The Interactive Great American Taxing Game: Tobacco

Release Date
January 27, 2014

Topic

Gov't Debt & Spending Government Taxing
Description

It’s the Great American Taxing Game and you have chosen to tax cigarettes to be paid by cigarette suppliers. Who actually bears the burden of the tax? Because smokers are pretty unresponsive to price changes, they are most likely to pay. This is not necessarily a bad thing: smokers pay higher prices and the government collects the revenue. But, does it work at all levels? Your host Prof. Art Carden demonstrates why cigarette taxes are not particularly effective at the state or local levels. Don’t forget to see what would happen if you chose to tax oil companies or luxuries instead.

The Crusade for Politically Correct Consumption [article]: This FEE article discusses how the push for sin taxes invites pork-barrel politics and stems from puritanical elitism.
A Higher Gasoline Tax Will Solve Everything? [article]: Another FEE article compares gas taxes to sin taxes, arguing that they are ultimately paternalistic measures.
Luxury Tax [encyclopedia entry]: A definition and history of the luxury tax.
The Effect of Tax Changes on Consumer Spending [report]: The New York Federal Reserve reports on the impact of taxation on consumer behavior.

The Interactive Great American Taxing Game: Tobacco
Suppose you imposed a tax on cigarettes to be paid by cigarette suppliers. Who actually bears the burden of the tax? If smokers are less responsive to changes in prices than sellers, then no matter who’s legally responsible for handing over the money to the government, the smokers themselves are those who are most likely to pay.
You might think you’re taxing a tobacco company. In reality, you’re taxing a smoker. If you’re a government looking to raise money with minimum waste, this might not necessarily be a bad thing. Taxing activities for which people are relatively unresponsive to changes in prices, like smoking. raises revenue with minimal distortion. In short, we don’t lose much in the way of gains from trade when we tax goods for which people are unresponsive to changing prices. We just transfer those gains from trade to the government.
This might not work at all levels. Consider state-level taxes for example. It’s true there might not be many substitutes for cigarettes per se, but what if we limit our attention to the market for cigarettes purchased in Tennessee or cigarettes purchased in New York City? There are a lot of substitutes for cigarettes purchased in Tennessee. Specifically, cigarettes purchased in any of the eight states that border Tennessee. There are also a lot of substitutes for cigarettes purchased in New York City, like cigarettes purchased out of state or in other parts of New York.
Indeed when places have ratcheted up their cigarette taxes, they’ve seen big increases in tax avoidance and smuggling. This can be as innocuous as people crossing the border to buy cigarettes and as dangerous and sophisticated as smuggling rings involving organized crime.
To summarize: cigarette taxes might be a good idea, except for when they aren’t. So if you’re government official needing to raise revenue, which one of these would you want to tax?