Public Sector Economics

1. Public Sector Economics Over-Shifting in the Cigarette Industry

2. Federal and State Excise Taxes • constant nominal (i.e., no inflation adjustment) amount per pack • occasional state exceptions. eg., Hawaii 1965-93 charged fraction of wholesale price • federal tax owed by manufacturer and state tax owed by wholesaler  wholesale prices include federal but not state tax • 1983: first federal hike since 1950’s (8 to 16 cents) • other federal hikes in 1991, 1993, 2002, 2009; now 101 cents • wide variation across states, now from 17 (MO) to 435 (NY) • national average state rates have more than tripled since Dec 31 1998, from 39 cents to 132 cents

3. Tobacco Master Settlement Agreement • 46 states agree with major manufacturers to waive lawsuits in exchange for $4+ billion payments from the industry • each manufacturer’s share of the payment depends on his market share  MSA payments impose a marginal cost on producers, beginning in 1999 • marginal cost varies from year to year, from 29 cents (1999) to 40 cents (2002)

4. Cross-Section vs Time Series • cross-section studies show shifting of 1 or 1.1 • “law of one wholesale price” • trans-shipping may limit cross-section variation in wholesale prices • even for a monopolist who significantly over-shifts • wholesalers have more incentive to ship than consumers • until last year, major manufacturers had only one (national) wholesale list price. even now, just a few regions • 1.1 may only represent over-shifting in wholesale and retail cigarette markets • time series suggests at least 1.3? • April 2009 fed tax increases 62 cents • Over prior year, state taxes increased 12 cents • Cigarette prices increased 97 cents  (97-4)/74 = 1.3