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Wednesday, February 28, 2007

Cigarette tax shot down, unfortunately

My previous post talked about what I view as a good bit of legislation passing in Indiana. Now I want to talk about a bill that was narrowly defeated in the House recently.

Governor Mitch Daniels proposed an increase in the State's cigarette tax by 25 cents. Proceeds would help provide thousands of uninsured Hoosiers with basic health insurance coverage. This is pigovian taxation at its best (For my view of supposedly Pigovian taxation at its worst - see my views on gas tax hikes).

Why would the Governors fellow Republicans nix such a fine idea? The negative externalities of smoking are heavily documented and, unlike other goods like gasoline, it is not a necessity, it is a luxury that provides addicts with short-term enjoyment at the cost of their and others' long-run health.

(I should be clearer here: technically cigarettes are not luxury goods since the income elasticities are not greater than 1 in absolute value. In other words, cigarette consumption does not increase much (if at all) the more money you have. The reason of course is becuase poor people, one can assume, have more problems in life - and cigarettes act to calm the nerves and provide a sense of relief to those problems. So while it may not technically be a luxury item, it is most definitely a non-necessity item - it's a good that people consume purely for recreation or perceived mental health benefit - a benefit that is short-run and largely imaginary.)

The great thing about a tax on cigarettes is that while it's not at all a necessity good (and demand for non-essential goods are usually relatively more elastic than those of necessity like gasoline), it's demand curve is somewhat inelastic since it is an addictive substance (people won't change consumption patterns as much for a given tax hike. Thus, revenues would be easier to come by from an increase in a cigarette tax. And, because it is a non-necessity good (a frill) with large negative externalies, there is a sense that it is ok if it means some poor guy can't afford cigarettes anymore (unlike gasoline, where a gas tax could really have negative effects on people's lives in general).

Most researcherr think the elasticity (price) of demand for cigarettes is around -.40. A 10% increase in cigarette prices (via a tax, per se) would reduce cigarette quantity demanded by 4%.

Of course, it's relative inelasticity means a larger tax should be placed on it if one wants to have a useful effect on the negative externality problems. I think 25 cents is probably too low given the substantial evidence of the negatives of smoking to society (not just health), but $0 is even lower! Indiana Republicans should be ashamed for not touting this tax increase. They should be ashamed that they'd rather let people keep smoking than let people live healthier lives.


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