New Evidence on E-Cigarette Taxes Highlights Competing Benefits and Pitfalls

Cigarette use in the United States has been on a consistent downward trend in recent decades, dropping from 20.9% to 12.5% between 2005 and 2020. However, the rising popularity of electronic cigarettes (E-cigarettes) has counteracted this reduction in tobacco use. This trend has been particularly prominent among adolescents. Between 2011 and 2015, E-cigarette use among middle and high school students increased 900%. The Centers for Disease Control and Prevention (CDC) estimates that in 2018, more than 3.6 million adolescents used E-cigarettes. This development presents pressing public health concerns. E-cigarettes produce an aerosol containing highly addictive nicotine, as well as many harmful substances such as carcinogens, chemicals linked to serious lung disease, and heavy metals such as lead.

The 2019 National Youth Tobacco Survey attributes this recent trend to several factors including misperception among adolescents. 28.2% of students indicated that they believed that E-cigarettes caused little to no harm to health, compared to only 9.5% for traditional cigarettes. The survey also identified peer usage and the availability of flavors such as chocolate and mint as key driving factors behind E-cigarette usage.

While parental influence, community education campaigns, and prevention programs play a role in curbing the adolescent use of E-cigarettes, government interventions can also impact the level of E-cigarette usage among both adolescents and adults. In June 2022, the Food and Drug Administration (FDA) ordered JUUL Labs Inc., the company behind many of the most popular E-cigarettes, to stop selling their products in the U.S., although JUUL has since been permitted to sell its products while it seeks legal appeal of the ban. The FDA’s increasingly aggressive actions have corresponded with the rapid acceleration in adolescent E-Cigarette use and follow intensifying pressure from public health groups for more restrictive measures to combat the alarming trend.

An increasingly popular policy has been to levy taxes on E-cigarettes. As seen with cigarette taxes imposed throughout the early- to mid-1900’s, these taxes are designed to disincentivize consumers from purchasing and using these products. By December 2019, 17 states and Washington D.C. had implemented an E-cigarette tax, and by September 2022, this number had nearly doubled to 30 states. This regulatory approach has spread rapidly nationwide — but has it proven effective at reducing E-cigarette usage?

A recently published study in the Journal of Health Economics provides new insight into the effectiveness of this policy in reducing E-cigarette usage. Prior to this study, there had been extensive research on how taxes impact the sale of alcohol and traditional cigarettes, and on how E-cigarette prices impact E-cigarette usage, but there had been minimal empirical research directly examining E-cigarette taxes. This new research is crucial for understanding the rapidly changing economic and policy landscape for E-cigarettes.

This study primarily relies on two data sources to estimate the impact of taxes on the price and quantity of E-cigarettes sold in states with varying tax policies: (1) retail sales data from nearly 28,000 stores, and (2) state-level data on E-cigarette taxes. The retail sales data is sourced from the NielsenIQ Retail Scanner Data (NRSD), which the study examines from 2013 to 2019. The study only includes stores that appeared in the NRSD each year from 2013 to 2019 to account for changes in the collection of retail locations during this period. The researchers also tracked product characteristics to control for changes in the E-cigarette market over time.

The state-level data on E-cigarette control policies includes data from the 17 states (and Washington D.C.) that had enacted taxes on E-cigarettes by the end of 2019. The authors constructed a “standardized tax measure” to control for the fact that states did not utilize a uniform mechanism for implementing the tax. For example, some states implemented a unit tax per milliliter of liquid volume while others implemented a sales tax as a percent of the retail price.

To isolate the effect of E-cigarette taxes and control for other policies that could plausibly influence E-cigarette usage, the authors also collected data from the “CDC STATE” system and the American Non-Smokers’ Rights Foundation on indoor air laws. Some of these jurisdictions have restrictions on indoor smoking and vaping in place as well as tobacco licensing requirements enacted by municipalities and states, both of which may have an impact on E-cigarette usage independently from the implemented taxes.

The study finds that for every $1.00 in taxes imposed on E-cigarettes, the price of E-cigarettes increases by $0.90. That is, almost the entirety of the tax burden is passed onto customers as higher prices. This occurs because manufacturers find it more profitable to pass the bulk of the tax onto consumers and lose a portion of sales than to absorb the tax while maintaining their customer base. In economic terms, this means that the tax incidence on E-cigarette users significantly outweighs the incidence on manufacturers. Without increased prices, users will have limited incentives to restrain their consumption levels. For every additional $1.00 imposed in taxes, E-cigarette sales decline by 919 milliliter per 100,000 adult residents. One milliliter of E-cigarette liquid contains roughly the same nicotine content as five traditional cigarettes, so this translates to a reduction of roughly 4,600 cigarettes per 100,000 people.

The response was particularly large for flavored E-cigarettes relative to non-flavored products. Sales of flavored E-cigarettes were found to be more sensitive to price increases induced through tax policy than alternative products. This could reflect increased price sensitivity of adolescent users who have less disposable income and are most drawn to flavored E-cigarettes. Given that 85% of young E-cigarette customers use flavored products, this finding indicates that taxation may be an especially powerful tool for remedying the E-cigarette epidemic among adolescents.

This policy is not without drawbacks. An individual driven away by the higher price of E-cigarettes might not forgo tobacco products altogether; they may consume other tobacco products instead. If E-cigarettes and traditional cigarettes are perceived as close substitutes, price fluctuations in one product group may shift customers to the other group. This effect may be particularly potent for nicotine-addicted individuals who cannot forgo tobacco products altogether when their preferred option becomes more expensive.

The study finds that a $1.00 increase in E-cigarette taxes will increase the sales of regular cigarettes by 4,863 packs per 100,000 adult residents. To put this tradeoff more concretely, for every E-cigarette pod not consumed, approximately 1.9 packs of regular cigarettes are purchased instead. This finding is especially alarming given that regular cigarettes are even more harmful than E-cigarettes. E-cigarettes contain fewer toxic chemicals compared to traditional products, and recent clinical trials indicate that individuals who switch from traditional cigarettes to E-cigarettes possess significantly lower levels of carcinogens and they experience fewer respiratory symptoms.

One alternative approach advocated by multiple experts (see, e.g., Chaloupka et al. (2015) and Sindelar (2020)) is to tax E-cigarettes at a lower rate than traditional cigarettes to reflect the lower public health harms induced by E-cigarettes. Such an approach might divert price-sensitive adolescents away from E-cigarettes without encouraging them to experiment with more harmful alternatives.

This study questions whether E-cigarette taxes discourage E-cigarette use and explores the economic interaction of decreased E-cigarette use with the use of traditional cigarettes. While the net impact of these taxes is not yet fully known, this study serves as an important foundation to understanding the policies that can be instituted to counteract increased E-cigarette use, which represents a substantial deviation from the longstanding trend of declining use of tobacco products in the United States. Future research could evaluate the optimal tax structure and other policy instruments to discourage the use of E-cigarettes without diverting users to more harmful alternatives.