Question

Cigarettes in Australia have long been subject to excise tax – a per cigarette tax levied on the suppliers of cigarettes. (The tax applies to all tobacco products, however for the purposes of this exam assume cigarette and tobacco consumption are the same thing). In 2016 the federal government announced that the excise tax rate for cigarettes would rise by 12.5% a year for the next 4 years. Over this period tax revenue collected from the sale of cigarettes has increased considerably. Legal cigarette consumption has fallen to an all-time low in Australia due to a combination of the tax on cigarettes, and public health initiatives such as plain packaging, health warnings and banning advertisements.

Part (c) Taxation of cigarettes is often justified on the grounds that cigarette smoking creates externalities. What is meant by the term “externalities” in this context? Give two examples of externalities created by cigarette smoking and explain how a tax on cigarettes could potentially address both of these. Using a fully labelled and explained diagram explain how a tax can increase efficiency in the cigarette market. What size tax should be levied to maximise efficiency in this market? (Indicate the efficient tax size on your diagram – no actual number required).

Part (d) Is a tax on cigarettes a regressive tax or a progressive tax? Explain your answer, including a definition of both terms.

Part (e) Australia’s police forces and border forces have warned that rapid rises in the tax on cigarettes have had unintended consequences of encouraging illegal activity such as smuggling, with proceeds funding other criminal activities. Explain why this might be the case. In your answer refer to the role that elasticity of demand plays in making illegal activity more profitable.

Answer 1

Part c]

The smoking of cigarettes are regularly viewed as damaging to singular wellbeing, and forces costs upon the general public also. The smoking of cigarettes is said to have negative externality connected to it. An externality is a cost forced upon an outsider because of the activity of some other financial operator. The smoking of cigarettes forces a negative externality upon a person who couldn't bear the smoke. Another pessimistic externality of smoking is that smoking by one individual regularly actuates another and the chain proceeds .Thus, because of this negative externality, the socially alluring measure of cigarettes is not exactly the real market flexibly of cigarettes. Because of this, charges must be forced by the administration to control the overabundance measure of the cigarette utilization. The Marginal social cost bend of cigarette smoking misleads the est of the Marginal Private cost bend of cigarettes.

The equilibrium quantity will be where MPB = MPC at Q0 but the social optimal quantity is where MSC=MSB at Q1. To obtain the quantity Q1 there is requirement of tax.

Part d)

The tax on cigarretes is highly regressive. Progressive tax are those tax which increases with the increase in taxable income. Regressive tax is the type of tax which decreases with increase in income But it is actually progressive tax fixed on every single cigratte and proportion tax is part of regressive only as it is inequitable.

part e]

As the government forces tax, the cost to be paid by cigarette purchasers increment to P. So as to evade the excessive costs the shopper frequently preterit to get it from the underground market where they get cigarettes at a less expensive rate. The dependence of the buyers lead to such low versatility of interest in the cigarette market. In the event of an inelastic interest bend a increase in the cost of the item prompts a lessening in the amount of cigarettes requested to a small degree. This would expand the income and the benefit in the bootleg[black] market.

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