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Obama calls for cigarette tax

hike of 94 cents a pack
By Steve Hargreaves @hargreavesCNN April 10, 2013: 3:19 PM ET

The federal tax on cigarettes is already $1.01 a pack. President Obama wants to
nearly double it. Smokers pay hefty state taxes on tobacco too.

NEW YORK (CNNMoney)

President's Obama's call for a 94-cent-a-pack

hike on federal cigarette taxes to fund early
childhood education programs is controversial.
Anti-smoking groups applaud the proposal, but some tax experts
and tobacco companies are against it.
The case for the tax. The tax is being presented as way to fund
education and reduce smoking rates. It would raise roughly $78

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billion over 10 years.

"The proposed tobacco tax increase would have substantial
public health benefits, particularly for young Americans," the
president's budget read. "Researchers have found that raising
taxes on cigarettes significantly reduces consumption, with
especially large effects on youth smoking."
After a 62-cent-a-pack tax hike was passed in 2009, cigarette
sales dropped by 10%, according to the Campaign for TobaccoFree Kids.
Related: What's in Obama's budget
There's also little doubt that fewer people smoking is a good
thing for society. Costs related to smoking amount to $193
billion a year in both direct medical payments and lost
productivity, according to a Centers for Disease Control study
done during the early part of the last decade. Smoking kills about
443,000 people each year.
Passing the tax "would be a giant step toward winning the fight
against tobacco, the nation's number one cause of preventable
death," Matthew Myers, president of the Campaign for TobaccoFree Kids, said in a statement.
Why it may be a bad idea. The biggest argument against the tax
is that it will fund early childhood education on the backs of the
poor. Not only is the tax not progressive - it does not go up the
more money one makes -- but a higher percent of smokers are
middle or low income.
The median household income for a smoker in 2011 was $27,700
compared to $45,761 for nonsmokers, according to Reynolds
American (RAI, Fortune 500), a cigarette maker which is,
unsurprisingly, against the tax.
Nearly half of all smokers had a household income of less than

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$25,000 a year. Meanwhile, under 15% of smokers had a

household income over $75,000.
"The idea of increasing taxes on low- to middle-income
Americans at this time is ludicrous," Bryan Hatchell, a
spokesman for Reynolds American, said in a statement. "The
effect of the payroll tax increase this year, along with higher gas
and food prices, have hit hard millions of Americans who are
simply trying to keep their heads above water financially."
Anti-smoking groups counter that the poor are especially
vulnerable to smoking's ill effects, as they often lack healthcare
and are less prepared financially to deal with an illness.
Cigarette taxes across the nation. Many smokers already pay a
high tax rate for cigarettes. The current federal tax rate is $1.01 a
pack. So Obama is proposing an increase to $1.95 a pack. But the
taxes don't stop there.
Some states and municipalities have also used cigarette taxes as a
cash cow for years. In New York City, the country's highest-tax
area, combined state and local taxes add up to $5.85 a pack,
according to the Campaign for Tobacco-Free Kids. In Manhattan,
a pack of cigarettes can cost $14, while at an airport duty free
shop they can be as low as $3 or $4 a pack.
Related: Obama's budget could hit Social Security payments
for seniors
But the taxes are low in other states. In Missouri, state taxes are
just 17 cents a pack. The average price of a pack of cigarettes
nationwide is $6, with taxes making up $2.49 of that.
Some economists question how wise it is to fund what will
presumably be a long term program -- early childhood education
-- with revenue that will likely fall over time. About 20% of
Americans smoke, a number that has dropped considerably over
the past several decades. The tax itself is specifically designed to
get people to stop buying cigarettes.

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Others say that while the tax won't be too much of a burden on
the overall economy, it will hit smokers and those that work in
the industry hard. They say the president could raise far more
money by focusing on spending cuts.
"It's excellent politics, but it doesn't make good economics," said
William McBride, chief economist at the Tax Foundation, a think
tank that advocates for lower taxes.
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This article talks about the increment of cigarette tax proposed by Obama from $1.01 a
pack to $1.95 a pack. The article offers two sides of argument, the advantage and
disadvantage in raising cigarette tax. Cigarette is a demerit good, and the market for
cigarette is an example of market failure. Demerit good is any good with negative
externalities of consumption that are undesirable for consumers, but which are
overprovided. Negative externality of consumption refers to external costs created by
consumers. Indirect taxes are taxes on spending on goods and services, paid indirectly
through the suppliers of goods or services to the government. Market failure refers to
the failure of the market to allocate resources efficiently.
Negative consumption externality graph

Diagram 1
As shown in the diagram above, MPB (Marginal Private Benefit) is greater than the
MSB (Marginal Social Benefit) as smoking causes harm to the society, the difference
between the MSB and MPB is the negative externality. Considering only the MPB, the

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free market equilibrium will be at P2 intersecting Q2, as a result showing an
overconsumption of cigarette measured by Q2 - Q1. Since MSC (Marginal Social Cost)
is greater than MSB (Marginal Social Benefit), there is a welfare loss as labeled in
diagram 1. To eliminate the welfare loss, the MPC have to shift upwards till MPC
intersects MPB at Q1, which is social optimal output. The amount of tax has to be
equal to the negative externality of consumption to completely eliminate the welfare
loss. As a result of the tax, it will drive up the production cost of cigarette from P2 to P3.
Producers revenue
form P2*Q2 to

will decrease
Inelastic Demand graph

P1*Q1.

Diagram 2
Demand of cigarette is very inelastic, changes in price of cigarette has a relatively low
effect in the change of demand of cigarette, as cigarette is addictive in the short run. As
tax is added, production cost of cigarette increases as a result supply of cigarette
decrease, form S to S + Tax, thus Q decreases to Q1. Since PED is relatively lower
than PES, tax incidence on consumers is greater than tax incidence on producers
because consumers are unresponsive to changes in price of cigarette producers can
pass on a relatively higher burden of tax on consumers. As shown in diagram 2, tax

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burden on consumers is the increase in price multiply by quantity, (P1 P)*Q1. The
rest of the tax burden, (P!P2)*Q1 is the producers tax burden.
Taxing on cigarettes reduces the disposable income of regular smokers, which may
lead to a decrease in living standards. As sated in paragraph 9, the effect of the increase
in tax this year, along with higher prices of gas and food have hit hard million of
Americans who are desperately trying to stay afloat financially, moreover, as stated in
paragraph 6, a higher percent of smokers are middle or low income makers, which
makes the indirect tax a type regressive tax because in regressive tax rich people pay a
lower proportion of income as tax in this situation since the amount of tax is fixed. For
example, comparing $10 in rich and poor peoples income $10 take up a larger amount
of proportion in the poorer peoples income, thus the tax is more heavy on the poor.
This thus increases the income inequality between the rich and poor. Another problem
in increasing tax of cigarette is that it may not reduce the cigarette consumption to a
large extent in the short run, as the demand for cigarette is inelastic. Increase in tax
reduces producers revenue, which may lead to a few problems like opposition from
producers to the government and higher unemployment. Structural unemployment may
rise since if the low level skilled worker go out of job, it will be hard for them to find
other jobs again.
On the other hand, since PED is low for cigarette, government revenue will be high
since tax per unit pack of cigarette is high and quantity decrease for the demand of
cigarette is low. The high government revenue can be used to fund merit goods, which
can benefit the society, and economy in the long run. Another advantage is that there
tends to be a greater reduction in smoking in the long run because elasticity increases
in the long run as consumers have more time to pick alternatives. By increasing tax and
reducing smokers, anti-smoking argue that it will reduce health problems in the society
since the poor are especially vulnerable to smokings ill effects. It can also
significantly reduce consumption, with especially large effects on youth smoking as
presented in paragraph 3.
Evaluating the pros and cons, the tax should be reduced rather than increased. As
mentioned in the last paragraph, William McBride, chief economist at the Tax

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Foundation suggested that increasing tax is excellent politics, however it does not
make good economics.