SPECIAL‐INTEREST SPILLOVERS AND TOBACCO TAXATION

This study explores the effects tobacco special interest has had on cigarette tax rates. Using a spatial econometric model to control for tax competition and the endogeneity present in state tax rates, this study finds that tobacco special interest has played a significant role in influencing state cigarette tax rates. Pounds of tobacco grown in a state and tobacco industry campaign contributions are associated with lower cigarette tax rates. The empirical results show that the magnitude of the special-interest effect can be two to five times as large when the spatial spillover effects are included. (JEL C23, H71, H73) I. INTRODUCTION The variance in cigarette tax rates across U.S. states has skyrocketed. Between 1960 and 2007, the variance in cigarette tax rates across all 50 states, measured in cents per pack, grew from 3.8 to 4,188.9. New Jersey increased its nominal cigarette tax rate $2.50 per pack, while South Carolina increased its nominal cigarette tax rate $0.02. What explains the divergence in tax policy? Basic public finance demonstrates the need for greater government tax revenues because of increased government expenditures. State government expenditures have grown, so states have pursued greater tax revenues, including larger excise taxes. (1) Recent empirical literature has also demonstrated that state tax rates can be interdependent, so an increase in one state's cigarette tax rates leads to increases in the rates of neighboring states. These two forces would suggest that tax rates should have dramatically increased in all 50 states. However, the tax rates have remained persistently low for most of the southeastern states. This study explores the determinates of cigarette tax rates for U.S. states from 1960 to 2007. I hypothesize that tobacco special interest, concentrated in the southeastern states, suppressed cigarette tax rates in tobacco-producing states. The persistence of low cigarette tax rates in the south, paired with tax rate growth in other U.S. states explains the parody currently observed. The literature has produced mixed results regarding the effects of tobacco special interest on cigarette tax rates and control policies. Hoffer and Pellillo (2012) and Gallet, Hoover, and Lee (2009) find that tobacco production influenced tobacco control expenditures and the implementation of several laws making it more difficult for youths to obtain access to tobacco, respectively. Holcombe (1997) found a significant, inverse relationship between tobacco production in a state and that state's cigarette tax rate. On the other hand, Devereux, Lockwood, and Redoano (2007), Fredriksson and Mamun (2008), and Besley and Rosen (1998) find special-interest groups have little or no effect on tax rates. These conflicting findings are heavily influenced by model selection, most notably the way in which each study attempts to correct for the spatial endogeneity of tax rates. As Brueckner (2003) points out, there exist many potential sources of interaction among governments that might result in spatial correlation among tax rates, but the most notable reason may be tax competition for mobile tax bases. In this study, I estimate a panel spatial Durbin model (SDM) and a dynamic SDM to control for tax competition, tax rate endogeneity, and tax rate persistence. I find cigarette tax rates are highly persistent and spatially interdependent. I also find evidence of a strong special-interest effect. Tobacco production and tobacco lobbying expenditures are associated with significantly lower tax rates in all model specifications. The magnitude of the effect of special interest is magnified nearly fivefold once accounting for spatial and dynamic spillover effects. II. LITERATURE REVIEW The vast literature relating to the tobacco industry has primarily focused on the consumption side. Many studies explore the effects of tobacco-related policies. …