mst taxation myth vs reality

Ad valorem state taxation maintains a growing and competitive marketplace for moist smokeless tobacco.

by Joseph R. Augustus, Senior Vice President of External Affairs for Swisher International Inc.

Tobacco Taxation Counterpoint — This is the second of a two-part series on smokeless tobacco taxation.Part one ran in the Dec. 2006 issue of Convenience Store Decisions.

Much has been written recently about the moistsmokeless tobacco marketplace. With new companies,such as Phillip Morris and R.J. Reynolds entering the category, and new products entering the marketplace, it is anexciting segment of tobacco product growth. These new productsand new times present new challenges for the category and raisesuch vexing competitive questions as, “How best to tax the products at the state level?” and “Who are the winners and losers ifthe tax methodology is changed?”

One existing manufacturer in the category began a quest in1999 to change the traditional ad valorem basis of state excise taxation to a weight-based form of taxation. An ad valorem tax is a tax that is based on the value of a product, thus all products bear the tax costs on a proportional basis based on price. A weight-based tax or, unit tax, is assessed on the product itself no matter what the value; thus placing a higher burden of taxation on products of lesser value. For example, under a weight-based analogy, a Ford would be taxed the same as a Mercedes just because they are both cars.

In our opinion, this anti-competitive action has accomplished littlemore than dividing an industry and creating a dangerous legislativeenvironment for the other tobacco products (OTP) category. Any timeyou open up the tax code, all products in the OTP category become vulnerable to a tax increase,including chewing tobacco, dry snuff cigars and pipe tobacco.Most states have rejected a change from the current ad valoremtax, and only a handful of states have accepted their pleas toconvert the tax methodology. The unnecessary legislative activityhas often caused many states to increase moist snuff taxes outof frustration over the heightened attention to the issue.

The ultimate loser, if the tax methodology is switched, wouldbe the value-conscious consumer. They would end up paying a higher price for their products, and the cost to the premium products would remain the same. This type of tax conversion willresult in a loss of volume in many stores, as the consumer willlook at other avenues to purchase their products at the lowestprice available. The tax that is applied at the state level, no matter how it is calculated, will not have an impact on stores’ margins; they will remain the same under both scenarios. The consumer will be the only one who loses if a weight-based tax isadopted, and the winner is the premium product manufacturerwho has closed the price gap between the categories by legislation instead of through the competitive marketplace.

Why, then, is staying the coursewith current ad valorem taxationbest? Quite simply, ad valorem taxation of moist snuff tobacco products—and OTP, especially in thesmokeless tobacco category—is themost efficient form of state taxation; it maintains fairness in the category, and is best for robust competition and for the adult consumer.

Why is ad valorem the most efficient method of state taxation? Within the OTP category, there arehundreds of product offerings in different packages, sizes, weights andtypes—pouch tobacco, dry snuff,moist snuff, plug, twist, cigars(large and small), roll-your-own, etc.Unlike cigarettes, beer or gasoline,OTP is not a “homogeneous” category, as once offered by the U.S.

Federal Trade Commission, and such a wide, expansive sector ismore fairly taxed under an ad valorem basis.

Under ad valorem, a product is taxed on value. The manufacturer studies the marketplace and determines its price point andthen makes the offering. The consumer then determines the winners and losers. Under a weight-based scheme, proponents say,”all tobacco products are the same, and all should be taxed thesame.” The difficulty lies in this static analogy. The current adultmarketplace for moist snuff products, and OTP, is not static and adult consumers are entering the marketplace looking for value. Adult consumersexpect variety and choice of products, andare looking for value to save money. Slapping additional disproportionate stateexcise taxes on value products will not”shore up state revenues.” It will, however, increase the price of those products tothe consumer. This is one manufacturer’sattempt to close the price gap betweenthe price value and premium segments.

It is also worth noting that proponentsof weight-based moist snuff taxation onlyadvocate for a change from the current advalorem state taxes on moist snuff, not allOTP. Therefore, with a desire to makestate taxation more efficient, they actuallymake it more complex. States that haveswitched to weight-based taxation findthemselves having to re-work tax forms;re-educate wholesalers and retailers as totax remittance procedures; endured costlystate administrative costs and deal withsuch vexing questions as, “Does theweight-based tax on moist snuff pertain todry snuff, as state tax codes does not differentiate specifically?”

Several states have had to go back(thereby opening up the tobacco tax code,again), after passing a weight-based taxon moist snuff and clean the legislativemess up surrounding the change.Converting from the current, establishedad valorem taxation to a risky, weightbased scheme is economically inefficient,administratively complex, trade complex and is “too much hurt for too little money” in the long run.

Fair Play?
How does ad valorem taxation ensurefairness? Much has been written on thispoint. Proponents say that a “loophole” exists in current ad valorem state taxationand converting to a weight-based schemeis fairer. That is simply not true. The current system of state taxation has existedfor many decades and has never been aproblem, until A) the marketplace and economic climate changed, B) states startedthe rampage to increase state taxes and C) value-priced products began erodingmarketshare from the premium brands. Itis easy for the trade to understand that weall oppose state excise tax increases. Wehave agreed and still agree on this point.The difficulty arises when a manufacturerdecides to break from traditional industrypositions and then attempts to use thestate tax code as a competitive weapon toregain marketshare, by increasing theirtaxes, in a changing economic climate.

Ad valorem taxes are fair to adult consumers. A “one-size-fits-all” weight-basedsystem of taxation will only add disproportionate taxes to adult consumers of pricevalue moist snuff products. In the name offairness, is that fair? Manufacturers disagree on the question of converting theexisting state taxation system, but we betthat consumers don’t. Adult consumersare looking for value, and they will vote with their pocketbooks if their tobaccoproduct of choice is hit with a 200%increase in state taxation!

It’s great to have legislative and intellectual debates over state taxation, but itis anti-competitive to attempt to manipulate the tax code in an attempt to stopadult consumers from buying value-pricedproducts. The robust growth that the moistsnuff category has seen over recent yearshas come from value-conscious consumers. Smart manufacturers recognizedthis phenomenon and adapted businessmodels and product offerings to align withcurrent adult consumer needs.

Fairness, I suppose, is in the eye ofthe beholder, but our opinion is that it isonly fair to have a state taxation policythat allows for competition and to offerconsumers an affordable tobacco productwith many and varied choices. The currentestablished and understood ad valoremmethod of state taxation helps maintain arobust, competitive and
fair method ofmoist snuff taxation.

As Convenience Store Decisions hasnoted in previous articles on this subject,tobacco retailers have enough to do tosurvive without the distractions of intramural competitive power plays befallingthem. Let’s remember the success thatthe moist snuff category has been. It is aprofitable segment for the conveniencestore industry and we should try to minimize the unfair, costly and anti-competitive/anti-consumer plans offered by some.