Smoking Tax Policy | Tobacco Harm Reduction

Tobacco harm reduction is at the forefront of excise taxAn excise tax is a tax imposed on a specific good or activity. Excise taxes are commonly levied on cigarettes, alcoholic beverages, soda, gasoline, insurance premiums, amusement activities, and betting, and typically make up a relatively small and volatile portion of state and local and, to a lesser extent, federal tax collections. policy discussions around the globe. Alternative tobacco products (ATPs) are at the heart of a heated debate regarding how to revise the European Tobacco Excise Directive (TED) and have been nearly the sole focus of the US Food and Drug Administration’s (FDA) Center for Tobacco Products (CTP) for the past decade.

Industry innovation created new ATPs like e-cigarettes, heat-not-burn tobacco sticks, and oral pouches that deliver nicotine to consumers without requiring them to inhale combustible cigarettes. While these products may be less safe than abstaining from nicotine altogether, the near scientific consensus is that consuming any of these products creates substantially less harm to the user than do traditional cigarettes.

Perhaps the most important element of these new products that warrants policy discussion is that, unlike the previous wave of smoking alternatives—transdermal patches, lozenges, gums, and very-low nicotine (VLN) cigarettes—the new products have demonstrated strong mass-market demand. Consumers are using the new products and smoking fewer cigarettes each day. The growth of the markets for these new products has prompted a robust policy discussion: how should ATPs be taxed?

To design an effective and appropriate nicotine taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy, it is crucial to understand the concept of harm reduction. Harm reduction emphasizes the practicality of reducing the harm associated with certain goods rather than attempting to eliminate it entirely through bans or excessively high taxes. Departing from prohibitionist-style efforts aimed at ending nicotine consumption, harm reduction emphasizes results over rhetoric.

Choosing the Right Tax BaseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.

ATPs present a challenging case for designing optimal tax policy. Excise taxes that target harm-generating products can often target the harm-causing element, encouraging market participants to internalize the external harm into their decision-making. Taxes on hard alcohol increase based on alcohol content or proof per gallon; carbon taxes price in external damages from pollution and climate change into energy consumption and production decisions.

ATPs don’t create similar kinds of external costs—and they may even generate net external benefits by decreasing smoking. ATPs also don’t have a clear ingredient to target with an excise tax; nicotine does not directly create external harm. Without a target ingredient to create the tax base, tax policy will be forced to use a broader category-based system with varying rates based on individual products.

In this case, quantity-based specific taxes are better than ad valorem taxes at aligning the tax base to the tax’s purpose. For nicotine products, the number of cigarettes smoked or the amount of vapor inhaled has a much clearer connection to any harm caused by this consumption than the retail sales price of those products. Specific taxation is often simpler because the tax can be calculated based on weight, volume, or quantity instead of an estimated value.

A weight-based tax for oral nicotine and heated tobacco products would be most effective. Similarly, vaping products can be taxed by milliliter of vaping solution. And any products sold in loose weight (like loose tobacco) can be taxed by weight. These structures capture the harmful behavior and keep the tax neutral.

Proposed Tax Structure for Alternative Nicotine Products

Tax Rates for Alternative Tobacco Products Compared to Cigarettes

Tax rates on alternative nicotine and tobacco products should create price differentials between less harmful products and combustible cigarettes. From a public health standpoint, the rationale for taxing alternative nicotine products at all is weak. ATPs create little or no external harm to bystanders.

While more research on the potential long-term harm of these newer products is needed, the evidence is clear that they are much less harmful than combustible cigarettes. If vapes are 95 percent less harmful than cigarettes, aggregate public health would improve even if 19 new individuals started vaping for every user that switched from cigarettes to vapes. Globally, this is nowhere near the case. The WHO estimates there are still 1.2 billion smokers and only 100 million vape users. Should those ratios reverse, a tax on vaping may warrant more discussion, though it would certainly come with millions of lives saved and billions less spent on smoking-related health care.

Should governments decide to tax ATPs, though, a broad tax structure could create tax and price differentials based on a continuum of risk. We propose a reduced tax rate corresponding to each alternative tobacco product’s risk profile, anchored to the existing tax rate for combustible cigarettes. In an ideal scenario, each product would have scientifically agreed-upon, precisely estimated, quantifiable harm and risk measures. Those measures could be compared to similar estimates for cigarettes to determine a measure of relative harm and risk.

Unfortunately, such scientific precision and consensus are realistically impossible. Instead of having precise estimates and differential tax rates for each individual product, a categorical approach still allows differential tax rates and facilitates a range of relative risk estimates for products.

We establish four categories of reduced-harm products. Products in each category would have a tax rate reduction compared to combustible cigarettes. The tax rate for Category 1, the most harmful of the reduced-harm products, would be 50 percent of the rate on cigarettes. Products in Category 2—less harmful than products in Category 1—would be 25 percent of the tax rate on cigarettes (a 75 percent reduction). Products in Category 3 would have a tax rate 10 percent of the rate on cigarettes. Finally, products in Category 4 would have no tax.

Any product can be placed into a specific category based on three criteria: harm caused, substitutability for combustible cigarettes, and ease of mass consumption.

The greater the harm caused by the product, the greater its tax rate. The less harmful, the lower the tax rate.

The more easily a product functions as a substitute for combustible cigarettes, the lower its tax rate should be. Transitioning from combustible cigarettes to any other form of nicotine consumption reduces harm. The degree to which a product is a substitute for combustible cigarettes is quantified by empirical studies that calculate the cross-price elasticity.

Finally, the more easily a consumer can consume large quantities of a harmful product, the greater the tax rate for that product will be. Based on these criteria, the following tax rates would support consumers moving to less harmful products.

Alternative Tobacco Product Tax Rates to Optimize Harm Reduction

As governments revisit nicotine and tobacco taxation in light of rapid product innovation and market shifts, the core tax policy objective should be clear: reduce the harm caused by smoking. Alternative tobacco products, while not risk-free, offer a meaningful pathway away from the dangers of combustible cigarettes. Tax policy that ignores this continuum of risk could undermine one of the most promising public-health shifts in decades.

A modernized excise framework should employ tax structures that reflect individual products and tax rates that align with relative harm. Specific, quantity-based taxes offer a neutral and transparent foundation, and a tiered-rate system ensures that safer products remain more affordable substitutes for smokers seeking alternatives. By anchoring ATPs’ reduced tax rates to cigarettes, policymakers can encourage migration toward less harmful options without resorting to prohibitionist tactics or overly punitive taxes.