Academic journal article Journal of Economics and Finance

State Tax Changes and Quasi-Experimental Price Elasticities of U.S. Cigarette Demand: An Update

Academic journal article Journal of Economics and Finance

State Tax Changes and Quasi-Experimental Price Elasticities of U.S. Cigarette Demand: An Update

Article excerpt

Abstract

This paper uses 336 state tax changes across the U.S. spanning 42 years (1956-1997) to provide an updated look at the quasi-experimental price elasticities of cigarette demand. It also studies the sensitivity of these elasticity estimates to changes in the cigarette market over time as well as their sensitivity to border-effect purchases. Besides replicating earlier findings, the results show a downward trend in these elasticities over time and sensitivity to border effect purchases. Policy implications are discussed. (JEL 118)

Introduction

In 1996, Americans spent $49 billion on tobacco products, with the majority of these dollars used to purchase 24 billion packs of cigarettes. Nearly 99 percent of these cigarettes were produced by only four domestic firms. This industry is characterized by a high level of concentration, small economies of scale, and lack of entry. The latter reflects a fear of law suits and strong existing brand loyalty as well as the informational barriers posed by advertising restrictions (ban on advertisements in television and radio). [See Chaloupka and Warner (2000) and Gruber (2001) for recent reviews.] Although the cigarette industry is still a large sector of the U.S. economy, its size has shrunk considerably over time. Since the release of the 1964 Surgeon General's report about the ill effects of smoking, public health officials have waged a massive campaign against tobacco use including restrictions on advertising, warning labels, smoking bans in public places, antismoking public service announcements, and educational programs.

The public sector has traditionally regulated smoking in one of three ways. The first and most important is excise taxation at the state, federal, and local level. The second tool for regulation is limits on smoking in public places (workplace, restaurants, public transportation, etc.). As of the end of 1997, all states except Alabama had some form of such regulation, with 21 states banning smoking in private workplaces. The third set of regulations on smoking involves restrictions on youth access to tobacco products. In July 1992, the Federal Alcohol, Drug Abuse, and Mental Health Administration Reorganization Act required that all states have in place by 1995 a law prohibiting any manufacturer, retailer, or distributor of tobacco from selling or distributing to individuals under the age of 18. [See Gruber (2001).]

In 1997, the average retail price of cigarettes varied from $1.46 in Kentucky to $2.65 in the State of Washington. Most of this variation in retail prices is due to differences in excise taxes across states. Total taxes on tobacco products (for fiscal year 1997) were $13.2 billion, consisting of $7.3 billion from state taxes, $5.7 billion from federal taxes, and $0.2 billion from local taxes. Ninety-six percent of these revenues were from cigarette taxes. The federal tax on cigarettes was $0.24/pack, and state taxes ranged from a low of $0.025 in Virginia to a high of $1 in Alaska and Hawaii. [See Figure 1.]

State tax changes have been frequent and varied. Between 1956 and 1997, there were 336 changes in state tax rates. [See Figure 2.] The largest nominal tax changes during the early to mid-1990s were in Arizona in 1994 ($0.40), Michigan in 1994 ($0.50), Hawaii in 1994 ($0.52), and Massachusetts in 1993 ($0.25). By 1997, the largest nominal tax increases were in Vermont in 1997 ($0.24), Washington in 1996 ($0.25), Massachusetts in 1997 ($0.25), and Oregon in 1997 ($0.30). Over the entire period of study, 1956-1997, the minimum tax change was -5 cents per pack, and the maximum was 52 cents per pack. The median tax change was 3 cents, and the average tax change was 4.4 cents per pack. [See Figure 3.] In percentage terms, the median tax change was 33.3 percent, while the average tax change was 38.8 percent. The minimum percentage tax change was -33.3 percent, and the maximum was 250 percent. We exclude from these percentage calculations tax changes starting from no tax, i. …

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