CIGARETTE TAXATION AND DEMAND - AN EMPIRICAL-MODEL

This paper evaluates the impact of taxation on cigarette consumption, using a recursive model that includes a retail price equation and a dy namic demand equation. The analysis is based on panel data for 11 west ern states over the period 1967-1990. Results indicate that cigarette consumption is price-sensitive, with a demand elasticity of -0.40 in t he short run and -0.48 in the long run. A tax increase, such as that i mposed in California in January 1989, can have a strong effect of redu cing cigarette consumption by between 11.2 percent in the short run an d 13.4 percent in the long run. These results support the theory of ra tional addiction and the hypothesis that, as a part of their oligopoly behavior, the tobacco companies often do raise end-market prices by m ore than the amount of the increase in tax rates.