Do Cigarette Taxes Make Smokers Happier?

Abstract

Economists have a well-established framework for understanding the welfare consequences of taxing goods that don’t create externalities. Taxes create dead-weight loss by causing consumers to distort their consumption away from their preferred choices. This cost is weighed against the benefits of government revenue. As established in the seminal analysis of Becker and Murphy (1988), this argument applies equally well to both addictive and nonaddictive goods. The same type of revealed preference arguments that suggest that taxes reduce the welfare of consumers of nonaddictive goods can be extended to “rational addicts”: agents decide to smoke by trading off the long-term costs of consumption against the immediate pleasures of consuming, all the while taking into account the addictive properties of the good in question. This model therefore suggests that the only justification for taxing addictive goods is the interpersonal externalities associated with consumption of those goods.