Some Limits on Taxing Sin: Cigarette Taxation and Health Care Finance

Politicians have long known the advantages of levying excises on items that the electorial majority view with disfavor. Discriminating against the consumption of these goods appeals to the puritanical prejudices of the majority. In addition, these sinful goods typically have an inelastic demand which makes them excellent instruments for raising governmental revenue. Although, historically, the individual state governments have been the major promulgators of these taxes, the federal government, faced with projected revenue short falls in many social programs, has been considering expanding their participation in this type of tax. Independent of the many arguments for or against such taxation policies, is the question of how much additional revenues can be generated by instituting new taxes or increasing existing taxes. Even a difference as small as .2 percent in projected revenue growth can lead to billions of dollars differences between projected and actual tax revenues.' In particular, problems arise in forecasting tax revenue when evaluating proposals for large discrete changes in tax rates. Using the 1993 President's Task Force on Health Care Reform's proposals to raise federal taxes on cigarettes as an example, we identify problems in forecasting revenue based on constant elasticity demand models and suggest an alternative methodology to lessen the errors. In early 1993, the President's Task Force on Health Care Reform led to two proposals to increase federal taxes on cigarettes. One doubled the tax from its current $.24 per pack to $.48 per pack. The other increased the tax by $2.00 to $2.24 per pack. The former policy was projected to increase revenues by $3b the first year [5]. The latter proposal, the extremism of which seems to have gotten everyone's attention, had several different scenarios. Depending on who is doing the forecasting, it will raise between $18b [5] and $28b [10] per year. Continuing the debate, Grossman [8] suggested that a $1.26 tax per pack would maximize revenue from the tax at $16b.2 Even though the enthusiasm for national health care legislation has waned, there is still a lesson to be learned from these policy proposals. The lesson is this: there are limits to taxation, even to the taxation of sin.