CDTFA’s Tobacco Programs

In this post, we provide information to support the Legislature’s oversight of the Department of Tax and Fee Administration’s (CDTFA’s) tobacco programs. In particular, we offer background information; comments on revenue trends, CDTFA’s enforcement activities, and the AB 3218 budget change proposal (BCP); and questions that budget subcommittees may wish to ask about these issues.

Background

CDTFA’s Tobacco Programs. CDTFA runs three tobacco-focused programs:

The Cigarette and Tobacco Tax Program administers a $2.87 per pack tax on combustible cigarettes and a 53 percent tax (adjusted annually) on the wholesale cost of other tobacco products, such as e-cigarettes, cigars, and chewing tobacco. Most of these revenues pay for health care or early childhood programs.
The Cigarette and Tobacco Licensing Program monitors tobacco retailers for compliance with various state laws. This fee-funded program is a key element of the Master Settlement Agreement that California and 45 other states reached with the four largest cigarette manufacturers in 1998.
The California Electronic Cigarette Excise Tax Program administers a 12.5 percent tax on retail sales of e-cigarettes. This program is small and new, so this post focuses on the other two programs.

Flavor Ban. In a November 2022 referendum, voters approved Chapter 34 of 2020 (SB 793, Hill), which bans most sales of flavored tobacco products. (“Flavored” refers to non-tobacco flavors, such as menthol cigarettes or fruit-flavored e-cigarettes.) This law established a fine for each violation of the ban, but it did not create a clear structure for enforcement.

Unflavored Tobacco List. In the 2023-24 session, the Legislature passed and the Governor signed Chapter 849 (AB 3218, Wood) and Chapter 462 (SB 1230, Rubio). These laws require the Attorney General to establish a list of unflavored tobacco products to simplify enforcement of the flavor ban. The laws also give CDTFA various tools to enforce the flavor ban, such as citations, product seizures, and license suspensions.

Revenue Trends

Tobacco Tax Revenues Have Declined Sharply. We generally expect tobacco tax revenue to drop by a few percent per year due to declining tobacco use. Since the flavor ban, however, revenues have declined much faster, from $1.84 billion in 2021-22 to $1.6 billion in 2022-23, then to $1.35 billion in 2023-24 (not including the new tax on electronic cigarettes). This suggests that the annual revenue loss from the flavor ban might be around $300 million to $400 million.

Interpretation of Revenue Loss Unclear. Under the flavor ban, people who otherwise would consume flavored tobacco have three main options: (1) avoid tobacco use altogether, (2) switch to unflavored tobacco products, or (3) obtain flavored tobacco from sources that violate the ban or from sources not subject to the ban (for example, other states). We do not know how much of the recent revenue decline is due to greater tax avoidance and how much is due to lower actual tobacco consumption. To the extent that tax avoidance could be a large part of the story, the size of the revenue loss highlights the importance of efforts to enforce tobacco tax laws.

CDTFA’s Enforcement Activities

Spending on CDTFA’s Tobacco Programs Has Declined. CDTFA is spending substantially fewer resources on its tobacco programs than it was before the pandemic. In 2018-19, the tax program had 75.6 filled positions, and the licensing program had 64.3 filled positions. In 2023-24, these programs had 53.2 and 41.9 filled positions, respectively.

CDTFA has provided two explanations for this decline. First, the department has found ways to carry out many program functions more efficiently. Second, since the pandemic, the department has struggled to fill jobs that require workers to perform enforcement actions in person.

Licensing Inspections and Citations Have Declined. Over the last few years, two key measures of the licensing program’s enforcement activities have declined. The number of inspections conducted in 2022-23 and 2023-24 was 52 percent lower than in 2020-21 and 2021-22. Over the same period, the number of citations issued dropped by 24 percent. These drops are particularly striking given that staff concerns about COVID-19 exposure likely diminished substantially over that period.

Seizures Have Remained Roughly Constant. In contrast to inspections and citations, the number of tobacco seizures grew by 3 percent. CDTFA reports that it has developed a more targeted approach, focusing the diminishing number of inspections on retailers who are more likely to be out of compliance. Consistent with this, the citation rate and seizure rate per inspection have grown substantially. This makes each inspection more productive but also more resource-intensive due to the staff time associated with enforcement actions.

Many Possible Explanations for Trends in Citations and Seizures. As noted above, one explanation for the growing citation rate and seizure rate is that CDTFA is targeting its inspections more efficiently. Another possibility, however, is that the underlying rate of compliance has declined. This could occur for a variety of reasons. For example, due to the flavor ban or other factors, consumer demand for illicit tobacco products could be growing over time. If so, this could make noncompliance more lucrative for businesses, leading to lower compliance, which in turn could drive up the citation rate and seizure rate per inspection.

AB 3218 BCP

Governor Proposes $3.5 Million in 2025-26 for CDTFA to Implement New Laws. The proposal would augment CDTFA’s appropriation from the Cigarette and Tobacco Products Compliance Fund by $3.5 million in 2025-26, bringing the total appropriation to $16.7 million.

New Laws Create Ongoing Workload and Perhaps Some Revenue. CDTFA’s estimated cost to implement AB 3218 and SB 1230 is $3.3 million in 2024-25, $5.5 million per year in 2025-26 and 2026-27, and $3.1 million in 2027-28 and ongoing. The new laws create penalties that could raise revenue to offset some of these costs. Due to some novel features of the penalties, the administration views the revenues as highly uncertain and has not presented a revenue estimate.

Proposal Sets Up Decision Next Year. The Cigarette and Tobacco Products Compliance Fund had a $2 million surplus in 2023-24 and entered 2024-25 with a $12 million balance. In principle, these resources, together with the proposed augmentation, should cover the cost of implementing these laws without any need to redirect resources away from other aspects of the licensing program. This, however, is only a temporary solution. In 2026, the Legislature will need to decide how much to appropriate for this program on an ongoing basis. It also will need to assess whether the new penalty revenues are sufficient to maintain the fund’s structural balance. If not, the two main alternatives are (1) a statutory increase in licensing fees, or (2) cuts to other aspects of the licensing program.

Proposal Heightens Concerns About Hiring and Retaining Inspectors. Under the Governor’s proposal, CDTFA should have adequate budgetary authority to take on the new statutory responsibilities without detracting from its existing responsibilities. In practice, however, budgetary authority might not be the most binding resource constraint. CDTFA has struggled just to fill tobacco enforcement positions provided under its existing appropriations. This calls into question how much of the proposed spending actually will materialize. We are concerned that these responsibilities ultimately could spread existing enforcement resources even more thinly.

Questions for Legislative Oversight

As budget subcommittees conduct oversight over CDTFA’s tobacco programs, they may wish to ask the following questions.

What are the major ways that consumers obtain untaxed tobacco products? What strategies do CDTFA and other law enforcement partners use to address these avenues for tax evasion?
Why has the number of tobacco inspections declined so much?
We have seen workload trends presented in terms of total inspections, seizures, citations, and appeals. The administration has noted that these measures can be difficult to interpret. For example, when CDTFA seizes a retailer’s noncompliant products, this counts as one seizure, regardless of the total amount of product seized. Can the administration provide workload measures that account for some of these limitations?
What steps has the administration taken to improve recruitment and retention of tobacco enforcement personnel? What additional steps could be taken?
What will happen if CDTFA cannot expand its tobacco enforcement workforce despite its growing responsibilities? How could the department could modify its approach to enforcement to manage this situation?