MANAGERIAL ECONOMICS AND CIGARETTE TAX | Academic Papers Help
MANAGERIAL ECONOMICS AND CIGARETTE TAX
In addition to any sales taxes and other local cigarette-specific taxes, cigarettes in the United States are taxed at both the state and federal level. The taxation of cigarettes has been practiced in America for ages and continues to be used as a source of revenue for the government. Officials in the public health sector support tax hikes because it eventually leads to decrease in the rates of smoking. The wholesaler pays the tax once on each pack and then the cost is passed on to the retailer through the price. The treatment of smoking by both the public and policy makers has changed enormously with time. In 1995, the excise tax on cigarettes on the federal and state levels was one third lower compared to the mid-1960s peak level. By 2003 the taxes had risen by over 50%. The government policy advocating for increase in cigarette taxes is opposite to the traditional economic perspective. The traditional model follows the standard approach where any decision that involves tradeoffs over time is modeled (Gruber, 2011).
The consumers are treated as rational and fully informed therefore their decision on whether to smoke or not should be respected. They are expected to weigh the benefits of smoking against health risks, costs incurred in terms of health and other related risks. This traditional economic model however overlooks the externalities imposed by smokers on others. It may be observed that the externalities are small considering that the costs are offset by savings obtained from smokers early mortality. These smokers pay social security taxes all their life and in most cases dont live to collect their benefits. In this view, the traditional model would propose the tax rates to be lowest possible.
The traditional approach does not take into account the problems smokers face regarding self-control. The fact that cigarettes are addictive should be considered when formulating policies. Enough evidence has been presented indicating that many adults fail in their attempts to quit even if they desire to quit. One study found that over 80% of smokers attempt to quit in a year and every eight and a half months the average smoker attempts to quit. Fifty four percent of the smokers seriously attempting to quit were found to fail within a week (Lav, 2002).
Cigarette taxes and demand reduction
High cigarette prices lead to a drop in demand. One way of increasing prices is through increasing taxes. Cigarette companies, according to most research, pass the whole amount of increase in tax to the consumer by increasing prices. The findings indicated that increasing the price of cigarettes by 25% percent as a result of taxes reduced consumption by over 11%. Therefore in a state where cigarettes cost an average of four dollars per pack introduces an extra dollar as excise tax to bring the cost of cigarettes to five dollars would experience a demand drop of 11%. These effects are relatively immediate. One study stated that the tax increase enacted by some states during the mid-1990s on a large scale, consumption relative to aggregate consumption fell in the first few years after the increase in tax. The long term effects of cigarette price are far more than the short term ones. The 1996 to 2001 statistics show that consumption of cigarettes dropped by more than 13% per year. This was a decline rate of 2.8 percent a year.
Other effects of increase in cigarette tax
Other than reducing consumption of cigarettes, taxes are also a source of revenue for the government. The states that raise taxes on cigarettes receive more revenue than would have been received if the rate was not increased. Theft, financing terrorism and smuggling are other effects of hiking taxes. Channeling is the change in how people obtain products that they seek. An example is Michigan where a certain period experienced rise in sales of kits so people can make their own unfiltered cigarettes due to cigarette tax hike.
Smuggling is the most prominent negative effect of cigarette taxes in the United States. There is a common perception that smuggling involves movement of goods across international borders in a bid to avoid duties or tariffs that are supposed to be paid on the product. However, it is not restricted to international borders alone. Smuggling can be practiced across state lines as well as county lines. Since 1960 the use of illicit tobacco in the United States as a result of excise tax has been traced by the Tax Foundation. Their estimate states that 5.6 percent of cigarettes obtained from smuggling in 1962 due to the cigarette tax that was at 26 cents per pack. The percentage rose by 2.2% when the tax rose to 35 cents per pack in 1997 (Lav, 2002). A further increase in tax is therefore expected to lead to more smuggling.
Apart from weapons, money and a document written in Arabic, a 2000 raid by FBI agents unmasked an alarming number of cigarettes. It is also expected that cigarette counterfeits might find their way into the American market as a result of high taxes which eventually lead to high prices. An example is the fake Marlboros that were reported to be exported from china. The counterfeits were found at Long Beach Harbor and had fillers such as sawdust instead of tobacco. The fact that this is one port and one brand raises the question of how many other ports are involved in this activity and how many other brands. Terrorism might be a farfetched effect but it is still possible. This is because ones the people feel a burden pressing on them, some modify their behavior and crossing this line would mean unlimited options of change even terrorism. Another effect of increase in cigarette taxes is seen in the change in overall population health. The number of people that develop smoking-related diseases will decrease and the mortality will also decrease. Those that have quit smoking and those that do not smoke have a lower risk of developing smoking-related diseases.
Distributional effects of cigarette taxes
The effects of increasing cigarette tax ranges in magnitude between men, women and youths and adults. It is suggested by the economic theory that youths and young adults are more sensitive to price increase than the adult smokers. First, there is the fact that young smokers have not been smoking for a long time therefore are less addicted hence they would adjust in case of price changes. Second is that most young people have low income therefore they would be more responsive to changes in prices. The youths also tend to be more present oriented therefore more responsive when changes come in cost of smoking. The target market of the cigarette companies would hence shift more to the adult population in case of a price increase. This would change the distribution chain with retail shops serving more adults getting more supply.
The bulk of cigarette taxes are felt most by the poor citizens. Those that earn a lower income are seen to respond more to changes in prices than the high income earning individuals. A 1975 memorandum by Philip Morris states that the decline in the Marlboro Red growth rate can be can be attributed to the great effect felt by low income people due to price elasticity. Marlboro brand was found to be affected more by price changes than other brands that get consumed by older people more. Marlboro is Smoked more by youths and young adults therefore a low income group. This indicates that lower income citizens feel the burden of cigarette tax more than the higher income ones. A gallup-healthways well being index carried out between second January and twenty ninth December of the year 2008 found that the lowest income earners paid most of their income on cigarette tax. The citizen earning less than twelve thousand dollars annually paid 34% of their income as cigarette tax. The next income bracket paid 28% followed by 22%, 16% and finally the highest income earners paid 13% of their income.
The number of smokers in the lowest income class was high too. 15% of the citizens in that income bracket were smokers followed by 38%, 22%, 13% and the highest income class had only 12% as smokers. These statistics illustrate that the poor individuals continue to pay more taxes yet they should be the ones who should be relieved the burden they face. There is also the issue of distribution of tax burdens within an income class. Smokers and non-smokers are both present among the poor. Treating two people in the same income level differently based on the fact that one is a smoker while the other is not is unjust. The tax increase supposes that the smoker will quit therefore he or she will not be burdened but it does not consider that the person that does not quit will suffer financially.
How the Government spends cigarette tax
The money received from the tax on cigarettes is spent by the government in several venues. A portion of the funds is distributed back to the individual states. Because most states depend on federal subsidies in order for them to fund some of their social works and programs, the tax money eventually filters back to the parks and local communities (Harris et al, 2007). The remaining funds are used in health related programs covering the national level. Some of the programs in the health sector include general health education, military health benefits and tobacco health education. The state government collects considerably a bigger amount of money every time a consumer buys a cigarette compared to the tax collected by the federal government from cigarette sales.
A 2008 New York Times article showed that a cigarette pack bought in Maryland would carry around two dollars in state taxes while the federal taxes take 39 cents. The state taxes can be used in several ways but funding health related agendas is most common. Examples of such agendas include Medicare and medic aid and Department of health funding. In a 2002 Virginia newspaper article, the Governor at that time was quoted to have vowed that all funds obtained from a pending cigarette tax was to be dedicated to the Medicaid program in the state. Not all the funds collected from the cigarette taxes are distributed to health related matters. State budgets have gaping holes and these funds are used to plug them. Items ranging from payroll for the highway police to state parks can be funded by these funds. Rather than spend the money on budget items of high priority, some states simply squirrel way the funds letting them to collect interest.
Independent institute, a government watchdog in Colorado, states that a 1999 bill in Colorado requires cigarette tax money to be placed in a trust fund and only 6 percent of the principle balance is allocated to spending per annum. Another cigarette tax can also be paid by the consumer imposed by the local community but this is dependent on where the consumer shops. The New York Times estimates that over six hundred thousand dollars in cigarette taxes is collected by municipalities every year with New York City estimated to collect as much as a dollar and a half for every pack sold in the five boroughs in the city. This money collected at the municipality level is unregulated just like state taxes and can be used on several purposes. They may be allocated to health programs, city employee payroll or even traffic enforcement.
Amount of cigarette tax that Government spends on Programs designed to help people stop smoking
2010 statistics show that the health care expenditures from both the public and private sector caused by smoking were an average of ninety six billion dollars on an annual scale. The federal government on the other hand allocates an approximate of thirty point nine billion dollars cigarette tax money on smoking-caused Medicaid payments annually (The Vermont Legislative Research shop, 2002). Looking at the two figures it is apparent that the commitment of the government to programs aimed at stopping smoking is minimal. Some are of the view that the government is not allocating enough money from the taxes to these programs. There is also a group that feels the efforts of the government are satisfactory.
California dedicated more funds to tobacco control programs in the 1980s and a considerable number of citizens became aware of the risks associated with cigarette smoking. Massachusetts and Florida followed suit in the 1990s. Several other states have also considered and implemented that approach. The states that devoted adequate funding to these programs and maintained it steady over the years showed that fewer youths started the habit of tobacco smoking, more adults quit smoking, the populations became healthier and there was a decline in the costs of tobacco related health care. The government finds it hard to allocate more money to tobacco control programs because of the hard economic times therefore more items need funding from the government.
Economic times are tough but the finances used by the patients suffering from smoking related illnesses will even make the times harder therefore ways to stop smoking should be prioritized. Effectiveness of the tobacco control programs in states has been proven therefore one would expect that the government would prioritize them more. However, this is not the case because presently only North Dakota is funding a tobacco control program and at levels that are recommended by the CDCP (Centre for Disease Control and Prevention). The people opposed to the control programs argue that the government is rescinding the peoples right of free will to choose. Stopping smoking is the reason cigarette taxes are increased. It would be therefore right to allocate a larger portion of that tax to control programs in order for people to stop smoking.
Amount of cigarette tax used in health related costs due to smoking
Washington voters in November 2001 chose to use the increase in cigarette tax to support the increased number of persons that are covered through the state basic health plan. The health plan provides subsidized health insurance for persons with family incomes that are under 200% of the poverty line (The Vermont Legislative Research Shop, 2002). The initiative supported an increase of 60 cents per pack with the vast majority of the revenue devoted to the increasing number of people that are covered in the plan. The 1995 fiscal year budget put more stress on use of the cigarette tax to pay for additional health costs arising as a result of smoking. The health plan estimated that the 11 billion dollars collected from cigarette taxes would go a long way in funding health care.
Those that would benefit from this funds more include pregnant women and older men suffering from illnesses related with smoking. Smoking in pregnant women is seen to sometimes cause complication on the mother and sometimes the baby. The baby may be born with a low birth weight therefore requiring health care which is expensive. Spontaneous abortions, sudden infant death syndrome and still births are also other illnesses related with smoking in pregnant women. The amount used by the government in health care costs is less than half of the amount spent by citizens in costs from illnesses resulting from smoking. The average amount estimated to be health care costs in smoking related illness is estimated at 75 billion dollars annually. Comparing this figure to the 11 billion dollar funding that the government plans to dedicate to health care costs shows how little the cigarette tax money is covering. Most people are therefore of the view that the government should increase its cigarette tax spending on health care costs due to smoking. The 1998 Master Settlement Agreement was aimed at increasing the funding allocated to health care costs that result from smoking.
Conclusion
When the prices go up the consumer demand goes down therefore increasing the price of cigarettes would lead to the reduced demand of cigarettes. The prices would increase if the government was to increase the tax on cigarettes. Consequently the cigarette companies would pass the increase on to the consumer by increasing the price of cigarettes. The burden felt by the consumer would either lead the consumer to quit smoking, reduce smoking or increase the amount they allocate for cigarettes in a particular period. The increase in cigarette tax would also cause a decline in the health care cost in illnesses related to smoking.
Some negative effects like smuggling would increase. The consumer would look for ways to avoid the tax rise by purchasing cigarettes from the black market. The distributional chain would be affected. Youths and young adults would most likely respond more to the rise than the adult smokers. This is because the youths have not been smoking for a long time therefore they are not too addicted. Most young people also dont have a high income therefore the price increase would lead them to quit or reduce consumption. There are many ways that the cigarette tax can be used by the government. Most common is the funding of programs aimed at helping people to stop smoking. Other funds are also spent on health care costs.
The United States government allocates a very small amount of the cigarette tax to programs aimed at helping people to stop smoking. An approximate amount of thirty point nine billion dollars is allocated to smoking-caused payments yearly. This figure when compared to the ninety billion dollars used on health care expenditures is a very low amount. Overall smoking is an issue of much concern because it is addictive therefore takes away the free will of the smoker to stop. Instituting measures such as these is necessary because the individual is beyond their control therefore they need help in removing themselves from this habit. Although cigarette sales bring in a lot of revenue for the government, other costs incurred as a result of smoking would be found to have a considerable effect on the nation. There is also the issue of health with individuals undergoing suffering in cases of illnesses that arise from smoking.
References:
Gruber, J. (2011). The New Economics of Smoking. The National Bureau of Economic Research. Retrieved October 1, 2011 from http://www.nber.org/reporter/summer03/gruber.html
Harris, F. H., McGuigan, R. J. and Moyer, R. C. (2007). Managerial Economics: Applications, strategies and tactics. Massachusetts: South Western College Pub
Lav, I. J. (2002). Cigarette Tax Increases: Cautions and Considerations. Center on Budget and Policy Priorities. Retrieved October 1, 2011 from http://www.cbpp.org/files/7-3-02sfp.pdf
The Impact of Cigarette Taxes on Health Care Costs and the Economy. The Vermont Legislative Research Shop. Published February 11, 2002. Retrieved October 1, 2011 from http://www.uvm.edu/~vlrs/Health/cigarettetaximpact.pdf
