Cigarettes continue to be the top in-store category based on sales dollars. On a monthly basis, the industry per store average over the past year was $39,127. However, its gross profit contribution slipped to 3.2% to $6,152 falling behind package beverages ($6,526), according to the National Association of Convenience Stores State of the Industry report.
While the numbers remain strong, the reason tobacco fell to No. 2 is simply taxation. Since 2002, 43 states have hiked smoking surcharges, which last year hauled in $14.5 billion nationwide.
The 1998 tobacco Master Settlement Agreement (MSA), which was supposed to provide some long-term stability and sales guidelines for the category, instead has caused tobacco to become an easy target for tax-happy legislators at both the state and federal levels.
New York is a prime example of tobacco’s overtaxation. Last June, the state added $1.25 per-pack hike to bring New York’s state surcharge on cigarettes to $2.75, which, coupled with the city’s own $1.50 tax, means Big Apple smokers are footing the highest tobacco taxes in the nation, with pack prices soaring past $9 in some city convenience stores.
The ironic part is that, in many cases, states may actually be losing money by raising taxes. For instance, the number of packs of cigarettes being sold in New Jersey, which has the second-highest tobacco excise tax in the nation at $2.58 per pack, has been steadily dropping, while sales at neighboring Delaware and Pennsylvania have almost doubled.
“A large portion of my customers come from New Jersey,” said Jazz Patel, who operates six Smoker’s Express stores in Pennsylvania’s Lehigh Valley. “We’re a short drive from the border and the price difference is great enough to motivate them to drive an extra 15 or 20 minutes.”
At best, tax increases are an imprecise tool. Case in point: all 50 states have excise taxes on cigarettes. But of the 40 that increased them between fiscal years 2003 and 2005, only eight met or exceeded revenue projections. Of the 32 that fell short, New Jersey missed by the largest margin, 67%, followed by Wyoming at 59% and Connecticut at 43%.
The tax situation is poised to get worse at the federal level in the coming months following the election of Barack Obama, industry observers are predicting. The expansion of the State Children’s Health Insurance Program (SCHIP) program is a top priority for the Democrats and may result in the single largest tax increase on one industry’s products in the history of the U.S. With President-Elect Obama a supporter of SCHIP expansion, the possibility of a tobacco tax increase to fund the expansion looms even larger.
“With the prospect of a $1.6 billion dollar shortfall plus a $10 billion dollar higher price tag, Congress will need to assess other options to expand SCHIP,” said Thomas Briant, executive director of the National Association of Tobacco Outlets (NATO.) “The options may include reducing the number of children covered by the SCHIP program, increasing cigarette and tobacco tax rates even further in an attempt to raise yet more revenue, or spreading the tax burden by increasing federal tax rates on other non-tobacco products.”
The fallout from an SCHIP expansion bill will likely include significant cigarette and tobacco sales reductions, large increases in the number of store robberies because the value of tobacco products would be so high, a floor stocks tax on cigarette and tobacco inventory adding up to an estimated $5,000 per store, employee layoffs and even potential store closings, Briant said.
Where are the dollars going? In addition to border states with lower taxes, bootleggers, Native American reservations and the Internet are the big winners.
A typical convenience store relies on cigarette sales for about 35% of its total sales. That number is much lower in New York and New Jersey, where stores have lost anywhere between 15-25% of their cigarette sales since the tax increase, said Jim Calvin, president of the New York Association of Convenience Stores (NYACS), who estimated that more than half of the cigarettes that are consumed in The Empire State are purchased without a New York State tax being collected.
“The vast majority of smokers who are no longer coming to our stores didn’t quit,” Calvin said. “They just quit coming to our stores and are now buying from lower-tax or no-tax venues.”
The tax affects more than just cigarette sales. Remaining convenience stores are losing profits from all sectors. “We also lose the sales of the other stuff those cigarette customers used to buy when they came through the door,” Calvin said.
What can be done to stop the problem from growing worse? Enforcement by the state to prevent New Yorkers from buying cigarettes at tax-free venues remains the best option. NYACS said sales at Indian reservations need to be targeted first.
The organization continues to support a state initiative requiring Native Americans to collect taxes on non-tribal members.
“Unfortunately, Gov. Pataki, Gov. Spitzer, and up to now, Gov. Paterson, have all refused to enforce that law,” Calvin said.
As a result, Indian reservations continue to cost convenience stores close to a billion dollars annually.
On the Internet, new state laws at best can only reach small parts of this problem. Besides the limits on the states’ ability to regulate interstate commerce, Internet sellers can easily avoid complying with state laws by delivering their products through the U.S. mails, which states have little power to stop or regulate, and the states’ ability to take action against Internet sellers based overseas or on Indian Tribal lands is also seriously limited.
Budget shortfalls in New York and other states pretty much guarantee that 2009 will be another difficult year. There are staggering tax and fee increases for New York convenience stores in Gov. Paterson’s proposed 2009-2010 state budget, released December 15, according to NYACS. In trying to balance the budget amidst multibillion-dollar deficits, the administration seeks to tax, re-tax, up-tax and overtax everything we sell, transforming our stores into nothing more than tax collection vehicles for the state.
Paterson’s plan, which is being echoed by governors through out the country, is predicated on increasing taxes on everything from cigarettes to soda. In New York, for example, here is a rundown of tax and fee proposals impacting convenience stores:
• Tobacco Registration Fee: For many years, the annual fee to register as a retail tobacco dealer with the state Tax Department has been a straight $100 per store. Now it would be $1,000 for retailers with gross sales under $1 million, $2,500 for retailers with gross sales of $1 million to $10 million, and $5,000 for retailers with gross sales of $10 million or more.
• Cigar Tax Hike: The excise tax would shift from 37% of wholesale value to a flat 50 cents per cigar.
• Tax on Little Cigars: Last year the Legislature passed a bill saying little cigars would be reclassified as “cigarettes” for tax purposes only if and when the federal government did the same. The state’s proposal would reclassify them now, regardless of federal policy, making the tax $2.75 a pack rather than 37% of wholesale value.
• Prepaid Sales Tax on Cigarettes: The prepaid sales tax on cigarettes would increase from 7% of the base retail price to 8%, effective June 1, 2009. The tax liability would not increase, but the timing would change.