The economics of cigarette taxes

July 10, 2012

The Congressional Budget Office recently took a look at how cigarette taxes affect the federal budget. It found that a 50-cent cigarette tax hike would save the government money as Americans got healthier, but nearly all of that new revenue would get wiped out as people started living longer.

If cigarette taxes went up there would—perhaps unsurprisingly—be fewer smokers. Demand for cigarettes tends to be relatively elastic and responsive to price, especially among younger smokers.

The CBO estimates that 4.3 percent fewer 18- to 24-year-olds would smoke by 2021 if a 50-cent tax hike were added today. Health care costs would drop as government programs would see fewer tobacco-related diseases. Reduced health care spending would, in the short term, reduce the deficit.

Gains in health care would soon be followed by gains in longevity. And when Americans live longer, the government pays out more benefits through programs like Medicare and Social Security. By 2025, the lower smoking rate ends up increasing government health care spending:

That, however, is only part of the story: The cigarette tax also would be bringing in additional revenue, both from the tax itself, as well as taxes on workers' earnings. (If longevity increases, the thinking goes, so does the time that workers remain in the labor force). Factor those two pieces in, and the CBO projects that an increased tobacco tax would end lowering the deficit by a pretty tiny amount.

The deficit, as illustrated above, would ultimately be expected to decrease by 0.015 percent of Gross Domestic Product in 2085—what the CBO describes as a "fairly small" change to government spending.

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Dylan Matthews | July 10, 2012