South-Western College Publishing - Economics  
Tax Revenues Go Up in Smoke
Subject Taxes
Topic Government and the Economy
Key Words Government, Revenue, Taxes, Prices
News Story

Governments are dependent on cigarettes - for revenue. In Florida, the state receives 34 cents for each pack of cigarettes sold. Over a third of that goes to local governments. In 1997-98, Florida collected $468 million in taxes from the sale of cigarettes.

The recent anti-smoking campaign-combined with higher cigarette prices-have resulted in fewer cigarettes being sold. As a result, Florida's cigarette tax revenue is likely to fall to $404 million in 1998-99. New Port Richey expects to lose $39,000 and Dade City may lose $19,000. Budget directors need to deal with their withdrawal symptoms quickly because the trend is likely to continue.

(Updated October 1, 1999)

Questions
1. The elasticity of demand for cigarettes is generally considered to be inelastic.
  a)Draw a price-quantity diagram showing a demand curve for cigarettes. Make sure its slope exhibits a general inelasticity.
  b)Add a supply curve which would exist in the absence of taxes on cigarettes. Now draw a supply curve which includes the effect of the unit tax on cigarettes. Why did you draw it as you did?
  c)Mark the equilibrium price and quantity. Show the total revenue generated and its division between the government and the producers.
2. The anti-smoking campaign has reduced the demand for cigarettes.
  a)Draw another diagram of the demand for, and supply of, cigarettes. Include both the pre-tax and post-tax supply curves. Mark the area representing tax revenues.
  b)Shift the demand curve to reflect the change in tastes for cigarettes.
  c)What happens to the tax revenue generated by cigarette sales? Illustrate on your diagram.
3. The higher price of cigarettes has been caused by the higher costs, such as legal costs, incurred by tobacco companies.
  a)Draw another diagram of the market for cigarettes, including the demand curve and the pre-tax and post-tax supply curves. Delineate the area representing the tax revenue.
  b)The higher costs incurred by the producers have shifted the pre-tax and post-tax supply curves. Illustrate what has happened and explain.
  c)What has happened to tax revenues as a result? Illustrate on your diagram. Explain your answer given what you know about elasticity.
  d)Is the real reason for the decrease in tax revenues the anti-smoking campaign or is it the increase in cigarette prices? Explain.
Source No author, "Taxes dip as cigarettes lose appeal," St. Petersburg Times, August 22, 1999.

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