Question

1. Which of the two taxes is likely to raise more money for the government and why?
A. The cigarette tax, because cigarettes are more expensive than most other tobacco products.
B. The cigarette tax, because people get addicted to cigarettes and are willing to pay the tax.
C. The tobacco tax, since people will keep buying tobacco anyway and you can reap the tax rewards.
D. The tobacco tax, because it covers a much broader variety of products to be taxed.

2. How could the cigarette tax “backfire” and actually lead to more negative externalities? Explain.

Answer 1

1. Option D

Research supports a set of policies regarding tobacco taxes, starting with federal, state and local tax authorities levying the highest possible taxes on cigarettes and all other combustible tobacco products, such as cigars, pipe, roll your own tobacco and hookah. Additionally, all tobacco products, including e-cigarettes, should be taxed at rates that discourage youth use.

2. Taxation is one of the most common policies used by the government to reduce demand of any product. Taxes increase the price of the goods which leads to reduced demand. Goods such as cigarettes have negative externalities and affect the society as a whole.

Disadvantages of cigarettes taxes

• Difficult to measure the level of negative externality
• The cigarette demand is inelastic, then higher taxes will not reduce demand much. For example, a small price change will not reduce consumption of the cigarettes.
• Taxes will cause inequality. A tax on cigarettes takes a higher percentage of income from those on low-income.
• Tax burden will implied on the family of the smoker too.
• Possibility of evasion. Therefore, taxes can create unintended consequences.