By Robert L. Shepherd with Shepherd, Williams & Associates LLC
Without question, moist smokeless tobaccois a profitable, growing and dynamic category.However, category and retail profits are at risk due to customer down-trading from premium to price-value products.Opponents of weight-based taxes have done much to muddy thewaters but, not surprisingly, what they fail to focus on is theissue most important to retailers—profitability.
The manner in which states tax moist smokeless tobaccohas a direct impact on retailer profits. Despite what opponentsof weight-based taxation have said and written, category andtax experts agree that a weight-based tax structure on moistsmokeless tobacco is not only the proper and fair tax method,but it will help preserve retailer profits. The primary opponentsof weight-based taxes arethe same companies who benefit most from an unfair state tax subsidy on price- value products. That begs the question: Are the opponents of weight-based taxation focused on their bottom line or yours?
RetailerProfits . . .Focus OnWhat’sImportant
Unfortunately, while moist smokeless tobacco is a profitable and growing category, retailer profits are being eroded by customer down-tradingfrom premium to price-value products. On a country-wide basis,a retailer’s average profit on a can of premium MST is about$1.17. On sub-price value, a retailer’s average profit per canplummets to about $0.52, a difference of $0.65. Said anotherway, on a national basis retailers, on average, make about125% more profit on a can of premium. It’s no wonder premiumsales are critical to a retailer’s business.
Retailers, however, face an uphill battle against ever increasing ad valorem taxes that artificially inflate the price gapbetween premium and price-value products, encouraging customers to switch to lower-profit products. Don’t take my wordfor it; instead let’s look at what third-party tax and industryexperts have said about ad valorem taxes. In an article entitled”Taxes on Smokeless Tobacco Unfair, Ineffective,” The Budgetand Tax News stated that “[m]uch of the effect of this ad valorem tax is merely to encourage more consumption of the inexpensive brand.” And in a recent industry article discussing MSTtaxation, industry expert David Bishop stated that “the ad valorem tax structure erodes retail profits in the MST category[.]”
The bottom line is this: ad valorem taxes unfairly force premium customers to pay the lion’s share of moist smokelesstobacco taxes and, as a direct result, many adults switch fromtheir preferred premium brand to less profitable price-valueproducts. A weight-based tax system levels the playing field forall products, for all customers, and it preserves retailer premium profits.
Level the Playing Field—Stop Penalizing Premium Customers
The opponents ofweight-based taxes may becorrect when they claimthat a Ford automobile would betaxed the same asa Mercedes automobile under aweight-based taxsystem. Unfortunately, this analogydemonstrates theirtotal misunderstanding of the differences betweensales and excisetaxes, and is totally without merit.
Cars are subject to sales taxes in most states, but not excisetaxes. Tobacco products are subject to both excise and salestaxes. Excise taxes are consumption taxes intended to tax alllike products the same. They are not intended to create a taxpreference for certain items. For that reason, excise taxes onvirtually all other consumer products such as cigarettes, alcohol and gasoline are unit or volume based. Under unit or volume based excise taxes, customers who purchase a six-pack ofbeer would pay more sales tax for a more expensive beer, butthe same excise tax regardless of the brand or cost of the product they select. It’s fair.
On the contrary, an ad valorem tax on MST is unfair becauseit distorts the market by placing the majority of the tax burdenon premium MST customers, thereby forcing them to alter theirpurchasing behaviors and trade down to less expensive, lessprofitable price-value products. Opponents of weight-basedtaxes cry out that the ultimate loser under a weight-based MST tax is the value-conscious customer. Thereality is that the price-value customerhas always benefited from an unfair,state-subsidized tax loophole, the effectof which has always been unfair to premium customers who pay more tax per canfor a similar product. Here again, statepolicymakers agree: “Forty states currently impose ad valorem excise taxes onmoist smokeless tobacco products.Policy makers in these states shouldrepeal this outdated, discriminatory taxpolicy…,” said the American LegislativeExchange Council (ALEC).
Ad valorem taxation of MST productsmade sense decades ago when there wasone price point and approximately tenproducts on the market. Back then, everyone paid the same tax—no inequity.
Today, there are over one hundredproducts and numerous everydayprice points, not to mention discounts,promotions and incentives. Theresult is tremendous tax inequity; the winners aremanufacturers of price- value products and the losers are your premium customers and your bottom line. Asystem that worked decades ago isnow unfit for its intended purpose: the dynamic and growing MST category has outgrown the ad valorem tax system. The tax code should notdictate the profitability of your business bycontrolling your customers purchasingdecisions. With the conversion to a weightbased tax, no customer is forced toassume a higher tax burden than anyother customer. It’s fair. It does not discriminate.
Weight-Based Taxes Make MSTTax Increases Less Likely
In addition, ad valorem taxes leavestate revenue departments short on projected MST revenue. The reason is downtrading. As more customers trade down from premium to price-value products, advalorem excise tax revenues are reduced.States forecast their MST revenue basedon prior years sales figures, but fail toaccount for the revenue loss caused bydown-trading from premium to price-value.Is there any wonder why your state keepsopening the tax code to increase MSTtaxes? Conversely, under a weight-basedtax, a state realizes the same revenue perunit regardless of the MST brand a customer selects, and there will be no need to take a tax increase since categorygrowth will automatically increase statetax revenues. In the first three quarters of2006, the MST category grew by morethan 8%. There is also a misguided notion,perpetuated by weight-based opponents,that eliminating the ad valorem tax will rob states of increased revenue from manufacturer price increases. It’s a slippery slope. Although states may capture some additional taxrevenue from a manufacturer priceincrease under an ad valorem tax, suchactivity simultaneously fuels an acceleration of premium customers trading downto price-value products. The net result isthat retailers realize less profit and statesend up collecting less total revenue.
A leading tax policy organizationdescribes the ad valorem tax dilemma thisway: “An ad valorem tax is a tax (stateexcise tax) on a tax (federal excise tax)which in turn artificially hikes a third tax, the sales tax. Instances of double andtriple taxation distort markets and hidethe true tax burden. This leaves lawmakers off the hook and taxpayers footing thebill,”said the Americans For Tax Reform.A leading, non-partisan legislative organization in 2006 explains ad valorem taxesin similar fashion: “Excise taxes based ona percentage of the price result in … market distortions, hinders economic activityand results in an unreliable revenuesource for the states,” said the AmericanLegislative Exchange Council (ALEC).
When state revenue departments fallshort on their MST revenue projectionsthey are left with little choice but to openthe tax code and increase the ad valoremtax. Adopting a weight-based
tax for MSTpromotes a predictable, stable and growing revenue streamas MST revenue isless beholden toconsumer purchasing behaviors, butinstead is basedupon predictableunit volume withinthe state, makingfuture MST taxincreases less likely. Nine states andthe federal government havealreadyadopted aweight- orunit-basedtax and thenumber ofstates considering suchlegislation isever increasing.
The manner in which states tax moistsmokeless tobacco has a direct impact onretailer profits. Category and tax expertsagree that a weight-based tax structure onmoist smokeless tobacco is not only theproper and fair tax methodology, but it willhelp preserve retailer profits. Quitefrankly, I can’t blame opponents of weightbased taxes for fighting to preserve thebenefits they’ve been enjoying thanks tothe unfair, state-subsidized tax loopholefor price-value products, but don’t let theirefforts erode your bottom line.