U.S. Senate Republican Policy Committee - Larry E. Craig, Chairman - Jade West, Staff Director
May 22, 1998

Revenue Effect of "Commerce-2"
Revenues Raised under Revised Tobacco Bill Remain Substantial

Monday's revised version of S. 1415, the tobacco bill (what we refer to as "Commerce-2"), contains many significant changes from the bill as reported, and the fiscal changes are some of the most significant.

This paper limits itself to the revenue effect of Commerce-2. [A separate paper looks at the spending; and for a look at the many other significant changes in Commerce-2, see RPC's Legislative Notice No. 67(a), "Highlights of the McCain Modification ('Commerce-2')" issued May 21.] Commerce-2 reduces the number of trust funds from six to a single one and is now on-budget. The trust fund, which remains the bill's primary mechanism for the spending and receiving transactions, now contains different accounts to handle the spending provisions stipulated in the bill. Notable is the fact that the projected amount of revenue flowing into the trust fund is substantially lower than what was estimated previously under "Commerce-1" (the bill as reported). (See, also on p. 2, a discussion of other key revenue changes in the bill.)

The Estimated Revenue Totals Under Commerce-2

This analysis provides an overview of the estimated revenue totals [see attached tables]. Based on estimates of annual industry payments and assuming some (but not the maximum) look-back penalties, RPC concludes that Commerce-2 would raise net federal revenues:

  • $64.8 billion over five years (JCT estimates)
  • $132 billion over nine years (JCT)
  • $514.2 billion over 25 years (RPC)

In addition to our own work, this paper has made use of analyzes from various entities, including: Joint Committee on Taxation (JCT), Congressional Budget Office, Senate Budget Committee, Senate Finance Committee, and the Senate Commerce Committee. This new figure is smaller than earlier estimates made by both OMB (which had estimated revenues of $755.9 billion over 25 years without including any penalty payments) and by RPC (which in a May 8th paper estimated revenues between $755.3 billion and $868.9 billion over 25 years -- the range reflecting no penalty versus the maximum penalty permissible). The main reason for this difference is that Commerce-2 explicitly states that Treasury will estimate and credit only "net revenues" to the trust fund. These net numbers are reflected in our new estimates. However, even though the JCT estimates lower net revenues to the federal government, the tobacco consumer will pay the absolute amount (see p. 5 for a per pack discussion).

Key Revenue Changes to Commerce-2

As in Commerce-1, the trust fund created is the entity that receives payments from tobacco producers and makes the disbursements to the various spending programs created by the legislation. Revenues will come from payments made by the participating tobacco companies, fines and penalties in this title, and "look-back" penalties for failure to meet certain underage smoking targets (contained in Title II of the bill). Commerce-2 now explicitly links spending to revenues and makes more spending subject to appropriations (with the exception, most notably, that payments to the states and aid to farmers remain direct spending). The following are other prominent revisions to the revenue provisions of S. 1415:

Revenue Effects: "Absolute" versus "Net," and Other Economic Factors

A comparison of "Commerce-1" and Commerce-2 would seem to present a conundrum: Commerce-2 potentially could raise more revenue than Commerce-1 ($885.55 billion, up from $868.9 billion over 25 years, assuming the maximum annual payments and look-back penalties were paid: see tables); however, less revenue will be credited to the trust fund ($514.2 billion over 25 years, see Table II). Why does this occur? The main reason is the difference between "absolute" and "net" revenues.

[Note that JCT in its estimate noted several inconsistencies in the legislative language, which if not corrected, could result in different payment levels from differing interpretations of the language].

The Net Revenue Totals: Payments to the Trust Fund

The attached Table 1 shows both the estimates of the payments to the trust fund and a comparison of the differences with what we call "absolute" totals. (Table 2 shows how the maximum potential payments were calculated: we assume maximum annual payments and maximum look-back penalties, but zero pass-through penalties and zero nonpayment penalties -- not because we don't assume they will be assessed, but because they are difficult to estimate).

The elements of Table 1 are explained below:

Column 1: Year. Commerce-2 defines years as calendar years, while JCT estimates on fiscal years. As a result there is some transference of payments in translating between the two.

Column 2: Absolute Annual Payments. These are the highest annual payments that the industry could make -- without taking into account the volume or net tax adjustments.

Column 3: JCT Net Annual Payment. These are JCT's estimates of the annual payments to the Trust Fund, through 2007 (which is as far as JCT would estimate).

Column 4: JCT Annual Payment Reduction Percentage. This is the percentage by which JCT reduced the absolute annual payment level (column 2) to obtain the net payment amount (column 3).

Column 5: Net Annual Payment at JCT 2007 reduction rate. In order for RPC to arrive at 25-year figures, we extrapolated the out-years by applying JCT's reduction rate in 2007 (58 percent) to the absolute annual payment levels (column 2). This gives us numbers for the remaining 16 years.

Column 6: Absolute Look-Back Penalty. These are the highest penalty payments that the industry could make -- they do not take into account volume or "net" reductions. [Note, we don't attempt to calculate the other allowable penalties in the bill.]

Column 7: JCT Look-Back Penalty. These are JCT's estimates of the look-back penalty payments to the Trust Fund through 2007.

Column 8: JCT Reduction Percentage. This is the annual percentages by which JCT reduced the absolute annual payment level (column 6) to obtain the net payment amount (column 7).

Column 9: Net Penalty Payment at JCT 2007 reduction rate. In order for RPC to arrive at 25-year figures, we extrapolated the out-years by applying JCT's reduction rate in the year 2007 (62 percent) to the penalty payment levels (column 6) for the remaining 16 years.

Column 10: Absolute Totals. This is the maximum industry assessment when the maximum annual payment is added to the maximum look-back penalties (see Table 2 for a detailed description).

Column 11: Net totals. This is RPC's estimated payment to the trust fund from the annual payment and look-back provisions, using JCT's assumptions for the first 9 years, and extrapolating from them for the remaining 16 years.

Price Per Pack and Impact on Taxpayers

According to JCT, the price per pack of cigarettes (calculated based on the total impact of Commerce-2 on the cost of cigarettes) over the next 10 years would be the following:

YearPrice ($ Per Pack)
19981.98
19992.88
20003.24
20013.41
20023.66
20033.83
20044.06
20054.12
20064.78
20074.84

In addition, JCT also estimated how the price increases would affect different income classes. Statistics show that excise taxes are regressive and disproportionately affect those in the lower income brackets. JCT distribution tables found that in 2003, a taxpayer making less than $10,000 per year would pay 35.1 percent more in federal taxes; a taxpayer making between $10,000 and $20,000 would pay 9.6% more; and a taxpayer earning between $20,000 and $30,000 would pay 4.2% more. Overall, taxpayers earning less than $75,000 a year, would pay 54.5 percent more in taxes.

The Volume Adjuster: The Unknown Variable

Section 403(2) of Commerce-2 states, "Beginning with calendar year 2002, the applicable base amount (as adjusted for inflation under paragraph (1)) shall be adjusted for changes in volume of domestic sales by multiplying the applicable base amount by the ratio of the actual volume for the calendar year to the base volume. For purposes of this paragraph, the term "base volume" means 80 percent of the number of taxable domestic removals and taxed imports of cigarettes in calendar year 1997." This volume adjuster is an essential component in determining the annual industry payments. Depending on how consumption levels change, this could increase or decrease industry payments.

However, making the required reductions sufficient to receive a downward adjustment in payments will be difficult for the industry. U.S. consumption in 1997 was 480 billion cigarettes -- this was the lowest consumption level in a decade, having fallen from 563 billion in 1988, 500 billion in 1992, and 485 billion over each of the next four years. The base amount stipulated in Commerce-2 then is 384 billion cigarettes -- 80 percent of that comparatively low 1997 consumption number.

Further making it difficult for industry to reduce consumption is the fact that the U.S. population is increasing. Current U.S. population is 270 million people. By 2023, the last year projected under Commerce-2, U.S. population is to be 330 million -- an increase of 22 percent. So, while this bill has no effect on population growth, it requires cigarette consumption to be reduced -- by 20 percent from 1997 levels. What this means is that reduced smoking by the current population of smokers is not sufficient to meet the volume-adjustment targets. Instead, there must be an absolute reduction in smoking.

Of course, this has large implications for industry payments and therefore federal revenue. JCT's preliminary estimate is that volume adjustments would be met and that the annual payments then would be decreased substantially. Under JCT's assumptions, gross industry payments would fall $3.6 billion in 2002 -- the first year the volume adjuster would be in effect -- and by $6.6 billion in 2007 (JCT's last estimated year). If JCT's estimates are not realized federal revenue could be much larger than currently projected.

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