Taxation Taking a Toll on Cigarettes

cigarettesMounting restrictions on the retail sale of tobacco continues to plague this core convenience store category.

By John Lofstock, Editor

Long a staple of the convenience store industry, cigarettes remain a category in crisis. The rise of e-cigarettes and a never-ending spate of federal, state and local regulations have taken a toll on this once thriving category.

Though controversial, cigarettes remain a legal product, and one that is important to the economic viability of the convenience store industry. In fact, according to the 2013 NACS State of the Industry Report, sales of cigarettes and other tobacco products still stood at an average of 40% of the industry’s in-store sales.
But from taxes to age verification, proposed regulation of e-cigarettes and heightened government attention to menthol, selling cigarettes has never been a trickier minefield to traverse.

That said, the population of adults who exclusively smoke regular cigarettes is declining, while those who use multiple tobacco/nicotine products, depending on the situation, location, or activity, are growing in number.

“The cigarette category has been declining for decades,” said Bonnie Herzog, managing director of beverage, tobacco and convenience store research for Wells Fargo Securities in New York City. “Retailers have already been handling this the best they can. They’ve been squeezed by the manufacturers, so what you see a lot of the retailers doing is allocating more space to the faster-growing category, such as OTP and now, more specifically, to e-cigs. That is what a smart retailer has done.”

It goes without saying that convenience stores still need to offer traditional cigarettes and allocate enough space to them. “Cigarettes are still the nucleus of the tobacco offering and why the consumer comes in,” Herzog said. “But there are many consumers coming in to make a dual purchase, or possibly switching to a new product. So I think the broader their offering is probably the better off they are.”

Rising Taxes
The pressures aren’t going anywhere any time soon. Taxation continues to be among the biggest obstacles retailers have to overcome. Herzog said increasing taxes at the state level will continue to hamper margins, especially as state and local governments look for ways to increase revenues.
States that have moved to increase the cost of cigarettes include:
• Oregon. The state passed a 13-cent-per-pack cigarette tax increase which goes into effect on Jan. 1, 2014.
• A proposed Missouri ballot initiative would allow municipalities and counties to establish their own tax rates on tobacco products.
• In November, Chicago Mayor Rahm Emanuel agreed to reduce his proposed 75-cent tax on cigarette packs to 50 cents. The increase will result in a new Chicago cigarette tax rate of $1.18, effective Jan. 1, 2014.

An unfortunate result of varying tax rates among states has been a black market for cigarette trafficking. Large quantities of tobacco products are bought in states with low tax rates and resold in states with higher taxes for a profit, according to the Bureau of Alcohol, Tobacco, Firearms and Explosives. Yet, little seems to be done to catch these scofflaws.

In fact, despite trying to eliminate smoking, states are going to great lengths to get their hands on tobacco dollars. In early December, the U.S. Supreme Court upheld Oklahoma’s right to collect payments from a tobacco company for cigarettes sold to American Indians. The high court let stand a decision by the Oklahoma Court of Civil Appeals that a state law requiring payments under the tobacco settlement applies to all cigarettes sold with a state excise tax stamp.
New York State, which already has the highest tax by far ($4.35) on a pack of cigarettes, has further restricted access of cigarettes to adult customers. New York City Mayor Michael Bloomberg in November signed into law an ordinance prohibiting retailers from selling tobacco products and electronic cigarettes to anyone under the age of 21. A second ordinance bans the redemption of coupons and other price reduction instruments on the sale of cigarettes and tobacco products to consumers.

Maintaining Menthol
As if the tax assault on cigarettes wasn’t enough, the viability of menthol tobacco products is under fire. The Food and Drug Administration (FDA) maintains that about 30% of all adult smokers reported smoking menthol cigarettes. The administration is reportedly considering whether to outright ban menthol cigarettes entirely.

“The FDA is committed to a science-based approach that addresses the public health issues raised by menthol cigarettes, and public input will help us make more informed decisions about how best to tackle this important issue moving forward,” said FDA Commissioner Margaret Hamburg.
Herzog said the likelihood of the FDA outlawing menthol is slim, but anything could happen.  “We are still waiting to hear what the FDA ultimately will do with menthol,” she said. “While the big concern is whether or not they will ban menthol, I think a more realistic worst-case scenario is that they come out and say that the levels of menthol should be reduced over time. Or they could come out and do nothing.”

Herzog called it tough to know exactly when that decision will come. “The comment period just ended on Nov. 22, so it’s going to take them a while to go through all of those comments,” she said.

More than 174,600 individual comments were submitted to the FDA.

Pushing Back
The National Association of Tobacco Outlets (NATO) submitted a set of comments responding to several specific questions asked by the FDA.
In the rulemaking notice, the FDA asked for public feedback on whether the agency should consider establishing restrictions on not only the sale and distribution of menthol cigarettes, but also the advertising and promotion of menthol cigarettes.

NATO responded that establishing additional restrictions on the retail sale of menthol cigarettes is unnecessary because retailers are responsible people who are not in the business of selling tobacco products to underage youth.  In fact, this high level of responsibility is evidenced by the FDA’s own state compliance inspection program which demonstrates that approximately 95% of retailers inspected successfully pass the inspections without any violations.

Instead of adopting additional regulations and restrictions on the retail sale of menthol cigarettes, NATO argued that the FDA should research the phenomenon known as the “enabling adult” in which adult-aged friends, family members and even parents obtain cigarettes legally and then provide them to underage youth.
With the FDA seeking to have an impact on youth smoking initiation, behavior and cessation, then addressing the problem of the “enabling adult” and taking action to educate the public to prevent minors from being provided cigarettes from adults could have a more positive effect on the issue of youth smoking than adopting further unwarranted restrictions on the retail sale of menthol cigarettes, NATO explained.

NATO went on to note that a number of current federal regulations exist on the sale of all cigarettes, including menthol cigarettes, which removes the need for additional restrictions on just menthol cigarettes.  These federal restrictions include outlawing the sale of cigarettes to anyone under 18, requiring retailers to verify a purchaser’s age, mandating that the sale of cigarettes be in a direct face-to-face exchange between a store clerk and the customer, allowing self-service displays only in stores where underage youth are not present, and banning the giving away of free samples of cigarettes. 

With these numerous regulations and restrictions already in place, there is no need to treat the retail sale of menthol cigarettes any differently than non-menthol cigarettes since all of these regulations apply equally to every kind of cigarette.

Also, the FDA asked for input on whether a ban on the sale of menthol cigarettes would result in a significant increase in illicit trade.  In its comments, NATO stated that a black market will arise if the sale of menthol cigarettes is banned in the U.S. because criminal elements will take advantage of the opportunity to profit from illicit cigarette sales.

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