Healthcare advocates say they support the tax, believing it will lead more smokers to quit. According to the Coalition for a Tobacco Free Louisiana, each 10 percent cigarette tax increase means 7 percent of children and 2 percent of adults quit smoking."
Looking at this situation intimately, this article and situation can be directly related to the economic theory of market failure. More specifically, this situation would fit under the existence of externalities. An externality occurs when the production or consumption of a good has an effect upon a third party. In this case, smoking cigarettes is harmful and therefore this would be considered as a negative externality. Externalities may be split into four types: negative and positive externalities of production, and negative and positive externalities of consumption. The consumption of cigarettes has a direct effect on third parties. Therefore, this article would fit under the negative externalities of consumption.
The negative externalities of consumption produced when smoking cigarettes make the marginal social benefits less than the marginal private benefits.
The diagram above shows how the marginal social benefits are less than the marginal private benefits, and therefore the welfare loss is produced.
The private utility is reduced by the negative utility suffered by the third party due to second hand smoking. People who smoke regularly do enjoy the private benefits of smoking; however, this immediately creates external costs for other people. Due to the fact that it is a free market economy, consumers will consume at the level where MSC = MPB. The negative externality which is being created will be ignored causing a welfare loss and a market failure. At this point the government will act to reduce or eliminate the negative externality.
This article is directly related to the government acting on the negative externality. Even though there are numerous ways for a government to approach this, President Barack Obama does so by imposing indirect taxes on all tobacco. Specifically for cigarettes the president plans on raising the taxes by 62 cents. This will shift the MSC curve upwards, and therefore this will reduce consumption to the socially efficient level of output (Q*). Also the government will gain significant revenue and Barack Obama plans on using the majority of this money to expand the Children’s Health Insurance Program.
The diagram above shows how the MSC was moved upwards because of Obama's decision. This will reduce the consumption of cigarettes to the socially efficient level of output (Q*), and as you can see the price to consumers will be greater (P2).
Overall, the indirect taxes added to cigarettes on the 4th of February looks like a very smart decision. The government will gain more revenue which will be used to help expand Children’s Health Insurance Program. However, there are also numerous limitations which arise when studying Obama's decision. First, cigarettes have quite an inelastic demand. This means that taxes do not manage to reduce the amount of cigarettes smoked very much. Basically this could mean that there was no dramatic change in the negative externality or welfare loss.
Also, if the taxes placed on tobacco is raised too much than this can lead to many different corrupt actions. For example, if on April 1 when the taxes are enforced, a huge amount of people stop buying tobacco, the people could look for other sources of supply. One case could be a black market forming between the US and Mexican boarder. If drugs and tobacco are smuggled illegally, this could lead to many worse negative externalities.
According to this analysis, Obama's decision to raise taxes a little more was a smart decision. The taxes were not raised enough to help form a black market; however, enough to force some people to quit smoking and also helping the expansion of the Children’s Health Insurance Program.
