The Roots of Nebraska's 'Fiscal Squeeze'

Wednesday, March 8, 2017

The $900 million-plus gap in Nebraska’s budget is creating some serious problems for our legislators in the unicameral this year. Budget crunches are not unusual, even in a state that generally makes better fiscal decisions than most. And while Nebraskans may have to fix it, much of the blame should be directed toward Washington and structural flaws in our government, rather than toward our legislators.

The situation has deep roots, and while it is unlikely to improve in the near future, it requires attention. As the federal government shifts the financial responsibility of its own policymaking to the state level, Nebraska is left with less flexibility to meet the needs of its own residents and local governments.

In a paper released by the Mercatus Center at George Mason University, I call this phenomenon the “Fiscal Squeeze,” because it’s leaving us without the ability to truly set our own state’s priorities.

Historically Nebraska has been in a relatively good fiscal position compared to states like Illinois and New Jersey, with their crushing levels of debt and unfunded pension liabilities. We have opportunities for growth and relatively healthy state finances. But when coupled with our own priorities, the Fiscal Squeeze has simply left us with too many new and expanding policy commitments.

The state gasoline tax’s scheduled rise, passed in 2015 to increase revenue, will only cover some of these costs (not to mention road maintenance). On top of this, Nebraska’s demographics have changed. In 2015, persons over 65 years of age comprised 14.7 percent of the population, up from 13.5 percent in 2010.

With this comes an increase in medical expenses due to expanding commitments to citizens over the past decades. This portion of the budget is growing rapidly, even as Nebraska refused Medicaid expansion under the Affordable Care Act. Medicaid alone accounts for 16.7 percent of the state’s budget and is growing by nearly 2 percent a year.

The growth of school spending in Nebraska helps illustrate the dynamic. Originally, schools were a locally funded priority. In the 1960s, budget surpluses and momentum from federal Great Society programs led to a shift from local funding to state funding. This was motivated by a desire to increase funding per student, and that part was successful.

But the change in school funding led to a disconnect. While the state is now footing the bill, local communities continue to decide school policy. When decision-making and financial responsibilities are separated, programs have a tendency to expand beyond what’s financially sustainable.

To fix this disconnect, education decision-makers and the lawmakers holding the purse need to participate in one process. Parental choice, while not purely a budget issue, is a surprisingly effective way to align their incentives. Programs like Omaha’s Tax Credit Scholarship, or changes to the law that accommodate charter schools, increase the efficiency of school finance while helping parents express their own priorities for their children.

What can be done about the Fiscal Squeeze? For starters, Nebraskans need to be assertive about prioritizing the programs that are most important. Making too many promises — sometimes under federal pressure — means some tough budget choices are inevitable.

Rather than continuing with this first-come, first-served race to see who gets the resources before they run out, let’s make deliberate choices about how we want to spend our tax dollars. Focusing on the things we need the most — for example, schools and health care — before those very things wind up on the chopping block.

Governing Nebraska's Fiscal Commons

February 22, 2017

State policymakers involved in drafting state budgets will face increasing difficulties in coming years as the rising cost of spending obligations such as schools, health care, and pension funds strains states’ ability to pay for them. At the same time, federal support for state programs will continue to shrink as the federal government is forced to grapple with its own fiscal problems. States will need to either reform their budgets or raise taxes as a proportion of income. This decision could be game-changing both for state budgets and for federalism more broadly.

Economist Michael D. Thomas focuses on trends in the state of Nebraska, which faces a looming fiscal problem. The expansion in the scope of tasks the state now manages, not just in terms of federal programs but also in terms of funding local programs, has resulted in spending mismatches with local priorities and a state government that is squeezed between the federal and local governments. The way forward is to set realistic priorities for spending at the state level. Nebraska has long benefited from a relatively good fiscal position, and is therefore in a better position to manage this task than other states.


The budgetary squeeze refers to a phenomenon of budgetary pressures that is affecting every state, including Nebraska. As program costs rise, Nebraska is increasingly budgeting for the short term. With a state government squeezed between budgetary obligations to both federal and local programs, political rhetoric shrinks to a choice to cut spending or increase taxes.

The squeeze comes from two sides: local to state and federal to state.

Local to State Squeeze

Since Nebraska attained statehood, it has placed a strong constraint on revenue (and therefore on spending as well). Limited to funding by a state property tax for decades, Nebraska policy making was constrained, such that the state could not deliver all the services voters wanted.

  • In the 1960s, Omaha’s public schools were in crisis. As urban flight worsened economic segregation, the state and federal governments’ aid fell short of what was needed. 
  • Omaha’s school district then annexed surrounding school districts in order to help make up the funding difference.
  • In 1967–1968, Nebraska introduced an income tax and a state sales tax, and these measures led to increased tax collections over time.

A 1988 report commissioned by the state found that Nebraska collected twice as much property tax per student as the US average and gave half as much state aid to school districts. The Nebraska state government began to attempt to supplement funding from local property taxes from state coffers. Since the 1970s (with a brief exception in the 1980s), the largest share of public school funding has come from the state government. (The figure below shows the funding sources for all US public schools.)

Meaningful reform had to avoid setting policy through piecemeal reactions to short-run events, and instead take a longer-term, big-picture view while formulating policy.

Federal to State Squeeze

The Nebraska state government doesn’t only face increased pressure to fund local projects—it also faces increased pressure from the federal government. The federal government has a spending issue and an entitlement issue:

  • The US government has benefited for some time from very low interest rates on sovereign debt, allowing it to spend much more freely than it would if it were paying a higher rate to borrow funds that will obligate future taxpayers.
  • At various times states have been skeptical about the likelihood that the federal government will continue to fund mandates into the future. Nebraska fears increasing its dependence on funds from the federal government.

Nebraska is a net recipient of federal tax dollars, according to a Tax Foundation report covering 1981–2005. The $1.10 received per $1 spent places Nebraska squarely in the middle of the pack of states receiving tax transfers from other states.

This is a good position to be in at the moment, but as the federal budget position weakens owing to increased entitlement spending on programs such as Social Security, Medicare, and Medicaid, the pressure on states to fund greater portions of these programs increases.


Nebraska has many options for reform. The “dynamic” approach to the fiscal commons, that is, the common pool of fiscal resources, points out that all the pathologies in policy were arrived at one step at a time and therefore can be corrected one step at a time.

The most important thing to do is to get the institutions right and the incentives correctly aligned. Nebraska should consider fiscal constraints on new priorities:

  • School choice is a great opportunity to get more out of every dollar spent on education. Moving away from thinking of schools as geographic monopolies can help solve this school funding problem.
  • Regarding pensions, tensions remain after a major pension reform in 2015 because current public-sector workers feel they are owed defined benefits on terms originally promised.

In terms of taxation, Nebraska can choose between two reforms:

  • It can reduce the tax rates on property so the extra revenue, currently returned through a tax rebate, is not collected in the first place.
  • It can create a clearer distinction between state and local spending so that each government entity can set its own priorities.

If states like Nebraska continue to manage local issues and finance them out of the state budget, it is more likely that the states will finance expenditures that are lower priorities for voters than what voters might accept if each local government financed a larger share of its expenditures from local taxes.

All Taxes Start as Good Intentions, but Don't End That Way

Sunday, October 4, 2015
William F. Shughart II

Good intentions are one of the least scarce resources on the planet. The trick, of course, is put all those good intentions to work in ways that actually achieve desired goals. In a world where virtually every other resource is in short supply, the targets of one’s good intentions must be focused on actions that address the most pressing issues.

The “Chicago Sweetened-Beverage Tax,” now being considered by the city’s Health and Environmental Protection Committee, is long on good intentions and short both on prioritization and on understanding of the economic principles of public finance.

The ordinance, introduced at the end of July, will, if passed, impose an excise tax of one cent per ounce on all sugary soft drinks sold within the city’s limits to curb consumption of “the number one source of sugar in the American diet.” As the ordinance’s preamble states, “numerous studies” have implicated sugar as contributing to a modern obesity “epidemic, along with the health problems associated with excessive body weight, including Type II (adult-onset) diabetes, asthma, and heart disease.

The proposed ordinance assumes that a one-penny per ounce tax will lead to a 23.5 percent reduction in retail sales of sugar-sweetened beverages (SSBs), whether pre-bottled or mixed from syrup or powder at restaurants and convenience store fountains, purchases of which are subject to the same penny per ounce tax. A 23.5 percent reduction in sales, in turn, is projected to lower youth obesity rates by 9.3 percent and to cut them by 5.2 percent in adults.

That estimate of a nearly one-fourth drop in sales assumes that (1) the new excise tax will be passed on fully to consumers in higher retail prices (a 12 cent increase for a 12-ounce serving, which works out to a 12 percent price hike if an untaxed container costs $1.00), (2) consumers will not respond by switching to (untaxed) diet sodas, which mounting evidence shows to be just as unhealthful as sugary soft drinks, or (3) buy untaxed or lesser taxed SSBs beyond Chicago’s city limits.

None of those assumptions is warranted. A study of the impact of a similar SSB tax implemented in Berkeley, Calif., on January 1, 2015, found that only 22% of the tax there – not 100% – found its way into higher retail prices. Our own research, published by the Mercatus Center, suggests that a 12 percent increase in SSB prices triggers only about a 6 percent reduction in retail sales.

The tax supporters’ good intentions thus will fall far short of expectations.

How will the projected SSB tax revenue be spent? Most of it is dedicated to a special “Wellness Fund” created by the same ordinance. Twenty percent of the fund’s receipts will sponsor studies on obesity and 75 percent will be spent on educational programs emphasizing the benefits of healthy eating and physical fitness. The revenue therefore largely will flow to educators and researchers, not ordinary people.

Between one and two percent of the revenue is earmarked for studies of the tax’s actual effects on Chicagoans. But scholars of public finance already have documented the effects of selective excise taxes on producers and consumers, not just in theory, but also in practice.

It likewise is well known that the burdens of selective excise taxes on sugary drinks, like all retail taxes, fall heaviest on low-income households. Berkeley tried to avoid the regressive effects of its SSB tax by exempting soda purchases made with food stamps, but we also know that poor people disproportionately suffer the health consequences of poor diet choices.

Finally, we also know that reelection-seeking politicians will raid any public treasury account like the “Wellness Fund” whenever other budget priorities become more salient. Does anyone expect the Wellness Fund to be spent as intended if potholes in Chicago’s streets must be filled or if the pension funds for police and firefighters go deeper into the red?

We think not. We also think that Chicago’s proposed SSB tax, although grounded in good intentions, simply is another political ploy to raise revenue on the backs of poor Chicagoans who are less able to pay it than commuters and middle and upper income households.

Regressive Effects: Causes and Consequences of Selective Consumption Taxation

March 3, 2015

Governments often impose selective taxes on goods deemed to be unhealthy or poor choices. These taxes are often referred to as “sin taxes” in the academic literature and in policy circles. They may target items such as sugary drinks, candy, alcohol, and tobacco, and are designed to mitigate the social cost of consuming these goods. The question for policymakers is whether these taxes are beneficial to consumers and to society as a whole.

In a new study for the Mercatus Center at George Mason University, scholars Adam Hoffer, Rejeana Gvillo, William F. Shughart II, and Michael D. Thomas show that selective consumption taxes may do little to change behavior and that the poor spend a far greater percentage of their disposable budgets on these selective consumption taxes. The study concludes that selective consumption taxes are both ineffective and regressive, and that improving education and increasing the availability of healthier goods may be better steps than raising taxes on those who can least afford them.


The study explores how consumption of 12 goods varies across incomes by calculating the goods’ income-expenditure elasticities (whether income affects consumers’ demand for the goods). The 12 goods are alcohol, cigarettes, fast food, items sold at vending machines, purchases of food away from home, cookies, cakes, chips, candy, donuts, bacon, and carbonated soft drinks. Data come from the Bureau of Labor Statistics Consumer Expenditure surveys for 2009 through 2012.

Price Elasticity vs. Price Inelasticity
Goods can range from very price elastic (as prices increase, demand will decrease substantially) to very price inelastic (as prices increase, demand will stay relatively the same). Some of the goods examined simply do not have healthier substitutes, or consumers are not willing to substitute.

Theory Behind Selective Taxes
Selective taxes will increase the market prices of the targeted goods. This being the case, the quantities of the taxed goods consumers buy will fall and the quantities of untaxed or lesser-taxed goods consumers buy will rise. Consumption of disfavored goods, such as sugary beverages or cookies, can lead to health-related problems. Theoretically, then, reducing the quantity of these goods that consumers buy could provide a health benefit to society. However, a review of the academic literature shows that the goods studied are price inelastic and consumers who switch to substitutes tend to switch to goods equally high in calories. 


Selective Taxes are Regressive
People with lower incomes tend to spend a much larger percentage of their budgets on disfavored goods than wealthier people do.

  • Searching for adequate substitutes for certain goods can be time-consuming, costly, or otherwise undesirable. For example, switching from potato chips to apple slices may sound like a great idea, but if for whatever reason the apple slices are more expensive or more difficult to get, consumers will not switch. Moreover, some substitutes may not be healthier than the original good. A good example of this would be switching from soft drinks to fruit juice even though such a switch may not reduce calories in the daily diet.
  • Approximately 2.3 million American families live more than a mile away from a grocery store and do not own a car. Areas without a grocery store within walking distance are called “food deserts” and include many lower-income neighborhoods. Lack of access to the full range of food choices limits some consumers, particularly lower-income consumers, in their ability to choose healthier substitutes for taxed goods.

Selective Taxes are Ineffective
Quantities purchased of the 12 considered goods decrease little in response to increases in their prices, including increases caused by imposing new selective sales or excise taxes or raising existing tax rates.

The evidence shows that the link between selective taxes and consumption of alcohol, sugary drinks, snack food, and other elements of poor diets is weak. This being the case, selective consumption taxes are unlikely to slow or reverse the ongoing obesity “epidemic.”


Individuals who continue to purchase “unhealthy” items after a tax has been levied or raised will see a decline in their disposable income—the money they have available for spending on other goods—making it more difficult for them to climb out of poverty. Stuck in poverty, these individuals will also be unable to adopt healthier diets, or to change their behaviors in the ways desired by the supporters of selective consumption taxes. Because the types of goods targeted by these taxes have relatively inelastic demand—meaning consumers will keep purchasing them regardless of increases in price—the taxes are regressive in nature. A better way to reduce unhealthy eating habits would be to introduce healthy alternatives in areas where none were available previously and to educate people regarding healthy choices in their daily diets. These are less intrusive ideas that do not involve raising taxes on the poor.

Junk Food Taxes Don't Work

Monday, March 2, 2015

What if I told you there was an easy way to fix various health problems that had a variety of benefits and very little cost? Your first reaction could be "let’s do it." This is the promise that comes with taxing items to change consumer behavior. But, after many years of failed policy attempts, you should be a bit more skeptical of this approach.

In a new research paper to be published tomorrow by the Mercatus Center at George Mason University on “Regressive Effects: Causes and Consequences of Selective Consumption Taxation,” my colleagues and I explore the taxation of junk food in more detail. So many other people were talking about the health effects of bad diet that we wanted to know more about how to stop the high rates of heart disease, diabetes and other health concerns that come from eating foods high in fat, salt and sugar.

What we found is that many people live in areas where little else besides this type of food is available, areas called food deserts – or what the U.S. Department of Agriculture defines as “as urban neighborhoods and rural towns without ready access to fresh, healthy, and affordable food.” On top of this, salt and sugar are the most popular preservatives. That means food can wait around until you get ready to eat it, unlike a banana or an apple slice. Convenience is an important aspect of food purchases. It’s no wonder so many people make the choice to buy cheap, convenient food that might ultimately make them subject to chronic health problems.

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Encouraging a Productive Research Agenda: Peter Boettke and the Devil's Test

October, 2010

Peter Boettke is the single most effective graduate mentor in the Austrian economics tradition today. One of the many teaching tools Boettke uses is the devil's test. The test is an effective teaching tool because it clarifies what the goals of the political economist as critic can be. Boettke teaches his students that much can be done to clarify the logic of incentives, which in turn clarifies the debate in political advocacy. We argued that the devil's test is a good example of how Boettke enables students to become not only effective teachers but also productive scholars. The analytical framework of the heuristic enables students to analyze complex policy questions in a rigorous way. Many of Boettke's students have successfully used the distinction between motivational assumptions and causal processes, which is implicit in the devil's test, in their research.

Find the article at the Journal of Private Enterprise.

Big Brother Declares War on Consumption

Sunday, August 4, 2013
Adam J. Hoffer
William F. Shughart II

Doctors routinely advise patients to avoid a wide range of unhealthy behavior, such as smoking, excessive alcohol consumption, a poor diet, and lack of exercise. Beyond these salutary suggestions, however, there is also a growing paternalistic trend to prohibit activities like smoking—and through targeted taxation, governments are taking aim at food deemed unhealthy for having too much fat, preservatives, salt, or sugar. New York City Mayor Michael Bloomberg's ban on large, sugary drinks was just ruled unconstitutional in a unanimous decision by the state Supreme Court's Appellate Division—but this ruling isn't likely to discourage hardened advocates.

Research in the new field of "behavioral economics" generally supports such policies, but what scholars often overlook is the impact taxes and regulations have on the poorest members of society. The simple fact is that poverty reduces the scope of choice. If an added tax drives up the cost of a Big Mac, it doesn't necessarily make economic sense for someone on a limited budget to spend the time and money to travel to the nearest "organic" grocery store and then prepare a meal at home. Many will pay the penalty for their dietary choice because it's still the most viable option available. They'll have to spend more to buy the same unhealthy meal. The only one benefiting is the tax collector.

When healthy alternatives are harder to find, the tax burden on the poor is compounded, and social policy that seeks to engineer consumer choice often ignores the ease of access—or lack thereof—for the poor. So, according to a new study, among the most important advice doctors could prescribe for patients is to avoid poverty.

recent study by Dr. Hallam Hurt suggests that poverty is even more harmful than crack cocaine. Following a group of cocaine-exposed babies born during the height of the crack epidemic in Philadelphia between 1989 and 1992, researchers observed no significant difference between cocaine-exposed fetuses and controls when it came to markers such as average IQ and school readiness. However, they found both groups lagging when compared to children in the same age group on a national scale. When the researchers looked for the cause, they observed other environmental factors that revealed poverty as the common link and "a more powerful influence on the outcome of inner-city children than gestational exposure to cocaine."

This confirms a point-of-view expressed consistently by economists for the last 250 years: The most important thing we can do for a society is to move people out of poverty. Since Adam Smith consolidated economic thinking in 1776, the main issue became one of explaining the causes and documenting the dramatic consequences of economic growth. And restrictions on choice impede the mechanism of growth.

The historical record is nothing less than astonishing. Poverty has fallen dramatically on a global scale. According to Census data, the number of U.S. families earning more than $100,000 (when adjusted for inflation) increased by 34 percent between 1990 and 2009. Those gains are most noteworthy among black families (a 47 percent increase) and families of Hispanic origin (up 51 percent). The economic engine of growth is breaking down society's long-entrenched barriers to success. While this is great news for the middle class, the poorest of the poor continue to comprise about 11 percent of the population. The push to engineer consumer choice continues despite knowledge of the benefits of vigorous economic growth. When people become wealthy, they start eating healthy—because they can afford to. Diets, exercise programs, and even the knowledge of healthy alternatives are more readily available when one has the flexibly that affluence provides.

Due to the limited choices already embedded in the geographic clusters of poverty, society's poorest people do not have suitable alternatives like the middle and upper classes might pursue. Somehow policy makers assume that taxing high-fat and sugary foods will create the infrastructure missing in the urban food desert where there are fewer fresh vegetables or health-conscious alternatives.

Because America's poor are mired in miserable circumstances, the solution is not to increase taxes and raise prices on their relatively few options. Instead, the solution should be to make it easier to escape poverty altogether. The economic engine of growth is the best friend the impoverished have for escaping their plight, and the recipe is no mystery: well-defined and enforced private property rights and limited government. Public policy priorities should accomplish these ends first. Perhaps the best place for political elites to debate the benefits of paternalism is at the country club, not in the government corridors where policy is made.

The mania for selectively taxing, banning, or regulating the consumption of "bad" foods should be re-examined by considering the impact on the poorest citizens. To the extent that options are available, taxing food choices might help promote a healthier middle-class diet, but it merely reduces the already meager income of the poorest among us.

Rational Irrationality and the Political Process of Repeal

January 7, 2013

The theory of rational irrationality suggests that voters are biased and do not face sufficient incentives to choose rationally; instead they vote for various private reasons. As a result, socially and economically destructive policies can receive widespread public support. Furthermore, because there is no private benefit of learning from experience, such policies can persist over time. We argue here that despite this otherwise dismal outlook on public policy, the theory of rational irrationality leaves two avenues for economically sensible reform: First, when the ex post costs of irrationality are higher than expected, rationally irrational voters will reduce their consumption of irrationality and demand more rational policies. Second, rationally irrational voters can be convinced to rationally update their policy preferences through the use of appealing rhetoric and persuasion by experts. We discuss these two avenues for reform using the example of the repeal of the 18th amendment, which, as we will show, relied on both updating as well as persuasive campaigning.

Find the full article at Wiley Online Library.

'Sin Tax' Costs Outweigh Benefits

Tuesday, February 5, 2013
Adam J. Hoffer
William F. Shughart II

Burdened by unfunded public pension liabilities and healthcare costs, state and local governments are in bad shape, considering the willingness of voters to embrace new spending proposals and their general reluctance to pay taxes to finance them.

Responding to the latest round of public budget "crises," policymakers around the country have begun reviving an old, but not necessarily good idea with added enthusiasm—taxing "sin." What better way to raise revenue than to find something that your neighbor buys or an activity he engages in that you don't like and tax it?

Alcohol, tobacco, and gambling have been taxed for a long time. A tax on whiskey—and the rebellion it triggered by corn farmers in western Pennsylvania—was, after all, one of Treasury Secretary Alexander Hamilton's first "revenue-enhancers." Later on, after Prohibition obviously had failed and the Great Depression had caused income tax receipts to shrink dramatically, Franklin Roosevelt ran for his first term as president on a platform calling for legalizing and taxing alcohol sales.

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Sin Taxes: Size, Growth, and Creation of the Sindustry

February 5, 2013

I. Introduction

Revenue shortfalls associated with the Great Recession and the corresponding slow recovery have hindered the ability of US state governments to balance their budgets. With lingering economic doldrums eroding governmental tax bases and strong resistance to proposals for cutting public spending or raising broad-based taxes, many states have begun searching for new revenue sources. Particularly attractive targets for revenue creation are goods deemed by policy makers to be unhealthy, to generate negative externalities, or both. Historically, certain items have been the primary focus of selective excise taxation: tobacco, alcohol, salt, stamps, tea, and motor fuels.[1] Owing to alcohol, tobacco, and gambling’s longstanding association with vice, taxes on these items are commonly referred to as “sin taxes.” While taxing items with presumed negative effects on public health, public morals, and the environment has a long history in traditional welfare economics, a growing number of consumer goods are now being added to the list of items singled out for selective sin taxation.

Recent additions to the sin tax category are foods that are high in sugar, trans fats, and other ingredients the public health establishment has associated with rising incidences of obesity,[2] type 2 diabetes, and similar so-called epidemics. Indeed, 33 states already have implemented a soft drink tax. Because public health expenditures are correlated with the consumption of these goods, a case has been made for the selective taxation of all sugar- sweetened beverages, junk food, and many items on the menus of fast food restaurants (see Brownell et al. 2009 and Jacobson and Brownell 2000).

This paper addresses three criticisms of sin taxes: First, the traditional Pigouvian justification applied to sin goods, such as alcohol and tobacco, is frequently misapplied to a progressively broader base of goods and services where the “sin good” label is questionable, such as automobile tires, candy, soft drinks, and fast food. The standard argument is that, because consuming these and other goods generates negative externalities that consumers are unable to take into account, private markets “fail” in the sense that consumers purchase more sin goods than is socially optimal. Hence, governments must intervene by imposing the appropriate tax rate so that consumers internalize the externality and reduce their purchases. However, at some point, this justification blurred with things like motor fuel taxes, originally justified as user fees meant to build and maintain highway capacity. Nowadays, the justification advanced for taxing sin goods is often based on paternalistic, normative grounds—policy makers can make better consumption choices for individuals than individuals can make for themselves. Second, like consumption taxes in general, the burden of sin taxes usually falls disproportionately on low-income households. Third, the expanding list of goods taxed in this way triggers socially wasteful lobbying by the affected producers. They lobby both to counter the imposition of new sin taxes and to prevent existing tax rates from rising. Special-interest groups that support new or higher excise taxes also invest resources in promoting their own points of view. To illustrate the government’s exploitation of this tax base, we additionally document the trends in sin taxes over time, including changes in sin tax rates and the amounts of revenue they raise.

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