new 'sin taxes,' for example on high sugar drinks and internet pornography. This working paper examines the arguments for and against imposing sin taxes. It argues that the use of sin tax revenues should be limited to ameliorating the problems caused by the 'sinful' product rather than for general governmental purposes. The paper uses the Master Settlement Agreement between the states and major tobacco companies to illustrate the moral hazard that is created when states become dependent on sin tax revenues. Finally, the paper draws out lessons from the states’ experience with taxing tobacco products to identify issues that should be considered as state legislatures weigh whether to enact new sin taxes.