Saturday, February 24, 2007

Thank You for Smoking!

I was having a look at the CBO’s Budget Options report (thanks to Mankiw). It has lot of interesting options of revenue and expenditure measures that are worth having a look-including the one below, increasing the Excise Tax on Cigarettes by 50 Cents per Pack;

“Tobacco is taxed by both the federal government and the states. Currently, the federal excise tax on cigarettes is 39 cents per pack; other tobacco products are subject to similar levies. In 2005, federal tobacco taxes raised a total of $8.7 billion, or about 0.4 percent of federal revenues. At the state level, excise taxes on cigarettes have more than doubled in the past seven years, from an average of 42 cents per pack to 92 cents. In addition, settlements reached with states’ attorneys general require major tobacco manufacturers to pay fees that are equal to an excise tax of about 50 cents per pack. Together, those federal and state taxes and fees boost the price of a pack of cigarettes by $1.81.

This option would raise the federal excise tax on cigarettes by 50 cents per pack. That increase would generate $4.3 billion in additional revenues in 2008 and a total of $26.6 billion through 2012. Because excise taxes reduce the tax base of income and payroll taxes, higher excise taxes would lead to reductions in income and payroll tax revenues. The estimates shown here reflect those reductions, as well as projected declines in cigarette purchases because of higher after-tax prices. Researchers estimate that each 10 percent increase in the price of cigarettes is likely to cause consumption to fall by 2.5 percent to 5 percent (probably more in the case of teenagers).

In general, the fact that taxing an item can cause consumers to buy less of it than they might otherwise can result in a less-efficient allocation of society’s resources—unless some of the costs associated with the taxed item are not reflected in its price. Cigarette use creates “external costs” for society that are not covered in pretax prices, such as higher costs for health insurance (to cover the medical expenses linked to smoking) and the damaging effects of cigarette smoke on the health of nonsmokers. Another problem with tobacco is that consumers may underestimate the harm they do to themselves by smoking or the addictive power of nicotine. Teenagers in particular may not be capable of evaluating the long-term effects of beginning to smoke. Thus, an argument in favor of this option is that raising tobacco taxes would reduce tobacco consumption—and thus its associated costs—by causing cigarette prices to reflect more of the total, long-term costs of smoking that would otherwise be borne by society as a whole and not considered fully by individual smokers.

No consensus exists about the size of smoking’s external costs, which makes it difficult to determine the appropriate level of tobacco taxes. Some analysts estimate that those costs are significantly lower than the taxes and settlement fees now levied on tobacco. Others maintain that the external costs are greater and that taxes should be raised even more. Technical issues cloud the debate; for example, the effect of secondhand smoke on people’s health is uncertain. Much of the controversy centers on what to include in calculating external costs—such as whether to consider tobacco’s effects on the health of smokers’ families or the savings in spending on health care and pensions that result from smokers’ shorter lives.

One argument against raising cigarette taxes is their regressivity. Such taxes take up a larger percentage of the earnings of low-income families than of middle- and upper-income families, for two reasons. First, lowerincome people are more likely to smoke than are people from other income groups. And second, the amount that smokers spend on cigarettes does not rise appreciably with income.

Some opponents of higher cigarette taxes note that the market has mechanisms that already make individual smokers, rather than society, bear many of the costs of smoking—for example, higher insurance premiums for smokers than for nonsmokers and the voluntary establishment of separate smoking areas in restaurants. In that view, such mechanisms and the penalty they exact for smoking eliminate the need to raise taxes in order to reduce costs to society.

Other opponents object to a tax that is intended to protect consumers from a supposed lack of foresight about the harmful effects of smoking. They argue that consumer protection is a specious justification for focusing on cigarette taxes when many other choices that people make—to use alcohol, consume some types of food, engage in risky sports, or work long hours at the office— can also cause unforeseen health or social problems.”

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