Sunday, March 20, 2011

A State tries to re-write the rules on Elasticity of Demand. Smoke em' if you have em'...

Here is a nice article loaded with Microeconomic concepts, such as taxes, elasticity, subsitutes and complements (hotel rooms and cigarettes are complements?). Read the article below the fold, but I am going to focus on elasticity.

New Hampshire Debates a Reduced Tax on Cigarettes

Legislators in New Hampshire believe if they reduce the tax on cigarettes (hence the retail price) they will gain more in revenues.  The tax currently is $1.78 and they propose a decrease of $.10 to $1.68.
""The bill passed by the House would cut the rate 10 cents to $1.68 a pack. The taxes are $2.51 in neighboring Massachusetts, $2 in Maine and $2.24 in Vermont.""
Against much research to the contrary, they believe the demand for cigarettes is relatively ELASTIC. Elasticity determines how sensitive demanders are to changes in the price of a good relative to their quantity demanded of that good. There is an inverse relationship between price and quantity demanded (Law of Demand), but how intense that relationship is helps determine elasticity.

A pack of cigarettes costs about $6.17 (google search) with tax included, in New Hampshire.  A $.10 drop in the price would represent a decrease of 1.6% in the price ($10 divided by $6.17 times 100).  For revenues to increase, there would have to be an increase in quantity demanded greater than 1.6%. Presumably from new smokers induced to take up the habit because the price is now cheaper (by a dime) OR it is smokers from neighboring states (Massachusettes, Vermont, Maine, etc) driving to NH to buy cigarettes at the lower price.

Applying the 
Revenue Test for Elasticity of Demand, a good is elastic if the percent decrease in price(-1.6%) induces a greater increase in quantity demanded (more than 1.6%) then total revenues will increase, to the delight of the NH lawmakers.

However, it is generally accepted that the demand for cigarettes is relatively
INELASTIC.  Using the example above, this means that quantity demand will indeed increase when the price decreases but it will increase by LESS THAN the 1.6% decrease in price. In other words, it will tend to not induce more people to smoke and given the price of gasoline (with no hard evidence) I dont believe people will drive even short distances to save $.10 for a pack of cigarettes. 

The taxes are ALREADY much lower than two of the three surrounding states, so I don't see how this will produce additional revenue..

This reminds me of a quote from Thomas Sowell:

""The first lesson of economics is scarcity: there is never enough of anything to fully satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.""

In general, the divide between understanding basic economic principles and politics remains wide...

New Hampshire Debates a Reduced Cigarette TaxBy THE ASSOCIATED PRESS

Published: March 19, 2011

CONCORD, N.H. (AP) — As some states look to tobacco tax increases to plug budget holes, a few are bucking the national trend and instead are considering dropping the rate to increase cigarette sales.

In New Hampshire, supporters argue that reducing the tax by a dime would help the state compete with Maine, Vermont and Massachusetts, while opponents say it would still lose millions of dollars even if sales improved.

New Hampshire’s House voted on Thursday to reduce the tax and sent the bill to the Senate, where its prospects are uncertain. New Jersey and Rhode Island have also considered reducing their taxes.

It is unusual for states to lower the tax, said Frank Chaloupka, an economics professor at the University of Illinois at Chicago. The sales increase is not enough to offset the drop in tax revenue, he said.

New Hampshire has raised its tax repeatedly since Gov. John Lynch, a Democrat, took office in 2006, increasing it to $1.78 from 52 cents a pack in 2005.

The bill passed by the House would cut the rate 10 cents to $1.68 a pack. The taxes are $2.51 in neighboring Massachusetts, $2 in Maine and $2.24 in Vermont.

Rhode Island’s bill would cut its tax by $1, to $2.46 a pack, compared with $3 in neighboring Connecticut. New Jersey last year considered reducing its tax by 30 cents, to $2.40 a pack, but has not followed through. Smokers in New York City pay the nation’s highest cigarette tax, a combined state and local rate of $5.85 a pack.

When states raise the tax, revenue goes up even though sales decline, Mr. Chaloupka said. Over time, tobacco tax revenue gradually drops after a tax increase as smoking declines, he said. To drive revenue back up, states have raised taxes again.

The only time tax revenues dropped after a state raised its tax was in 2006, when New Jersey raised it by 17.5 cents, he said — though the revenue decline was more likely because of adoption of a comprehensive smoke-free policy. New Jersey raised the tax by 12.5 cents in 2009 and revenue rose, he said.

Mr. Chaloupka said that any reduction in cigarette prices would add to Medicaid and other health care costs. The Campaign for Tobacco-Free Kids estimates that if the New Hampshire cut were enacted it would mean more than $21 million in long-term health costs.

The campaign also estimates a 10-cent drop per pack would result in 1,000 new young smokers in New Hampshire.

State Representative Susan Almy, a Lebanon Democrat and member of the House Ways and Means Committee, said the health impact was not taken into account in the committee when it promoted the tax cut.

Instead, lawmakers are looking at a study by the New Hampshire Grocers Association, which has consistently criticized the tax increases as hurting small businesses, particularly along New Hampshire’s state line.

The Grocers Association president, John Dumais, said its study showed that cutting the rate a dime would reduce the state’s tobacco tax revenue, but that would be offset by an increase in state taxes collected from people renting hotel rooms, eating in restaurants and buying alcohol, lottery tickets and gasoline.
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