Taxes, Cigarettes And George Lucas

The great economist Arthur Laffer long ago observed that high rates of taxation don’t always correlate with high levels of government revenue. If the tax-or price-put on certain activities is too high, individuals will often change their behavior to avoid paying it.

Legislators have for the longest time resisted Laffer’s reasoning, and, as evidenced by the electorate’s willingness to elect politicians eager to increase taxes, voters aren’t completely sold either. But as individuals, on the micro level, it seems we’re all correctly enthralled by the “Laffer Curve.”

Take George Lucas-one of the most prominent film producers in the world. OK, so Hollywood has never been a hotbed for supply-side devotees (despite former actor and future president Ronald Reagan’s advocacy). But filmmakers understand and abide by supply-side principles, even if they do so unwittingly. Whatever Lucas’ politics, taxes have profoundly changed his behavior when it comes to making movies.

“As a producer,” he recently told The Wall Street Journal, “I will always go to the country that has the best crew coupled with the most tax incentives.” Lucas-the man behind the immensely popular Indiana Jones and Star Wars franchises-produced The Young Indiana Jones Chronicles in the Czech Republic. But due to better tax plans offered elsewhere, it’s unlikely he’ll stage future projects there.

One destination Lucas could consider, however, is Hungary. Presently, Hungary is offering tax incentives for filmmakers that trump those offered in the Czech Republic, and judging by film-production spending in each country, the level of taxation has a substantial impact on where film crews settle.

Production spending in the Czech Republic hit a peak of $270 million in 2003; by 2008, spending had fallen to $40 million. Conversely, Hungary was able to attract $21 million in production spending back in 2004 when it passed welcoming tax incentives. Last year, that number rose to $250 million.

Just as prices of goods inform our purchasing decisions, so do taxes. Thanks to more onerous levels of taxation on movie production in the Czech Republic, its government is now collecting a larger percentage of a smaller revenue pie. On the other hand, Hungarian legislators can look forward to a smaller percentage of a much bigger pie. Rates of taxation matter.

Just as the tax rate on movie production can lead to shifts in the location of film sets, tobacco smokers frequently game local and state tax regimes to buy cigarettes as cheaply as possible. Particularly of late, state governments around the U.S. have turned to “sin” taxes as a way of shoring up budget shortfalls that have resulted from slower economic growth.

What they didn’t account for is the willingness of citizens to work around those taxes. For one, online cigarette stores allow smokers to buy cigarettes from states that tax them the least. High-tax Washington, D.C., borders Virginia, so it’s more than common for District residents to either travel into Virginia to buy cigarettes or pay friends who live there to bring them over.

In addition to relatively minor transactions like those mentioned above, the usurious taxes have also led to large-scale smuggling between states for the same reasons. Not surprisingly, increased smuggling across state lines has led to major budget shortfalls in states that hoped the sin taxes were their path to balanced budgets.

Indeed, The Wall Street Journal has reported that “states are losing about $5 billion annually in tax revenue because of illegal tobacco sales.” And with cigarette taxes varying even by county in places like Virginia, local governments are now experiencing budgetary problems as consumers cross county lines to make their purchases.

What the states and counties apparently didn’t account for is the simple truth that taxes are a price, and when they rise, consumption frequently shifts to where prices are lower. Just as George Lucas shops for movie locations based on cost, so do consumers reorient the location of their cigarette purchases.

The greatest amount of cigarette tax avoidance is centered in New York City. With combined state and local taxes of $4.25 per pack, smokers are being forced to pay as much as $10.50 when they buy cigarettes. The large difference between the actual cost of cigarettes and their New York City retail price has naturally created major incentives among smugglers to work around the tax man.

So while tax authorities in New York have arrested a few modern bootleggers, the tax premium there means that the risk/reward ratio is high enough that many smugglers will continue to try and evade the authorities-and logic says they’ll frequently succeed. As long as they do, city and state revenues from cigarette sales in the Empire State will decline until taxes are reduced enough so that smuggling and out-of-state purchases are no longer a profitable endeavor.

The irony in all this is that New Yorkers have seen this movie before. Back in 1972, New York state increased the cigarette tax from 9 cents to 21 cents per pack. But as a New York Times editorial observed after the increase, “revenue from cigarette taxes has dropped far below estimates even though smoking has not. The difference is so great that a reduction in the tax rate to put the smugglers out of business would probably produce greater income for the state.”

History, as they say, is repeating itself. Contrary to what politicians frequently assume, raising taxes is not the equivalent of raising revenues. Whether on film production, cigarettes or income, the best way to raise taxes is often to cut them.
© Copyright: Forbes

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