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Higher taxes and higher prices for cigarettes in Minnesota and the substitutions smokers make

In March, I wrote this entry to Bastiat’s Bastions in response to Jindal’s proposal to hike state cigarette taxes.  My critique was not so about raising tobacco taxes or not, but suggesting that the Louisiana Department of Revenue had done a poor job in estimating the effects of such taxes on state revenues, as I had a paper I was revising on tax revenues for Louisiana from increasing cigarette taxes. Well, Jindal has momentarily backed off of his push to raise cigarette taxes to help offset state revenue lost from eliminating the state income tax, but other states are pushing their cigarette taxes up.

I came across this news article from WCCO–CBS Minnesota, about how Minnesota is raising its cigarette taxes.  The difference in state cigarette taxes between Minnesota and it neighbors will result in $0.31 more per pack than in Wisconsin, but $2.39 more per pack than cigarettes sell for in North Dakota.  Remember a difference in $2.39 per pack amounts to a difference of almost $24 per carton of cigarettes. Such a large price difference will surely provide an incentive for some Minnesotans to buy their smokes in North Dakota.

Notice in the WCCO article that some Minnesotans are looking to stock up on as many cigarettes as they can buy now in anticipation of the higher prices that will start in two weeks.  Not only does it seem that the higher prices is causing smokers to substitute cigarettes now for cigarettes in the near future, but is also expected to cause smokers to switch to less taxed eCigarettes and roll-your-own cigarettes.

Another point I want to make is the one I make in the final paragraph of my previous blog post on cigarette taxes, that even though cigarette demand in Louisiana is estimated to be a bit on the elastic side, higher taxes are still estimated to increase tax revenues from cigarettes even though we have seen that revenues decline when prices are pushed up and demand is elastic.  I can assure you that all of this is as it should be, but the puzzle persists.  No one could figure this out in the spring term.  I will give the first person who correctly figures out this puzzle an extra 5 points.

-MC

13 Responses to “Higher taxes and higher prices for cigarettes in Minnesota and the substitutions smokers make”

  1. For a raise in cigarette excise taxes to be effective, they have to be at similar levels in neighboring states, otherwise the tax just transfers demand to other states and induces inter-state trade.

  2. LE says:

    The elasticity of demand is in a changing state. The environment for smokers is also changing. There are few places now that allow smokers access in, near, or around the vicinity to enjoy a cigarette. Maybe the increase in tax along with the denied access would cause demand all together to decrease for the smokers.

    • mcoats says:

      Hi LE,
      While there may be some longterm shift or drifts in the price elasticity of demand, that is really not where the problem or puzzle has its start. What is going on is that while the movement along the demand curve because of the tax is the same part of the demand curve, what is really going on is that the price elasticity of demand can be in the elastic range,the “taxx elasticity” is going to be smaller because the tax is added to the pric, which means a 100% increase in the tax may only amount to a 10% increase in the price. Why does that matter? The government gets the tax revenues, not the total revenues, because sellers receive revenues as well. Since the percentage change in the price is smaller than the percentage change in the tax, the tax elasticity is smaller than the price elasticity. The tax elasticity is what we have to look at to see what will happen to tzx revenues.

      -MC

  3. EP says:

    Nicotine is highly addicting and no matter how high prices increase people are going to pay the price for the cigarette. When the price initially increases people will not buy as many cigarettes and try to quit because they do not want to spend more money than they have to which is a natural human instinct. After a while people are going to give in and eventually start paying the higher price for a pack of cigarettes because they need them. Sometimes before a price of a cigarette rices and consumers know about it they will go out and buy plenty of them and stock up on them so when the prices rise they will not be affected by the price rise. This could contribute to the fact that revenues do not always increase when the price of a pack of cigaretttes in increased.

    • mcoats says:

      The reason cigarette tax revenues increase even though the demand is elastic is that it is the tax revenues going up, not the total revenues to sellers or tax revenues plus sellers revenues, which is spending by buyers. Total spending by buyers does indeed go down. It just drops to sellers a lot–by more than the increase in tax revenues.

  4. ME says:

    Maybe the new quantity demanded for cigarettes is about to drastically change due to the change in the taxes and prices. Since the prices are going up, not as many people will go out and buy cigarettes now. I know that many places now do not let you smoke in, near, or around many public buildings and places. This is also true for on campus here at Nicholls. Since there are fewer places you are allowed to smoke, in addition with the higher prices, the total demand should decrease.
    -ME

  5. CC says:

    It seems to be a mystery as to why the cigarette taxes push revenue up while it is an elastic demand. I think that the demand for cigarettes is becoming more inelastic than elastic. As with inelastic demand, when a price has little to no effect on the demand and supply, the total revenue increases; this can also be considered as a perfectly inelastic demand.

  6. KEH says:

    Maybe the elasticity of cigarettes is changing. Many people in the United States smoke, but it seems to be difficult to quit. Observing students on Nicholls campus, it seems to me that many are addicted to nicotine, even at a young age. Cigarettes are a normal good, but people might underestimate the costs of consuming it and might not realize how much they are actually spending on it.

    • mcoats says:

      KEH, That is a good answer, just not the right one. Yes, it is quite possible that the elasticity changes. The state elasticity has probably increased, especially as more internet-based sales have increased and as the internet has a bigger part of people’s lives (internet penetration). This is a point that Goolsbee, Lovenheim and Slemrod make in this article (BTW, Goolsbee used to be Obama’s Chairman the President’s Council of Economic Advisors, and these authors were astute enough to cite my paper on estimating cigarette demand!).
      -MC

      • KEH says:

        Congratulations on the citation! Another thing to look at are the substitutes and their prices. The e-cigarette is a very popular product at the moment because it portrays the product as delivering the nicotine without all the harmful chemicals of a regular cigarette. It also is cheaper than the cartons by a significant amount. Also, prices of medications, patches, etc. for quitting are high and may seem less beneficial in the short term to smokers.

  7. GR says:

    I think that the rise is a good thing. It’s a passive aggressive way to get people to stop smoking. People who do not approve of the tax will either switch to cheaper packs or maybe even , the untaxed and illegal, marijuana.

    • mcoats says:

      Grant, take a look at my previous post on cigarette taxes and elasticity. There is a mystery there. The demand in the state is elastic, yet higher taxes push revenues up. This seems to be a contradiction to our rule that when price goes up when demand is elastic, revenues drop.

      BTW, look at all the somewhat new substitutes for cigarettes. Of course, as we mentioned in class, a big substitute for cigarettes in Minnesota are cigarettes that can be bought in other states.

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