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Where There's Smoke, There's Controversy
Subject Taxes
Topic Government and the Economy
Key Words Cigarette tax, budget, revenues, healthcare costs, federal aid, tax rate, employment
News Story

The Ohio General Assembly is considering an increase in the cigarette tax of 50 cents per pack to help offset a projected budget shortfall of $750 million in 2003. There two sharply divided camps on this issue.

The protagonists calculate that the state's revenues would increase by $400 million a year from the current $263 million. This would help cover the $597 million cost of Medicaid for tobacco-related illnesses and $3.4 billion in direct health care costs. It is argued that it is unfair for non-smokers to subsidize smokers' health care costs as much as they do. Indeed, 65 percent of Ohio voters support the tax increase. The National Cancer Institute has recently published a report showing that tax increases reduce the number of children starting to smoke and decrease the number of those already smoking. That translates into more healthy and productive citizens. Fewer under-age smokers would also improve sales compliance by retailers, and would therefore reduce the risk of the state losing $30 million in federal aid for drug and alcohol treatment. Twenty-two other states are also contemplating cigarette tax increases.

The skeptics argue that the proposed tax increase to 74 cents a pack in Ohio would set the tax rate at levels higher than in neighboring Indiana (15.5 cents), West Virginia (17 cents), Kentucky (3 cents), and Pennsylvania (31 cents), and that this will lead to purchases out of state by Ohioans living near the state line. One economist estimates that, already, 42 percent of cigarettes consumed by Cincinnati residents are actually bought in Kentucky. If the out-of-state purchases increase, the state will receive less tax revenue, retailers will lose sales of cigarettes and other items they sell, and jobs will be lost. Even a 12-cent tax increase is estimated to reduce employment by 2,000 jobs. (Protagonists disagree, citing other research.) Also, since cigarettes are purchased more by lower-income earners, blacks, and the less educated, the tax will be borne disproportionately by those groups. It is also questioned whether the tax hikes reduce teenage smokers. As an alternative to tax increases, it is argued that the state should cut back its own spending.

(Updated October 10, 2002)

Questions
1.

Draw a diagram of the supply and demand for cigarettes sold in Ohio (including the current taxes). Show the equilibrium price and quantity.
a) Illustrate what would occur if the tax were raised.
b) Explain what would happen to the equilibrium quantity and why, with reference to your diagram and the news story.
c) Show the increase in tax revenue on your diagram. What would determine its size?

2. The tax revenue is expected to increase if the tax hike is enacted. What does this tell you about the elasticity of demand for cigarettes? Explain why using economics.
3. Is the demand for cigarettes perfectly inelastic? Why or why not? Refer to qualitative and quantitative information in the news story.
Source David Owsiany, "Cigarette taxes unfair - and they won't work," and Tracy Sabetta, "Plan is a 'win-win' for Ohio's budget - and kids," Cincinnati Enquirer, May 5, 2002.

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