Last week members of the Senate Finance Committee including chairman Max Baucus (D., Mont.), Jay Rockefeller (D., W.Va.), Chuck Grassley (R., Iowa), and Orrin Hatch (R., Utah) cut a deal to increase the funding for the State Children's Health Insurance Program to the tune of $35 billion over five years. To generate this money, the deal imposes a new luxury tax on cigars.
To understand why the luxury tax on cigars is a terrible idea, we need to revisit the history of the luxury tax of the early 1990s--a history that congressional members' severe amnesia is preventing them from remembering. Class-warfare thinking infected the luxury tax of 1990. Think of the multimillionaire whose wife was wearing a gold-and-diamond necklace and a fur coat. They were getting into their limousine to drive to their 100-foot yacht on which they would spend their weekend. How was it possibly fair that the rich spend so lavishly on such unnecessary items when Joe Six-Pack struggled just to put food on the table? Imposing a luxury tax on those items was a proper way to even things out, to make the rich pay their "fair share" to fund the government programs that helped Joe Six-Pack.
Unfortunately, Congress never bothered to consider that increasing the tax on these items, and thereby increasing the price of those items, might change the behavior of said rich people. (Indeed, many members of Congress stubbornly refuse ever to acknowledge that taxes ever affect behavior.) But said rich people had other ideas. If the price of jewelry, furs and yachts suddenly increased, then maybe purchasing a winter home in Florida seemed like a much better deal. Or maybe those rich people would take a shopping trip to other parts of the world, where the prices of jewelry, furs and yachts were now much more competitive thanks to the U.S. Congress.
And if members of Congress never considered that the luxury tax would discourage rich people from buying luxury items in the U.S., then they surely never considered that such an effect might not be so good for the Joe Six-Packs who worked in the industries producing luxury items. A Joint Economic Committee study later found that 330 jobs in the jewelry industry and 7,600 jobs in the yacht industry were lost thanks to the luxury tax. Perhaps the greatest irony was that in 1991 the federal government paid out over $7 million more in unemployment benefits to those workers than it collected in luxury tax revenues....
Fast forward to 2007. The current tax on cigars is a maximum 4.8 cents a cigar. The new proposed luxury tax on cigars is 53.13%, up to a maximum tax of $10 a cigar. Thus, if you like cigars worth $20, you'd be facing a staggering tax increase of 20,733%. By comparison, the luxury tax of 1990 was an increase of only 10%...
Of course, about as many people are going to shed tears for the person buying a $20 cigar as did for the rich person buying a yacht. But they might feel a lot of sympathy for the Joe Six-Packs who work in the cigar industry. Exact numbers about how many people work in the cigar industry today are hard to come by since the federal government stopped collecting data on cigar producers a few years ago. In 1999, the Census Bureau reported that 3,845 people worked in the cigar industry. Norm Sharp, president of the Cigar Association of America, guesstimates that the industry now employs between 7,500 and 10,000 workers, a plausible number given the growth in the industry in recent years. Whatever the number, what is clear is thousands of cigar employees face a fate similar to workers in the yacht and jewelry industries in 1990.
That is what Congress's severe case of historical amnesia yields--an astronomical tax increase leading to workers losing their jobs. But try to look at the bright side. If those cigar workers lose their jobs, the resulting decline in their incomes will mean that their kids will have no trouble qualifying for the State Children's Health Insurance Program.
I was with a glass and mirror company that was a supplier to a famous yacht manufacturer at the time of that tax on high-end goods and I saw first hand the effect of the luxury tax on workers who had no idea a "luxury tax" could hurt them.
Bottom line: All taxes have consequences and often the unintended consequences are the harshest.