Cigarette Taxes: Effects on the Economy

University Degree Business and Administrative studies

Tobacco is big business in the United States. Alone, cigarette sales in the United States in 2005 totaled $82 billion (Capehart 2007). Federal cigarette excise tax collections are estimated at $7.4 billion for 2001 (Tobacco Outlook Report, 2003). For governments, tobacco tax revenues have become an integral part of the tax structure, and important for boosting state and federal coffers. This paper will look at the effects of increased cigarette taxes on consumption, government revenues, and employment in the tobacco industries.

Law makers like to argue that cigarette taxes are used to reduce consumption. This while partially true does not totally account for the reduction in smokers over the last 24 years (Sahadi 2005). This is due to the fact that the price elasticity of demand for cigarettes is somewhere between -0.3 and -0.5 (see figure 1) (Bradford, 2003; Chan and Capehart 2004). This indicates that the demand curve is inelastic. A ten percent increase in price would reflect as a 3-5% decrease in consumption. This inelasticity is supported by the fact that between November 1998 and April 2002 wholesale manufacturers prices rose eightfold (Tobacco Outlook Report, 2003). During the same time period there was not an eightfold reduction in smokers even taking into account the people that quit for health reasons. Education around the health dangers of smoking is responsible for a larger part of the total reduction in cigarette sales (Sahadi 2005). So we can conclude that increased taxes have a moderate effect on cigarette sales.

Governments have come to rely on incomes from cigarette taxes have increased over the last 50 plus years (Centers for Disease Control and Prevention: Morbidity and Mortality Weekly Report [serial online]. 2002). The reduction in consumption is a moderate effect of increased prices (including tax) due to the to the price inelasticity of demand. As mentioned earlier, much of the decrease is due to an increased awareness of the health hazards of smoking. If taxes stayed constant, revenues would only fall 1.5% per year given the rate of smoking reduction in the United States (see figure 3) (Lindblom 2007). In effect, government does not have to set taxes at a much higher level to compensate for demand reduction for cigarettes like it would in an industry with elastic demand. Cigarette taxes produce fairly reliable streams of revenue for the government. It may also contribute to the steady decline of cigarette consumption in a slow, sustainable manner, which provides a social benefit.

While some may see increased taxes as a form of gouging by the government, it is helpful to understand that there are some negative externalities that are passed on to nonsmokers. The total economic costs associated with cigarette smoking are estimated at $7.18 per pack (vs. average cost of $4.26 per pack) of cigarettes sold in the United States (Centers for Disease Control and Prevention). It would be responsible for the government to use tax revenues to offset some of this difference in economic cost and retail cost of cigarettes. Any policy that helps decrease smoking should aid in decreasing ...