Tuesday, June 9, 2015

What happens when you raise tax on only some types of tobacco?

In 2009, the Federal government increased tax rates on roll-your-own tobacco, relative to pipe tobacco; and on small cigars, relative to large cigars.  What happened?
Monthly sales of pipe tobacco increased from approximately 240,000 pounds in January 2009 to over 3 million pounds in September 2011, while roll-your-own tobacco dropped from about 2 million pounds to 315,000 pounds. 
HT:  GAO, who also have a video on how to make cigarettes from pipe tobacco:


  1. The video you have been shared is very helpful. Thanks for posting.
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  2. Perhaps the genius bureaucrats will eventually figure out that raising taxes on the one-percenters will generate more revenue than nickel-and-diming folks who are just trying to save a little money on their smokes. -SC

  3. ESC, Economics, Fall 2015
    Raising taxes on tobacco is a cost-effective way to reduce tobacco use, and reduce the overall cost to the health care system. “Tobacco use is the single largest cause of preventable death, and not only shortens the # of years users live, but shortens the # of healthy years”. Because people tend to buy less of a product when the real price increase makes it less affordable, this is a great way to reduce consumption. “One average raising tobacco taxes to increase price by 10% is estimated to reduce tobacco use by 4%”.
    Health care is very expensive. Perhaps the cost to taxpayers for services like Medicare and Medicaid can be reduced if more of the users were healthy non-smokers. “One year after quitting smoking, the risk of coronary heart disease is ½ that of a smoker. After 10 years, the risk of lung cancer falls to half that of a smoker, and there is a decreased risk of mouth cancer, throat, bladder, cervix and pancreatic cancer”.
    While increasing taxes on tobacco has the obvious benefit of generating revenue for the government, it also reduces the health care burden.
    The idea is that while intended effect of a tax is to raise revenue for the government, the unintended consequence is that it deters some wealth creating transactions (Froeb), I feel that with tobacco this isn’t necessarily the case, because while it may deter the tobacco companies from wealth, the individuals spending money on tobacco will replace their spending on some other product, thereby creating wealth for some other organization.

    Froeb. 2016. Managerial Economics A Problem Solving Approach.

  4. The concept of raising the taxes on a specific product is a great example of an elastic good. Tax increases on specific tobacco products led specific consumers to find a substitute product to complement their needs. It is a perfect example of how increasing cost for a product will cause a change in demand of the consumer to an alternate product.

    The motivation to increase the taxes on these products is certainly multifactorial. A smoker is more likely to have heart disease, diabetes, and an array of other deleterious health consequences causing an increase in cost.

    As a healthcare provider, it is not uncommon to ask a patient’s history to find out that he or she has chronic obstructive pulmonary disorder (COPD), diabetes type 2 and high blood pressure. Following that history, you ask his or her status of smoking only to find out that it has been a habit for years with failure to quit. These implications cause an increase in the usage of healthcare, which ultimately costs the American people millions, if not billions, of dollars each year. By creating this artificially high tax, the government simply changed the supply and demand curve without looking at alternative substitutes to include within the taxes.

    Albeit ironic, the higher taxes could have set into motion other deleterious products such as: smokeless tobacco, e-cigarettes and other products. Although little is currently known about the health hazards these products may manifest, scientists and healthcare providers could ‘potentially’ see additional other ailments result as a consequence.

    Gara, Antoine. (2013). “Big Tobacco Takes Its Last Drag As Economic Change Looms”. Forbes. http://www.forbes.com/sites/thestreet/2013/09/06/big-tobacco-takes-its-last-drag-as-economic-change-looms/2/

    National Cancer Institute. (2015). “Harms of Cigarette Smoking and Health Benefits of Quitting”. http://www.cancer.gov/about-cancer/causes-prevention/risk/tobacco/cessation-fact-sheet

  5. In April 2009, the Children’s Health Insurance Program Re-authorization Act (CHIPRA) increased federal excise tax rates for smoking tobacco products (cigarettes, roll-your-own tobacco, pipe tobacco, small cigars, and large cigars) (Office, 2012). Tobacco use is a major source of avoidable disease and death. The cost disparity between tobacco products caused a shift in the type of use of tobacco. This tax provides an example of destroying wealth for one manufacturer and creating wealth for another. The new tax increased cost and shifted consumption by price sensitive customers to lower cost products.

    Marginal analysis can be used even though the extent of and all impacts are not know. Though the marginal cost of production remained the same, the marginal cost of consumption increased. The manufacturer could decrease revenue, until the price was close enough to larger tobacco products to increase sales where marginal sales and revenues equal cost. These steps should be taken at single intervals, gauging customer preferences. The Federal GAO recognizing the disparity in taxes and loss revenue recommended an equalization of the tobacco tax in 2012 (Office, 2012).

    Froeb, M. S. (2014). Managerial Economics A Problem Solving Approach. Boston: Cengage.
    Office, G. A. (2012, April 18). International affairs > 31. Tobacco Taxes. Retrieved September 30, 2015, from gao.gov: http://www.gao.gov/modules/ereport/handler.php?1=1&path=/ereport/GAO-13-279SP/data_center_savings/International_affairs/31._Tobacco_Taxes

  6. The endless taxation on tobacco products drives those who use them to find ways of keeping the prices static. Smokers turn to vaping and electronic cigarettes, those who roll their own can turn to pipe tobacco, as given in the example. This is an example of the balance that needs to be struck between profit and price. For tobacco companies, who are saddled with years of settlements against them, raising the prices to increase profit and combat their own rising expenses is a dicey prospect, as smokers who pay twice the cost of the product in taxes are weary of paying for their habits. Consumers will travel to other states or order online, finding ways to avoid their personal price point for their habits. States who raise their taxes too high risk killing the geese that lay their golden eggs, if consumers purchase in other states or quit smoking, their source of revenue dries up. Long taxed at rates that would cause an outrage if implemented at, say, fast food restaurants, tobacco users will quickly search for alternatives, as the numbers above show.

  7. When you raise the tax on only some types of tobacco, you create a demand for alternative goods, though this is not the only effect raising taxes has. As the government tries to squeeze every last dollar out of us, for many years it has forced those in my area to buy their cigarettes from Native American Smoke Shops, where they are not taxed. My wife has been the payroll manager at a large Native-owned business in WNY for several years now, and they had enough future vision to start manufacturing their own branded products twenty years ago. This still has not been enough to keep them from over-spending and under producing cigarettes. Perhaps had they done a marginal analysis to determine the impact of the substituted product, they may have been able to avoid several layoffs that took place in the last year when it did not go as planned. It goes to show that many people will still do what they need to for the name brand products they crave, even if it means bypassing an alternate product at a fraction of the price.

  8. With the increase in taxation on roll- your- own tobacco in relation to pipe tobacco, it caused an increase in demand for pipe tobacco. The reason for this is that products that have close substitutes tend to have more elastic demand. Often when there is an increase in price to a product with close substitutes people begin to look elsewhere to find similar alternatives. When demand becomes more elastic it is actually decreases the “profit-maximizing price.” In other words as price increases where there is elastic demand the revenue decreases as can quite significantly in this example. Using the price of elasticity of demand formula you can determine elasticity or inelasticity is in relation to price and quantity. A familiar situation may occur with cigarettes verses e cigarettes.

    Froeb, M. S. (2014). Managerial Economics A Problem Solving Approach. Boston: Cengage.

  9. When a raise in tax happens with certain products it can result in less purchases of the product. For tobacco for instance, an increase in tax has resulted in an increase in effective ways to stop smoking. Since the price is much higher, less people purchase them. There are many people that still use cigarettes but “higher tobacco taxes also save money by reducing tobacco-related health care costs, including Medicaid expenses. States can realize even greater health benefits and cost savings by allocating some of the revenue to programs that prevent children from smoking and help smokers quit” (State Tobacco Taxes, 2015). It seems that New York has the highest tobacco tax to $4.35.

    Works Cited
    State Tobacco Taxes. (2015, July 1). Retrieved from Tobacco Free Kids: http://www.tobaccofreekids.org/what_we_do/state_local/taxes/

  10. Todd Barton-MBA Student SUNY Empire State CollegeSeptember 19, 2017 at 11:47 AM

    This topic is very personal to me as I lost my mother directly related from tobacco related illness; she was only 53 years old. The example above is what is called price elasticity. When taxes raised the price of roll your own tobacco products, consumers moved away from those to alternatives like pipe tobacco. Price elasticity measures the sensitivity of quantity of price. A demand curve which quantity changes more than price is said to be elastic (Froeb, McCann, Shor, & Ward, 2016, P. 72). The unintended consequences of implementing higher taxes to roll your own tobacco change the demand of consumers to an alternative product that also have health issues related to their use.
    The intended effect of a tax is to raise revenue for the government, but the unintended consequence of a tax is that it deters some wealth-creating transactions. (Froeb, McCann, Shor, & Ward, 2016, P. 19) I feel for this example, this is not the case as consumers will spend their money on other goods. Additionally, by deterring tobacco useage via taxes, health cost will go down for those individual that quit or never smoke. However, government should increase taxes on other tobacco products if they want to maximize their goals of deterring tobacco products as a whole and eliminate the elasticity effect of taxing just one type. “Every state and the federal government can achieve significant health and revenue gains by further increasing tobacco taxes. Governments can raise even more revenue — and reduce all tobacco use — by increasing taxes on other tobacco products, such as smokeless tobacco and cigars, to parallel the rate on cigarettes. This discourages all tobacco use.” (State Tobacco Taxes. (2017, August)

    Froeb, L., McCann, B., Shor, M., & Ward, M. (2016). Managerial Economics. Boston, MA: Cengage Learning.

    State Tobacco Taxes. (2017, August). Retrieved from Tobacco Free Kids: http://www.tobaccofreekids.org/what_we_do/state_local/taxes/