Like the proponents of Proposition 56, I wish we could wave a magic wand and eliminate smoking. But our state government lacks a magic wand; all it can do is outlaw and tax our activities. So, from a public health standpoint, the $2 per pack cigarette tax increase mandated by Prop 56 is the next best thing to a magic wand: it deters smoking while raising money for the healthcare system. Unfortunately, taxes can have unintended consequences, and, in the case of Prop 56 these unintended consequences could have negative implications for the health of our state’s General Fund.

In Fiscal Year 2015-2016, the General Fund received $84.8 million in cigarette excise tax revenue. Given a tax rate of ten cents per pack, this means that 848 million packs of cigarettes were sold legally statewide. This number has been falling and should continue to decline in the near future, especially with the passage of legislation that prohibits sales of cigarettes to young adults below the age of 21.

The $2 per pack tax increase would further accelerate this downward trend, reducing sales and excise tax revenues. Prop 56 would devote some of the revenue from the new $2 tax to offsetting revenue losses caused by the drop in cigarette sales. For example, two cents of the current 87-cent excise tax are devoted to breast cancer screening. Lower cigarette sales will reduce deposits to this fund, but Proposition 56 directs the state’s Board of Equalization to offset this affect with some of the revenue from the new tax.

In addition to these true-up payments, Proposition 56 earmarks money for administrative and auditing expenses, as well as $48 million annually for enforcement, $40 million to UC for physician training and $30 million to the Department of Public Health to support new dental programs.

After these fixed expenditures, the remaining funds will be divided as follows:  82% for increased Medi-Cal provider payment rates, 11% for tobacco prevention programs, 5% for tobacco research programs and 2% for school-based tobacco prevention programs. None of the new revenue would go to the General Fund for discretionary use, to “keep Sacramento bureaucrats and politicians from diverting funds” (in the words of bill proponents) – apparently because elected officials can’t be trusted to allocate tax revenues.

The Legislative Analyst Office estimates that revenue from the new tax will be in the range of $1.27 billion to $1.61 billion in FY 2017-2018, implying sales of between 635 million to 805 million packs. But, there is a risk that the real number will be below the low end of this range, not because of people kicking the habit but because of smuggling.

According to the Mackinac Institute, smuggled smokes accounted for 31.5% of cigarettes consumed in California in 2013. New York State, with the highest tobacco excise tax, also had the nation’s highest smuggling rate: 58%. If Proposition 56 passes, California’s excise tax rate of $2.87 per pack will still be below that New York’s rate of $4.35, but New York doesn’t share a border with Mexico where a pack of Marlboros costs just $2.55. Mexican-brand cigarettescost even less.

Besides reducing revenues from the new $2 tax, smuggling generates an array of associated crimes including burglary, credit card fraud, money laundering and contract killings. This increased crime may require stepped up law enforcement at the state and local levels – requiring more General Fund expenditures not funded by the new tax.

Reduced demand for legal cigarettes could also trigger a shortfall in tobaccoMaster Settlement Agreement (MSA) revenues. In 1998, state attorneys general won a settlement from major cigarette manufacturers under which the tobacco companies make annual payments to state and local governments to compensate them for increased health costs arising from smoking. The state of California received $357 million from this agreement in 2016; cities and counties received an additional $357 million.

Many states and local governments did not want to wait for their annual settlement payments, so they worked with Wall Street to borrow against the future income – issuing bonds that would be serviced from future tobacco settlement revenues. As legal cigarette sales fall, the revenue from the MSA declines, creating a risk of default on the bonds. Last year, California issued anew $1.7 billion series of tobacco settlement bonds that are backed by the state’s commitment to seek a General Fund appropriation if settlement revenues fall short of the amount required to pay interest and principal on the bonds. Policy changes that reduce domestic cigarette sales increase the risk that such an appropriation will be required.

Proponents of Prop 56 suggest that smoking increases healthcare costs, but they only look at one side of the equation. While it is true that smokers get cancer and other diseases, the fact that they die prematurely from these conditions means that they don’t live long enough to suffer from other costly diseases. In its fiscal analysis of Prop 56, the Legislative Analyst Office recognized this point by noting that “state and local governments would experience future health care and social services costs that otherwise would not have occurred as a result of individuals who avoid tobacco-related diseases living longer.”

Smoking reduces life expectancy between four and ten years. These last years of an individual’s life are usually characterized by high and increasing medical costs. A long term study of almost two thousand men in Finland found that total healthcare costs that were €4700 (or $5244) lower for smokers than for non-smokers over the 27-year length of the investigation. In the US, researchers estimated that if military members and their beneficiaries stopped smoking immediately, the federal TRICARE insurance program would incur additional healthcare costs averaging $1700 per individual.

Finally, to the extent that public employees cut back on smoking and live longer, the overall cost of their pensions will be higher than expected – placing a further burden on the General Fund.

While the opportunity for California public employees and for all Californians to live longer should be celebrated, our fiscal policies need to respond accordingly. In the case of Proposition 56, the failure to allocate any new revenue to the General Fund will ultimately result in deficits that we and our children will have to address.  A better alternative would have been a smaller excise tax that would trigger less additional smuggling and with most of the new revenues directed to the state’s General Fund.