Question

Suppose there is a bill to increase the tax on cigarettes by $1 per pack coupled with an income tax cut of $500. Suppose a person smokes an average of 500 packs of cigarettes per year—and would thus face a tax increase of about $500 per year from the cigarette tax at the person’s current level of consumption. The income tax measure would increase the person’s after-tax income by $500. Would the combined measures be likely to have any effect on the person’s consumption of cigarettes? Why or why not?

Answer 1

While one might think that the income tax cut and the tax on cigarettes would cancel each other out, it might not be the case. the important thing to consider which demographic this person belongs to. It is seen that imposition of a tax on cigarettes reduces consumption of cigarettes amongst teenagers and young adults. Thus if this person belongs to this demographic their consumption of cigarettes will fall. For a middle income demographic the effect can be assumed to be negligible.