A Laffer curve for cigarettes?

By Megan McArdle

Conservatives are very fond of the Laffer Curve, which says that sometimes, lowering taxes can raise revenue. Liberals love to make fun of it by pointing out that all the Republican claims that this would happen have, in practice, failed to pan out. The liberals have the better of the empirical, though not the theoretical argument. Tautologically, the curve must be true: at 0% tax rates, you raise no revenue; and at 100% tax rates, you raise no revenue, because why would anyone work? (Plus they'd find it hard to, having no money for food or shelter to keep themselves alive). Somewhere in between, the curve must maximise. Unfortunately for conservatives looking for practical justifications for tax cuts, that point is at some rate higher than current American income taxes.

But that doesn't mean the Laffer Curve still can't be interesting! There are, after all, other taxes than the income tax; and some areas may be hitting the Laffer point, as Jacob Sullum points out:

In an Asbury Park Press op-ed piece, Gregg Edwards, president of New Jersey's Center for Policy Research, argues that the state's cigarette tax—at $2.57½ a pack, the highest in the country—has reached a "tipping point" where a higher rate no longer brings in more money. In fact, he notes, the latest increase in the tax was followed by a reduction in revenue, from $787 million in fiscal year 2006 to $764 million in fiscal year 2007. The decrease in cigarette purchases is partly due to smokers who cut back or quit (an avowed goal of higher cigarette taxes), but Edwards notes that many smokers may be getting cigarettes online, in neighboring states with lower tax rates (cigarette sales in Delaware are mysteriously on the rise), or from the black market. The differential between New Jersey's tax and other states' is a smuggler's dream. Imagine what you could make by hauling a truckload of cigarettes from, say, South Carolina, where the tax is 7 cents a pack.



For cigarette taxers, of course, cutting back is a feature, not a bug, of the tax. (As it is for the kind of people who favour raising the income tax in order to dampen status competition). But Laffer effects don't always come from cutting back; they can also come from shifting activity. People may simply shift their shopping, or earning, elsewhere--to a place, or time period, in which it's more advantageous. Here in DC, a proposed car trip to Virginia seems to be an invitation to one's smoking friends to place cigarette orders. (In New York City, trips to Westchester and New Jersey had much the same effect.)

If New Jersey is simply an altruistic cancer-hating state, of course, that doesn't matter. Some people will cut back, which is good; and some other people will buy cigarettes in New York or Pennsylvania, which is too bad, but not really any of New Jersey's business.

This does not, however, strike me as a very good model of the behaviour of actual politicians. I will be curious to see what happens to New Jersey's cigarette tax henceforth.

This article available online at:

http://www.theatlantic.com/business/archive/2007/08/a-laffer-curve-for-cigarettes/1790/