Economics of Smoking

Price: Effect Of Cigarette Taxes

Another explanation of continued smoking is that although real cigarette prices have risen, cigarette prices may remain too low to deter much smoking. There is a basic distinction between the extensive margin and the intensive margin. The former refers to a decision to smoke or not to smoke and the latter refers to the amount, conditional on whether the person smokes at all.

Extensive Margin

At the extensive margin, the tax responsiveness of youths and adults depends on two separate types of behaviors – initiation and cessation. A higher cigarette tax affects initiation decisions for youths and cessation decisions for adults. The general consensus is that the price of cigarettes in the USA is negatively related to smoking participation. However, the magnitude of these negative price elasticities and whether youth smoking is more sensitive to price than adult smoking has been the center of much recent controversy.

Studies alternatively measure price responsiveness with data on cigarette prices or excise taxes. The effect of a given increase in the excise tax on prices depends on the amount of shifting that occurs. The amount of shifting of an increase in a state excise tax on retail prices of cigarettes might be less near a state border if state B does not follow state A’s excise tax increase.

Conventional wisdom suggests that youth cigarette consumption is highly sensitive to price and is greater than price sensitivity for adults. This is not borne out by empirical studies that control for other determinants, or else only weakly. There is little evidence that higher taxes prevent smoking initiation in adolescence but some that taxes influence decisions regarding cessation and at the intensive margin. Initiation decisions may, after all, be driven by noneconomic and unmeasured determinants such as peer acceptance and many studies have not included direct measures of ‘smoking sentiment’ amongst peer groups or in localities, which may be correlated with taxes and prices.

Carpenter and Cook (2008) used repeated cross-section data from 1991–2005 and controlled for antismoking sentiment, finding that price elasticities for smoking participation range from -0.23 to -0.56. For adults, the general consensus has been that price elasticities for adults fall within the -0.3 to -0.5 range. Higher taxes appear to reduce smoking participation by older adults, especially for those who are less educated and from low-income households. Associated with a $1 increase in the excise tax are participation elasticities ranging from -0.29 to -0.31 for the 45–59 age group, just above -0.2 for persons aged 60–64. These elasticities appear to be lower in other countries (e.g. Russia and China). The price elasticity of smoking varies with other demographic factors, including education and gender. Among Irish women, for example, cigarette taxes have the greatest negative effect on initiation for women with intermediate levels of education. For cessation, cigarette taxes have the greatest effect for women with the lowest level of education. However, the pathway through which educational attainment affects the propensity to smoke remains unidentified. Although there is no established theoretical reason that would explain differences in smoking by gender, historically men have had higher rates of smoking than women but the gender gap has narrowed in recent decades. Research findings on the impact of cigarette prices on smoking participation by gender are mixed. It seems that women are nearly twice as responsive to cigarette taxes as men.

Intensive Margin

At the intensive margin, an increase in the cigarette tax results in a decrease in the number of cigarettes consumed daily; however, one study showed that smokers often compensate either by extracting more tar and nicotine from each cigarette (Adda and Cornaglia, 2006) or by shifting to a cigarette brand with more tar and nicotine content (Farrelly et al., 2004) with the result that tar and nicotine consumption is not reduced and for one group (18–20) appears to have increased. More recently, Abrevaya and Puzzello (2012) reexamined Adda and Cornaglia’s (2006) evidence on the compensatory behavior of smokers who, facing higher taxes, reduced cigarette consumption although maintaining their cotinine (a biomarker for nicotine) levels. They used (1) appropriate clustered standard errors, (2) a larger sample from the same years and survey than the data in Adda and Cornaglia’s (2006) analysis, (3) cigarette-prices instead of and in addition to cigarettetaxes, and (4) sampling weights. Abrevaya and Puzzello (2012) found that the Adda and Cornaglia (2006) results were not robust. They find little empirical support for compensatory behavior found in subsamples of smokers. Stehr (2007) reported elasticities of intensity for adult men and women of -0.09 and – 0.12, respectively, which implies that most of the effect of an increase in the excise tax is from a reduction in the fraction of adults who smoke.

Effect Of Cigarette Prices On Smuggling

Cigarette price differentials cause changes in buying patterns, both across geographic areas, such as US states, and across selling modes, such as internet sales versus sales from bricks and mortar stores. Two studies focus on tax avoidance through internet purchases of cigarettes. Lower cigarette prices for cigarettes obtained over the internet have two major potential effects. First, they may increase aggregate cigarette consumption. Second, they may shift purchases from other retailers to internet vendors. Internet penetration increases the negative effect of an excise tax increase on taxable cigarette packs per capita sold.

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