“My goal here is not to raise taxes. My goal is to make sure that we provide the necessary services, and that if we are to increase revenue, we do it in such a way that the revenue raised, and raised quite a responsibility,” Hubbard said. “I think this is a proposal that does it.”
David Sutton, a representative cigarette manufacturer in Richmond, Va.-based Philip Morris USA, said that it would not be fair to fill the shortfall of income tax a minority of taxpayers. “You’re talking about raising taxes on one segment of the population, to provide financing for the general fund, which benefits the entire population of the State,” he told the newspaper. “It’s a fairness issue of taxation.”
Sutton also said raising taxes on cigarettes will encourage smokers Alabama to cross state lines to buy cigarettes; it hurts sales in stores and other retail outlets in Alabama.
Current state of Alabama’s cigarette tax of 42.5 cents per pack was, as of November 17, the fifth lowest among the 50 states, the report said, referring to the National Conference of State Legislatures. The average state tax amounted to 1.29 dollar per pack.
The basic economic problem in this article is negative externalities. An externality occurs when there is a divergence between social and private costs and benefits. Cigarettes and secondary smoking are considered to be negative externalities of consumption. In this case the marginal social benefit (MSB) is less than the marginal private benefit (MPB). This is shown in the diagram below.
Because of a free market, the consumers will maximize their maximum personal benefit (when MPC=MPB), and consume at the level where MSC (marginal social cost) =MPB. This will create over-consumption of cigarettes at Q1 at a price P1. The socially efficient output is at Q and so the free market overproduces from Q to Q1. This causes welfare loss to society and a market failure.
The government will attempt to do two things to reduce or eliminate the negative externality and the market failure.
Firstly, the government is placing partial ban on smoking. That is, making it illegal to smoke in certain areas, in this case restaurants, malls, etc. the hopes of politicians are by making it more difficult to smoke the demand for cigarettes will fall and so reduce smoking and secondary smoking.
The most effective answer would be a total ban, but loss of tax revenue; unemployment in the tobacco industry, loss of votes and the emergence of a black market could be factors against this. It seems that if the government wanted to ban smoking they would have done it a long time ago, since the tobacco industry is not a new industry.
Secondly, the government will impose further indirect taxes on cigarettes, in order to reduce consumption. Therefore, it needs to assess the cost of negative externalities to society. It then sets tax rates on those equal to the value of the externality. This internalizes the externality, making smokers pay for the costs to society. However, it is often very difficult for governments to place a monetary value on negative externalities and therefore decide the optimum tax rate.
The imposition of an indirect tax on cigarettes increases costs to consumers by shifting MSC (36) +tax. The result should reduce consumption from Q1 to the socially efficient level of output Q, while the price to consumers will be P2 or P3 depending on the tax increase. Fewer externalities are created and the government will gain significant tax revenue (Q x $1.36 or Q x $1), which it may use to correct some of the negative externalities created by smoking.
However, the demand for cigarettes is relatively inelastic, due to the habit-forming nature of the good, which means that taxes don’t necessarily reduce quantity demanded very much. Therefore, quantity demanded doesn’t fall to the socially efficient level.
Also, if taxes are raised too much, then people start looking for other sources of supply or perhaps substitutes for cigarettes such as cheaper cigarettes off the internet. A cause of this may be the emergence of a black market; this contradicts the Editorial Board’s statement “we are strong advocates of raising cigarette tax – and the higher the better”.
Taxation seems to be the better choice, provided that the revenue gained exceeds the social costs. The tax revenue can be used to subsidize health-care costs to ease the burden of the taxpayer. It can also be used to educate and advertise against smoking, as well as initiating programs to help smokers stop. Hopefully this will in the long run reduce the demand for cigarettes and so shift MPB to the left closer to MSB, thus reducing the health-care costs. However, it would increase the costs to smokers and producers in the tobacco industry. In the short run, this may lead to unemployment; while in the long run unemployment might fall since the indirect costs, such as lost wages due to smoking related illnesses, will fall.