Tobacco Taxes and Public Policy to Discourage Smoking

Abstract

In this paper, we present evidence of the likely impact of cigarette tax hikes on consumers, governments, and producers. We show that 100 percent of a tax hike is passed onto consumers in the form of higher prices. Using both state and individual-level data, we find a cigarette demand elasticity of -0.30 to -0.50, with long-term elasticities 1.75 times the short-term values. We demonstrate that cigarette taxes have become much more regressive over time as smoking rates among the highest income groups have fallen sharply. One reason for this drop is the large decline in smoking rates for the most educated. Given their ability to shift tax increases onto consumers, tobacco companies bear little of the burden of a tax. We estimate that for every $1 raised in tax revenues, cigarette companies lose only 8 cents in before-tax profits. Using daily stock prices, we conduct an event study examining how new information about litigation and settlement of state Medicaid cases against cigarette manufacturers changed the value of the firm. Events that increased the plaintiffs' chances in state Medicaid cases had a statistically significant negative impact on firm value while movements toward settlement greatly increased stock prices. Finally, we consider the external costs of smoking. Although some argue that current tax revenues exceed the external costs of smoking, these estimates typically exclude the costs of maternal smoking. We show that the costs of maternal smoking range from $0.42-$0.72 per pack which makes the question of whether these costs should be considered external critical in any cost-benefit analysis.