Thursday, July 15, 2010

Tax Revenues to the Federal Government increase at record pace... Smoke em' if you got em'

    Taxes increase on tobacco products and tax revenues to the government increase.  Makes sense and should always happen, right?

Reuters: U.S. pockets $20.6 bln in sin taxes in FY'09

""Americans armed themselves to the teeth and paid through the nose to have a smoke, according to a U.S. government report released on Wednesday. The U.S. federal government collected $20.6 billion in taxes on alcohol, tobacco, firearms and ammunition in fiscal year 2009, up 41 percent from the previous fiscal year, according to the annual report of the Alcohol and Tobacco Tax and Trade Bureau. Part of the U.S. Treasury Department, the TTB credited most of the $6 billion rise in revenues collected to the increased taxes on the tobacco industry as a result of the Children's Health Insurance Reauthorization Act passed in February 2009...""
    Well, that depends on elasticities. To fund part of the recently passed heathcare reform, the federal tax on cigarettes was increased by 62 cents to a total of $1.01. The tax on chewing tobacco was increased  from $0.195/lb. to $0.50/lb.  Because the price of cigarettes varies greatly for state to state, mainly because of individual state taxes levied on cigarettes, it is difficult to ascertain the percentage change in the price of cigarettes at the retail level.  However, we do know that the price elasticity of demand for cigarettes is relatively inelastic.  This means that the percentage decrease in quantity demanded for tobacco products is LESS than the percentage increase in the price of tobacco products (%chg in quantity demanded divided by %chg in price yeilds a number less than 1).  In other words, consumers of tobacco products are less sensitive, in regard to their quantity demanded,  to price increases for this particular good. 
     An easy way to see how the Federal governments tax revenue increased so dramatically, I am going to use the a modified Total Revenue Test for elasticity.  Lets call it the Total Tax Revenue Test.
     The tax before the increase was $.39 ($1.01 minus $.62) and let's assume, for simplicity sake, the quantity demanded for cigarettes in the marketplace was 100 packs.  The tax revenue would be 100 X $.39 = $39 to the Federal governement. Now the tax increase of $.62 is added to $.39 which makes the total tax move to $1.01 OR a percentage INCREASE of +159% ($1.01 minus $.39 then divide by $.39 then multiply the result by 100).  Now assume that 25 fewer packs of cigarettes will sold because some people, despite the addiction, will not buy because of the extra expense.  The percentage change in quantity demanded is -25% (100 minus 25 divided by 100 then mulitply by 100). 
   We have all the information we need to calculate total tax revenue.  AFTER the tax is imposed  the total tax collected, even though the quantity of cigarettes demanded decreases, is 75 packs X $1.01 = $76 (I rounded up).  Before the tax increase the govt received $39 and after the tax increase they received $76, or a percentage change in tax revenue of 95 % ($76 minus $39 divided by $39 then mulitply result by 100). 
   This appears to be a good deal for the Federal government and its attempt at providing a source of revenue to pay for the healtcare. However, can you think of any pitfalls that will throw a monkey wrench into this particular funding mechanism? 
    This example re-inforces the importance of taking elasticity into account when it comes to government (fed, state, local) policies on taxation.  Lesson: Tax the right thing, you increase revenues and get less of the good.  Tax the wrong thing,  you decrease revenues and get less of it...
     Now you know... :)
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