Is Smoking Inferior? Evidence from Variation in the Earned Income Tax Credit

Abstract

In this paper we estimate the income elasticity of smoking. In contrast to previous research, we address the econometric endogeneity of income as a determinant of smoking participation, cessation, and cigarette demand conditional upon participation. We use an instrumental variables (IV) estimation strategy that exploits exogenous variation in family income generated by changes in Federal and State Earned Income Tax Credit parameters. Using the IV strategy we find that smoking cigarettes appears to be a normal good among low-income adults: higher instrumented income is associated with a higher probability of smoking participation and a lower probability of smoking cessation. The magnitude and direction of the changes in the income coefficients from our OLS to IV estimates are consistent with the hypothesis that correlational estimates between income and smoking related outcomes are biased by unobservable characteristics that differentiate higher income smokers from lower income smokers.