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High, Low, or No Cigarette Tax?

Sep 11, 2010 • Behavioral Economics, Demand, Supply, and Markets, Government, Thinking Economically • 187 Views    9 Comments

Recently, Connecticut legislators were pleasantly surprised because an increase in the cigarette tax generated more revenue than they expected. You might say that the results were predictable. However, if a state increases taxes, it is possible that consumers will stop buying the item or go somewhere else to get it.

If a person who smokes lives in New York where the cigarette tax is $4.35, would he travel to Pennsylvania to pay $1.60 or further to Virginia where the tax is $.30? According to a 2008 study from Harvard’s Kennedy School, to save $1.00 on a cigarette purchase, a person will travel 2.7 miles when each extra mile costs that consumer $.37.

The Economic Lesson

All of this is about much more than cigarettes. It relates to recession generated diminishing state tax revenue. States need to pay for roads and teachers and police. They have current salaries and pension payments for retired workers. 

Income taxes and sales (excise) taxes are primary sources of most states’ revenue. However, with tax revenue down because of the recession, states are trying to figure out how to raise more money (or to spend less). Arizona has even tried to sell its state capitol building. Other possibilities are “sin” taxes on cigarettes, soda, and alcohol. The question, though, is how high can taxes go before they backfire. Too high and people avoid them; too low and they miss potential revenue.

An economist would say the sales tax debate is about the price elasticity of demand. If price changes a lot and the quantity we buy remains the same, as with medication and gasoline, then our demand is inelastic. By contrast, if price swings have an impact on buying, then our response is elastic. With soda, within a certain price range our demand is inelastic. Once we reach a 35% increase, though, we switch to an elastic response. Connecticut’s revenue increase implies that cigarette demand is inelastic.

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  • Alissa Anzevino

    I agree with all of the comments above; I think that the benefits of the “sin taxes” outweigh the potential losses. The state governments would be able to collect revenue while deterring people from bad habits. I think Mira’s comment is particularly insightful in terms of how to make the taxes most effective on both the government and the consumer end.

  • korberm11

    @EmilyMiller: I agree with your point of view. Adding “sin taxes” would overall improve both the economy and Americans’ state of health.

  • korberm11

    Moderation is definitely key; states should raise their taxes to the maximum point of inelasticity on “sin” commodities. The balance between too high and too low is one that can be achieved through trial and error. Cigarette taxes could also be instated on a national scale. This would eliminate the problem of people driving out-of-state to evade the tax.

  • EmilyMiller

    I completely support these “sin” taxes. Smoking is a habit that should be curbed. If it takes a high tax that may deter people from purchasing cigarettes, that is an excellent way to decrease lung cancer and other life-threatening diseases that smoking causes. Raising money should not be the first concern; decreasing cancer fatalities is much more important. If the government can increase the state tax revenue, than that’s just another benefit.
    This tax reminds me of the tanning tax that made headlines recently. Some people are staunchly opposed to the 10% tax; however, it is just another way for the government to increase tax revenues while also deterring Americans away from carcinogenic UV radiation. I do not see a problem with that; the government is saving our lives. And if you choose to subject yourself to tanning, then you pay the price in more ways than one.

  • LewisK

    When some states are in such high debt I think that there is nothing wrong with raising taxes on non-necessities. Cigarettes are known to be harmful but i think that raising the tax on them should be an intensive for people to start trying to quit. I don’t understands people who would drive to other states for cigarettes. I agree with the statement that taxes must be the right amount for them to be effective. If a tax is too high people will avoid the product all together.- but is this so bad for cigarettes?

    -Kim Lewis

  • Paige Shepperly

    One state that has been extremely affected by the recession is California. The taxes have gone up but cuts in the university budgets are still being made. The only one that will not be affected quite yet is UC Berkeley. Because it is such a popular school it will be the last one to have cuts made. Unfortunately, the schools have had to double their acceptance of out of state students and have started to use many more teaching assistants than actual professors. As teacher salaries go down the quality of education decreases as well. It is sad to see something so important to society being affected by the economy. Education is the last thing anyone wants to lose, especially in California where they have so many good schools. Most of the kids do not want to leave and they have not had to until now. This change in dynamic is going to cost everyone more money to get a quality education. Prices are rising in everything and not just of schools. It is scary to think about but it is definitely interesting to look back in history and see how different the cost of life was then compared to now and to think how much money we are going to have to make in the future to sustain a lifestyle similar to the ones we live now.

  • birdf11

    With America in a recession and state tax revenue at a low, the government must get creative to find the money to pay for government paid jobs, roads, and retirement pensions. It is an interesting idea to raise cigarette, alcohol, and soda taxes, but is it moral? Although it is expected that most people drink alcohol and soda, and smoke cigarettes, we cannot assume that everyone is using these materials for bad purposes. Perhaps scientists are using soda to run an experiment, or that a chef is using alcohol for a recipe. If the taxes must be increased on certain goods, I believe that the goods in the highest demand should be the first to experience an increase in taxes. If

  • elizabeth.y

    Although some people would disagree with further raising taxes, at this point it almost seems necessary. At this time, state budgets are less than sufficient. New Jersey has been firing teachers and getting rid of costly programs. In order to start to fix our suffering budget, we might need to start raising some taxes. The

  • CarolineGiroux

    The debate about weather raising taxes will decrease purchasing or generate more revenue is a very interesting one. I think that the idea of elasticity will certainly shed some light. It is important to think about how badly people want/need certain things. It would only be effective to raise sales taxes on things that people really need, because then they will continue to purchase even though prices have gone up. However, another idea would be to increase taxes on items that are detrimental to health because then people might stop purchasing them. This would not necesarily have a positive effect on the economy (especially for the companies selling these products). However, we also need to take into account the fact that the people will be angry if taxes continue to rise on their everyday products. The correlation between a rise in revenue and a rise in taxes is what economists hope to see but in the case of cigarettes, this is not a positive thing.

    Caroline Giroux

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