Report 2005-034 Summary - June 2006

Board of Equalization:

Its Implementation of the Cigarette and Tobacco Products Licensing Act of 2003 Has Helped Stem the Decline in Cigarette Tax Revenues, but It Should Update Its Estimate of Cigarette Tax Evasion

HIGHLIGHTS

Our review of the Board of Equalization's (Equalization) implementation of the Cigarette and Tobacco Products Licensing Act of 2003 (act) revealed the following:

  • Based on its analysis of cigarette tax stamps sold, Equalization estimates it received $75 million in additional cigarette tax revenues between January 2004 and March 2006 because of the act and the new tax stamp.
  • Equalization's estimate of $292 million in annual cigarette tax evasion is based on an unrepresentative sample and an overstated number of retailers of cigarettes and tobacco products.
  • Although the act and new tax stamp have caused a stabilization of the historical decline in cigarette tax revenues, these revenues will continue to decline as long as more Californians stop smoking.
  • In fiscal years 2003-04 and 2004-05, Equalization spent $9.2 million to implement the provisions of the act, with most of that amount paid toward staff salaries and benefits for licensing and enforcement activities.
  • Equalization imposes penalties in accordance with the provisions of the act.

RESULTS IN BRIEF

The Cigarette and Tobacco Products Licensing Act of 2003 (act), which took effect in January 2004, requires the Board of Equalization (Equalization) to license all entities engaged in the sale of cigarettes and tobacco products in California. It also provides additional funding to Equalization to enforce the provisions of the act. The intent of the act is to lessen cigarette tax evasion and increase collections of cigarette tax revenues.

Because cigarette tax evasion by definition is taxpayers' failure to report information, estimates of its magnitude are only approximations. Equalization believes its implementation of the provisions of the act has increased cigarette tax compliance. Although we agree with this assessment, we also believe that some of the factors Equalization uses to calculate the benefits of the act are overstated because they are based on the results of inspections in areas where illicit cigarette sales are more likely to occur. This results in estimates at the high end of the range of potential tax evasion. Further, because a new, less easily counterfeited tax stamp is now in use, increases in cigarette tax compliance since January 2005 can show only the blended effects of the act and the new tax stamp.

Between fiscal years 2001-02 and 2003-04, collections of cigarette taxes fell, continuing a trend of declining revenues caused largely by the declining prevalence of smoking among Californians. Collections of cigarette tax revenues stabilized in fiscal years 2003-04 and 2004-05, the years during which Equalization was licensing sellers of cigarettes and performing inspections of retailers. Consequently, the stabilization and reversal of the historical decline in cigarette tax revenues is to some degree the result of Equalization implementing the provisions of the act, in addition to the effects of the new cigarette tax stamp.

RECOMMENDATION

To provide a more accurate estimate of the extent of cigarette tax evasion, Equalization should update its calculation of cigarette tax evasion using data gathered after implementation of the act.

AGENCY COMMENTS

Equalization stated that it agrees with the overall conclusions and finding of the report. It also noted that it has already taken action to address the recommendation.


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