Tuesday, May 20, 2008

Do higher cigarette prices make smokers better off?

Economists have long searched for goods they can tax which impose no deadweight losses (DWLs) on society. Henry George supposed that assets like land which are in fixed supply can be taxed without social costs since customer demands will not change and supply will not change - the only effect of a tax on rents would be to shift rental income from land owners into the pockets of government. Such taxes produce large transfers but impose no DWLs. George in fact argued that all taxes should be based on taxing land. He wasn't quite right because he ignored quality improvements in land - these are less likely to be made with hefty land taxes - and anyway a tax base that was based on land would be too small to fund Labor Party wish lists. (George's idea was quite smart however and led later economists, such as that legendary genius Frank Plumpton Ramsay, to suggest focusing taxes on goods in inelastic supply and demand to avoid allocative losses).

My colleague at Monash University, and by far the best welfare economist in Australia, Professor Yew-Kwang Ng, has suggested taxing diamond-like goods whose value is seen to be higher in the eyes of consumers when they are more expensive. Again the basic idea is that noone loses with such an excise tax. The government gets revenue and diamond consumers get more satisfaction by being able to display even more expensive diamonds.

Now I have found a third twist to the possibility of taxes without DWLs that involves taxing naughty or sinful goods that consumers really know they should not consume. FXH sent me a link to this attractive piece in Slate that reviews a relatively old paper by Jonathon Gruber and Sendhil Mullainathan arguing that excises on tobacco products made consumers better-off in both the US and Canada by increasing their ability to resist the temptation to indulge in the filthy habit of cigarette smoking.

Its a fairly complex argument but basically this paper argues that higher taxes and hence higher prices give consumers greater motivation for self-control. Higher prices reingage the cognitive parts of the brain and make it easier for smokers to cut back or stop smoking

It is worth noting that this argument augments traditional Ramsay-George arguments for levying hefty taxes on cigarettes because their demands are relatively inelastic. From these perspective taxing cigarettes both punishes a sinful activity and delivers loads of dough to the Treasury.
Thanks FXH for the Slate reference.


Anonymous said...

Does this mean that there is no upper limit on the tax that should be applied to cigarettes? $100 per pack perhaps?

Applying your argument also implies that petrol excise should be much higher than it is, for environmental reasons.

Anonymous said...

The reverse of the arguement for other drugs is that if demands are relatively inelastic (especially to addicts, and that really wouldn't surprise me), then it seems pointless trying to raise their prices via policing.

Also, as I always complain , the leap between neurons in your brain to cognition and then to complex behavior is so far that you may as well consider anything to do with it hyperbole (its 21 century phrenology), even in well explored areas like addiction.

Anonymous said...

Do higher cigarette prices make smokers better off?

harry, ask smokers about smoking and listen to them.

1. Most smokers are addicted and most smokers these days come from the lower income groups.

2. make it more expensive for smokers and they would still buy smokes. Make it prohibitively expensive and you would end up with contraband and people could end up smoking stuff that could actually be dangerous.

4. Smokers would sell their family in slavery for the habit.

5. higher prices would only work for those who are thinking about quitting otherwise a higher tax would only be reducing disposable income for lower income groups.

6 I have a arrangement that I buy 3 cigs a day from a store nearby at two bucks each as i want to quit. I have asked them to price them so high because the very high price dissuades me from buying more.

Anonymous said...

The argument is stupid because you cannot easily contrast the cost (less funds for other activities) with the benefits (margin increase in the ability to quit). However, higher taxes on smokes make non-smokers much better off.

Plus, the smoker who wants to quit may get some marginal benefit, but the smoker who enjoys the habit and wants to continue is heavily punished.

Why should the government tax sins? And are they sins at all? Perhaps we should be taxing adultery because that does at least hurt the victim spouse.

To my mind the idea of a sin tax is clearly unfair. If the stated attraction for such a tax is that the demand is relatively inelastic then it starts to sound downright predatory.

Anonymous said...

"Why should the government tax sins?"

Because Harry says so. You are obviously new here.

hc said...

Actually democratically elected governments seek to tax sin and even smokers themselves seem to want to limit their consumption as the article suggests.

Cigarette Prices said...

Very interesting post.