Minnesota Gov. Tim Pawlenty’s call for a big cigarette tax increase raises issues of why we tax tobacco and how high taxes should be. While economists can answer the first question, we can only make rough estimates about the second.
Governments long have taxed tobacco for two reasons: First, the tax was easy to administer because tobacco grew in fewer areas than wheat or wool. Most customers got it through identifiable merchants. Evading the tax was hard. Second, demand for tobacco is “inelastic,” meaning increasing prices with a tax does not reduce consumption very much.
Thus, governments tax tobacco for pragmatic reasons. Any idea of discouraging socially harmful behavior was secondary. That has since changed.
Support for the current wave of tobacco taxes can be found in the century-old insights of British economist Arthur Pigou. He reasoned that when a product involves external costs — when it harms someone besides the person using it — people will use more of the product than is good for society. Imposing a tax equal to this external cost restores correct incentives for economic efficiency, though it does not eliminate all use or all external harm.
Pigou did not identify tobacco as having external costs, yet his ideas do apply here. Since the 1970s, we’ve seen growing evidence that second-hand smoke hurts people beyond the smoker. With rising shares of health care costs paid by society as a whole rather than by individuals, extra medical expenses resulting from tobacco cost all taxpayers.
Today, most advocates of higher cigarette taxes argue that resulting higher prices deter young people from becoming addicted. Higher taxes also compensate society for extra health costs from smoking. Estimates of such excessive health care costs vary widely.
Deciding which expenditures are directly because of smoking is one reason for differences. One approach lists all the diseases linked to smoking. Treatment expenditures for anyone who has smoked and later gets a listed disease are tallied as “smoking related” costs. The assumption is that, if not for smoking, the people involved never would contract any of these illnesses. Such studies typically identify enormous social costs of tobacco.
Better studies look at the difference in disease and treatment costs between otherwise comparable groups of smokers, nonsmokers and nonsmokers exposed to second-hand smoke. Only amounts by which medical expenditures for smokers exceed those of nonsmokers count as smoking-related.
Other studies attempt to quantify the indirect costs of smoking, such as productivity losses from workplace cigarette breaks or smokers taking more sick days.
The range of the per-pack cost estimates here is remarkable, from under 50 cents to $40. While the higher estimates are questionable, the existing federal tax of 39 cents plus Minnesota’s 48 cents per pack still leaves us in the very low end of the range. Even with the governor’s proposed 75-cent increase, we still will be in the low end of the ballpark.
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.