Increase in Cigarette Tax Reduce the Sales of Cigarettes - Assignment Example

RUNNING HEAD: Increase in cigarette tax reduce the sales of cigarettes. Increase in cigarette tax reduces the sales of cigarettes. Name: Course title: Tutor: Institutional affiliation: Department: Date of submission: Q1 (a) ANSWERS. Tax is a levy imposed upon the taxpayer by a by the state. Cigarette taxation refers to an excise tax imposed on the purchase or sale of a cigarette. Cigarettes tax are a significant source of tax revenue in many countries because; the price elasticity of cigarette is not elastic. Cigarette is a bad good and has an inelastic price elasticity (Heckman, Lochner, & Taber, 1998).This is illustrated by figure (1a) Figure (1a) Do Price (Demand curve) P2 ……………………………… P1 ………………………………………… Do 0 Q2 Q1 Quantity The figure above illustrates price inelastic of bad goods (Friedman, 1957). For example, tobacco products. A price increase from P1 to P2 causes a less than proportionate decrease in amount demanded i.e. quantity decreases from Q1 to Q2 If cigarette tax increases, the price of all tobacco product will increase. However, demand decreases less proportionately (Stotsky & WoldeMariam, 1997).This because many smokers are addicted to smoking and don't have any alternative. The quantity demanded decreases but not proportionally as increase in price after tax increase. Empirical studies reveal that the imposition of cigarette tax would increase the price, therefore, reducing amount demanded and sales (Keen & Baunsgaard, 2005). Empirical research Research has demonstrated that increase in tax increases price of cigarette, which lead to a moderate fall in the number of cigarette consumed. Even though, cigarette has a fairly inelastic demand curve. The percentage of people smoking declines because a tax increase: discourages nonusers from starting to consume, encourages current users to quit, and discourage former smokers from starting again (Ghura, 1998). Since an increase in cigarette taxes results, in high prices for every smoker, the effect of even small reduction of cigarette smoking can be very large across the whole population. Thus, increase in cigarette tax will lead to increase in prices of cigarette. As a result, the consumption of cigarette will reduce, and this can be quite substantial in formulation of policies (Fjeldstad & Rakner, 2003). In 1989, a world bank research found that, all else being equal, a price increase of about ten percentage would on average reduce cigarette consumption by about 3.9% in third world countries and about 8.5% in developing countries. In their empirical analysis, 86 studies published in the year 2001 examined the price elasticity of cigarette. Gallet and list (2001) found an average price elasticity of -0.49. Indicating that, on average, a 10% rise in price will lead to 4.9% reduction in consumption. International Agency for Research conducted a study on Cancer in the year 2011. It concluded that, a price increase on cigarettes consumption had a price elasticity of about -0.4. Jonathan Gruber and Sendhil Mullainathan (2002) studied the happiness gained or lost because of cigarette consumption. They conclude that taxation makes a smoker happier because it serves as a control device. It either forces individuals to smoke less or quit smoking. Jonathan Gruber (2000) concludes that the cigarette prices affected consumption among teens in a significant way. i.e. tax increases cigarette prices which make it unaffordable to the teenagers. Wei Tan (2006) has shown that taxation reduces cigarette consumption in both short run and long run, while restriction on cigarette marketing can only affect consumption indirectly through their impacts on the market. Christopher Carpenter and Philips cook (2007) have shown that, increase in cigarette tax reduces the number of youth who smoke. Diagram below shows effect of an increase in cigarette tax on the amount consumed. Increase in cigarette tax will lead to increase in prices which leads to a fall in quantity demanded hence low sales(Mertens & Callaghan, 1942).A Change in amount demand, as a result of price increase, may have a small effect because demand for cigarette inelastic. This is illustrated by figure 2 Figure 2 S2 (s1+tax) Price S1 P2 ………………….. (100 tax) P1 ……………………………… 0 Q2 Q1 Quantity demanded Explanation When there is no exercise tax imposed on cigarette, the demand curve is D1 and supply Curve is S1. The equilibrium price and quantity are P1 and Q1.cigarette tax imposed shifts the supply upwards by the amount of the tax ($ 100) to a new supply curve S2. Reason; a tax increase may discourage the production of tobacco, therefore, reducing it supply. Increase in tax leads to increase in equilibrium price from P1 to P2 i.e. the amount received by seller from the buyer. Equilibrium quantity will decline from Q1 to Q2. The price received by the sellers decline by P1-P2. Buyers pay a total of P1 + $100 This increase in the price of cigarette will: discourage those who have not started smoking not to start, encourage smokers to quit and discourage nonsmokers not to start smoking (Friedman, 1957). In addition, smoking has negative externalities making social cost be higher than the private cost. If a social cost gets higher than the current price, social efficiency can only be increased by forcing smokers to pay the true social cost (Agbeyegbe, Stotsky, & WoldeMariam, 2004). A tax increase shifts the supply curve to the left, causing a reduction in supply. Shift of supply curve is more socially efficient because at Q2 social marginal cost equals social marginal benefit (SMC=SMB), if a tax is used to measure the cost of an externality. In general, the total consumption of cigarette will decrease in the economy. Q1 (b) ANSWERS. Tax policy can be an effective method of reducing the number of smokers. It can be implemented by imposing a set of a percentage tax on cigarette to increase the price. Some empirical research and economics theory does not support tax policy as efficient means of reducing number of smoker under the following basis; They argue that smokers already pay much tax, and they do not cost the government much because they die early saving pension and health care expenditure. Cigarette demand is inelastic and, therefore, increase in price will result to a small fall in demand. High tax will encourage people to smuggle illegal cigarette and avoid paying the tax. However, both empirical studies and economic theory discussed above give a clear foundation for supporting the use of tax policy as a way of reducing cigarette consumption, through increase in price. They illustrate how the burden of price increase is passed to the final consumers, who are discouraged to consume thus, reducing the sales of cigarettes. Reference Agbeyegbe, T. D., Stotsky, J. G., & WoldeMariam, A. (2004).International Trade liberalization, exchange rate regime, and tax revenue (Vol. 4). International Monetary Fund. Fjeldstad, O.-H., & Rakner, L. (2003). Taxation and tax reforms in Third world countries: Illustrations from sub-Saharan Africa. Friedman, M. (1957). Tax and Consumption theory. Princeton university press Princeton. Ghura, M. D. (1998). Tax Revenue in Sub-Saharan Africa-Effects of Economic Policies and Corruption (Epub). International Monetary Fund. Hecklord, J. k., Lonner, L., Taber, C. (1998). Tax policy and human capital formation. National Bureau of Economic Research Mertens, J., & Callaghan, C. B. (1942). The Law Income Taxation. West Group. Retrieved from http://www.getcited.org/pub/101172305 Stotsky, J. G., & WoldeMariam, A. (1997). Tax effort in sub-Saharan Africa. International Monetary Fund. Read More