Impact of cigarette taxes on demand for cigarettes

A number of studies have examined the effect of cigarette taxes on retail prices. When those studies conclude that increases in cigarette and other tobacco taxes would certainly result in a higher price for these products, differences exist in the estimated magnitude of the increase in retail prices for a give level of tax increases. Early studies concluded that pricing behaviour of the cigarette industry was similar to that of firms in a competitive industry in spite of its oligopolistic structure, thus cigarette taxes were fully passed to the price of cigarettes at the retail level. Recent studies, which accounted for the dynamic nature of an oligopolistic industry, or modelling the demand and supply for cigarettes simultaneously, however, found that cigarette prices were increased by more than amount of the tax increase. For example, Keeler et al. (1996) estimated that a one-cent increase in a state’s cigarette tax would raise retail prices in that state by 1,1 cents. The levels of taxes vary across nations or states or provinces in a country. Increasing the level of taxes in a higher-tax nation or a higher-tax state in a country would lead to a larger price differential across countries or states and a higher incentive for cross-border shopping and cigarette smuggling. Thus, the impact which increasing cigarette taxes might have on consumption in an individual country or state depend partly on the changes in cross-border shopping and cigarette smuggling which result from the tax increase