Cigarette Tax Hike Sparks Panic Buying - Micro Economic Discussion

The thing that caught my attention in this article more than the obvious points of supply, demand and elasticity was the fairness of the tax. Dr Andy Marks, a Senior Researcher with the St Vincent de Paul Society states that "poorer people are over-represented among smokers". The two tests typically used to evaluate the "fairness" of a tax are the Benefits Principle and the Ability-to-pay Principle. The benefits principle fails the fairness test as the taxes of both high and low income earners will be used to fund the public health system when a greater number of high income earners will have private health cover and not be a burden to the public system (Australian Bureau of Statistics 2006). The ability-to-pay principle states that generally people earning a higher income are best able to pay any increase in taxes (McTaggart, Findlay and Parkin 2010, 140). Therefore an increase in taxes on smoking will likely discriminate against lower income earners whilst higher income earners may continue to smoke despite the tax increase.

Also of interest is that the article does not specify the tax incidence of the increase. It appears to imply that the full cost will be borne by the consumer but this may not be the case. In order to determine who pays the tax burden we need to consider the supply, demand and then the elasticity of demand.

A pure analysis of the supply and demand shows that a tax aimed at the buyer could potentially result in the supplier paying some of the added tax. A worked example of this with respect to taxing chewing gum is shown in McTaggart (2010, 136) and in Figure 1. Even though the buyer pays more for the goods the supplier will also pay in the form of decreased revenue. However, as cigarettes are very addictive it can be very difficult for a smoker to substitute an alternative product to replace the cigarettes if they can no longer afford to smoke. The demand for cigarettes is therefore relatively inelastic and as such it is likely that a greater proportion of the tax will be incurred by the smoker or the buyer.

As a non-smoker it is very interesting that using economic theory it can be argued that a tax on cigarettes is unfair and then also even more interesting to think that it is not only the smokers that are affected by an increased tax.

References:

Australian Bureau of Statistics. 2006. Private Health Insurance: A snapshot, 2004-05. Cat. No. 4815.0.55.001. Canberra: ABS. http://www.abs.gov.au/ausstats/abs@.nsf/mf/4815.0.55.001 (accessed 12 September, 2011).

Hall, A. 2010. Cigarette tax hike sparks panic buying. http://www.abc.net.au/news/2010-04-29/cigarette-tax-hike-sparks-panic-buying/415828 (accessed 12 September, 2011).

McTaggart, D. Findlay.C, & Parkin, M. 2010. Economics. 6th Edition. French's Forrest, Australia: Pearson Australia.