On the Pigovian nature of cigarette taxes

Martha King at the Show Me Daily notes that Missouri’s cigarette taxes are the lowest in the nation and tries to make a rather interesting argument about liberty:

Although the majority of Americans don’t smoke, a new poll suggests that most voters would favor increases in tobacco taxes as an alternative to state budget cuts. This kind of discrepancy demonstrates one of the main problems with cigarette taxes — those least directly affected by the tax feel justified in imposing a tax on those most affected.

This analysis falls rather short. Here are some problems with it.

  • Martha provides no empirical support for the notion that those most affected by cigarette taxes don’t also think that these taxes are justified.
  • Cigarettes don’t exist in a vacuum. Like many goods and services, their production and use as intended create serious negative externalities that aren’t priced into the market price of cigarettes.That is to say, there are many costs of smoking that smokers don’t pay for when they purchase a pack of cigarettes.

The health costs of cigarettes are high and undisputed. This is particularly true when you include the victims of second or third-hand smoke. At some point government healthcare programs foot a substantial amount of the costs and generally everyone is worse off:

The data in this book are based on present value of loss for men and women who are smokers at the age of 24. One factor that is distinct in this study is the calculation of “quasi-external cost,” which the authors define as the cost of freedom of choice to the family members of smokers, including children who are nonsmokers. In their longitudinal analysis of lifetime smoking, the authors estimate that the social cost of smoking, which is a sum of purely private, quasi-external, and external costs (the latter determined by excise tax) for a 24-year-old person turns out to be $39.66 per pack of cigarettes. The cost to Medicare, Medicaid, and Social Security is substantial. The quasi-external cost of smoking to the spouse of a 24-year-old who smokes comes to a staggering $28 billion. After considering these numbers and the amount of people who turn 24 each year and smoke, the authors of this book have predicted that the national external and quasi-external lifetime cost per year is $13.8 billion for females and $32.8 billion for males. Thus, with each new cohort of 24-year-old smokers in the United States there is an additional $204 billion of lifetime costs. These staggering expenses in light of the high number of smokers in the country make a convincing argument for rethinking the issue of public health policy making. Federal and state cigarette excise taxes have increased dramatically over the years. The calculations made by Sloan and his coauthors provide an analytical reason for such increases.

This study is not a complete evaluation of the costs of smoking. There are many other studies that attempt to quantify the hidden economic costs of smoking and there is of course much debate on what methodology is best, etc. I would note that one cost that I’ve never seen computed is the harm done to the earth and our groundwater as toxic chemicals seep out of the millions of butts smokers casually toss wherever they can (4.5 trillion a year globally, according to one estimate).

My intuition is that cigarettes, particularly in Missouri, are underpriced. Raising Missouri’s taxes would be an excellent way to make smokers pay for the harms of using cigarettes; my only comment is that is it is probably true that we don’t have the political will to raise them high enough. As a matter of functional policy I would at least align Missouri’s cigarette taxes with neighboring states, as drastically lower prices in Missouri provide an attractive opportunity to cigarette smugglers, who buy cigarettes in Missouri on the cheap and market them in black or grey markets particularly in Chicago, where taxes are way higher.

Economists like Arthur Ceceil Pigou have approached this problem before and favor policy mechanisms that “internalize the externalities”. In real life this is often done simply by taxing the good or service that is implicated in the negative externality. Generally this is a concept addressed in introductory economics classes.

So if we’re going to make a John Stuart Mill argument about liberty and whatnot, I would say that yes, liberty is important, and it is also important to understand precisely where all the costs of cigarettes manifest themselves and be prepared to make an appropriate cost-benefit analysis.

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2 thoughts on “On the Pigovian nature of cigarette taxes

  1. […] On the Pigovian nature of cigarette taxes « Ducks and Economics […]

  2. […] This post was mentioned on Twitter by eapenthampy, eapenthampy. eapenthampy said: Answering Martha King at the @ShowMeInstitute on why Missouri's cigarette taxes are actually way too low http://bit.ly/du6YWk […]

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