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The good tax

No one enjoys paying taxes. Remember receiving your first paycheck and discovering how much of your hard-earned money you would be sharing with the government? Most of us recognize that some taxes are necessary. We are happy to have roads, schools, courts, and a military, but don’t feel great about having to pay the taxes that fund them. Although economics recognizes the need for taxes to fund the government, it is pretty clear-eyed about the downside of taxes:

  • Corporate taxes are problematic because they involve taxing the same earnings twice. Once a corporation has paid taxes on its income, it distributes some of that income to shareholders as dividends–which are then taxed a second time. It would make more economic sense to forget about corporations and just tax shareholders.
  • Income taxes, particularly in the United States, have so many loopholes that they distort economic incentives. For example, people who would be better off renting a house may decide to buy because buying is cheaper once they factor in that they can deduct mortgage interest payments from their income tax.

Nonetheless, taxes are sometimes good for us, despite the economic drawbacks. One example is the tax on cigarettes.

Smoking is costly for society. According to the US Centers for Disease Control, smoking-related illness costs the United States more than $300 billion per year, approximately the same amount as Americans spend on all prescription drugs combined. The health costs and lost productivity due to cigarettes are estimated to be $19.16 per pack. If a higher tax on cigarettes reduces smoking, this would be a good outcome.

Historically, states were willing to impose “sin taxes,” that is, taxes on items considered to be socially undesirable or harmful like alcohol and tobacco, because demand for these products was generally robust—hence the taxes provided a dependable revenue stream.

More recently, and particularly in the case of cigarettes, a different motivation has come to the fore. If the tax is high enough, it may discourage consumption, which would be a good thing. So, the question is: do higher taxes on cigarettes reduce sales?

Figure 1 plots the adult smoking rate on the horizontal axis and the level of state cigarette taxes on the vertical axis. The tax data in figure 1 do not include a federal tax of $1.01 per pack of cigarettes, or taxes by cities and counties, such as Chicago ($1.18), Cook County ($3.00), New York City ($1.50), Philadelphia ($2.00), and Juneau, AK ($3.00). Note the high tax rate in the northeast and far west, and the relatively low tax rate in the major tobacco-producing states (NC, KY, VA, SC, TN, and GA, highlighted in red).

Figure 1: Cigarette taxes and smoking rates, by US state by Richard S. Grossman. Used with permission.

The trend line in Figure 1, which illustrates the relationship between cigarette taxes and smoking, suggests that higher taxes are, in fact, associated with less smoking. However, the data also suggest that high taxes have their limits. New York, for example, has the highest state tax on cigarettes ($4.35 per pack), but its adult smoking rate is still higher than the slightly lower-tax states such of Massachusetts ($3.51), Connecticut ($3.90), New Jersey ($2.70), and California ($2.87). The data also clearly indicates that the state tax rate is not the sole determinant of smoking. For example, Utah which has a relatively low tax rate also has a lower smoking rate, presumably due in part to Mormonism’s prohibition on smoking.

The adult smoking rate may not be the best indicator of the success of cigarette tax policy. Adult smokers are usually long-term smokers who are both more likely to be addicted and have more money, and so may be less discouraged by high cigarette taxes. Young smokers, however, are less likely to be addicted and have the financial means to support a smoking habit, so we would expect their demand for cigarettes to be more sensitive to taxes. Figure 2 plots the youth smoking rate on the horizontal axis and the level of cigarette state taxes on the vertical axis.

Figure 2: cigarette tax and youth smoking, by state by Richard S. Grossman. Used with permission.

Figure 2 bears out this assertion. The flatter trend line illustrates that higher state taxes lead to a greater decline in smoking among youth than among adults, and suggests that a number of states could lower their youth smoking rate even further by raising the excise tax.

Of course, state policy on cigarette taxes can be subverted by smuggling if the divergence between state taxes are substantial. Buying just one package of cigarettes in Virginia, where the tax is $0.30 per pack, and selling it in New York City, where the city and state tax combined are $6.01, would lead to a profit of $5.71. Since a pack of cigarettes is quite small and weighs only a few ounces, large scale smuggling presents a significant profit opportunity. One way of increasing cigarette taxes without encouraging additional smuggling would be to increase the $1.01 per pack federal tax on cigarettes.

Cigarette tax policy is far more complicated than the simple analysis presented here. There are many additional factors that may affect youth and adult smoking patterns, including race, gender, ethnicity, advertising, and legal age of smoking. And, since smoking is more common among the less affluent, cigarette taxes are likely to be regressive.

Despite these caveats, the evidence is clear that taxing cigarettes can save lives.

Featured image credit: cigarette smoking smoke ash by markusspiske. Public domain via Pixabay.

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