Tag Archives: cigarettes

Tax effect on price signal drives economic activity “underground”: cigarette tax in NY

Thanks  Vickie for sharing this fascinating piece – quite timely – on the diversion of economic activity to the black market following a change in price signal due to a particular selective excise tax policy.

Underground cigarette market exploding in aftermath of tax hike – NYPOST.com

Read this article and pay attention to the particularly interesting aspects:  (1) the alleged pressure on small operators to engage in this behavior because cigarettes are such an important (inelastically demanded) product that little corner stores rely on them to bring in custom for the more elastically demanded other goods they sell – so if your competition starts selling the untaxed close substitute of contraband cigarettes, you will be pressured to do so as well because otherwise not only do you lose the cigarette sales, you lose the profit on the other stuff people buy at the same time as they pick up their smokes; (2) one signal that this behavior was taking place was that the drop in legal cigarette sales was greater than that estimated based on the anticipated impact of the rise in price due to tax on smokers on the margin of quitting; (3) even though the quantity of legal cigarettes demanded (the tax base) has gone down due to the tax rise in price, the revenue derived from the tax instrument has gone up (because revenue is tax rate X base – if the rate is sufficiently high, even a smaller base could yield more revenue); (4) though not pointed out explicitly in the article,  (3) above is not necessarily proof that this move is a net positive for budget balance:  consider that the overall impact of the tax increase on revenues and expenditures would have to take into account the costs of increased enforcement and judiciary activity; the (delayed) net benefit of any quitters’  health improvement (complicated to estimate); etc.  From a fiscal federalism aspect though, we can observe that some of the enforcement cost can be offloaded upward to another gov’t via the role of the Federal ATF…




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