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-t' C81-05559 Su bj ect: . . Mr. Harry G. Daniel Datec September 17, 11981 • Myron Johnston Teenage Smoking and'the Federal Excise Tax on Cigarettes I have just finished studying a National! Bureau of Economic Research (NBER) working paper entitled "The Eff ect of Government Regulation on Teenage Smoking."* In the paper the authors examine the impact on teenage smoking of (1) the excise tax on cigarettes, (2) the FCC Fairness Doctrine (i.e. the anti-smoking commercials), and (3) the cigarette advertising ban. This is by far the best study I have read concerning the effects of the anti-smoking commercials, and the only study I know of that attempts to determine the price elasticity of cigarettes among different groups. Because of the quality of the work, the prestige (and objectivity) of the NBER', and the fact that the excise tax on cigarettes has not changed in nearliy 30 years, I think we need to take seriously their statement that "...if future reductions in youth smoking are desired, an increase in the Federal excise tax is a potent policy to accomplish this goal." Given that a further reduction in youth smoking IS the goal of many pressure groups and Federal agencies, and that the goal of balancing the Federal budget through budget cuts seems increasing elusive, I think we can expect an increase in the excise tax on cigarettes, probably within a year. There are other thiings that lead me to believe that there will be increases in the Federal excise taxes on both cigarettes and alcoholic beverages: (1) It can be argued that excise taxes are "voluntary" taxes in that payment of them can be avoided by refraining from purchasing the product, and that therefore increasing excise taxes does not reduce discretionary incomes, (2) Both, cigarettes and alcoholic beverages have low price elasticities, so the additional taxes can be passed on to the consumer with little adverse effect on the industries, (3) Prices of cigarettes and alcoholic beverages (as measured by the Consumer Price Index)! have increased more slowly than prices generally, (4) Excise taxes contributed only 5.0 percent to total Federal revenues in 1980, down from 8.1 percent in 1970 and 12.5 percent in 1960', (5) A 25 percent increase in the excise taxes on cigarettes and alcoholic beverages would' reduce the Federal deficit by over two billion dollars, yet have a minimal effect on the Consumer Price Index. Givenithe current price of gasol ine andithe state of the automobile industry, I do not think it would be pol!itically feasible to raise excise taxes on cars or gasoline, but I think cigarettes and alcoholic beverages are fair game for increased taxes. *The paper is a part of the NBER''s research program in Health Economics and was supported by grants from the National Science Foundation!to the NBER and from the National Center for Health Services to the New Jersey Medical School. The authors are Eugene M. Lewit, Office of Primary Health Care Education, New Jersey Medical School; Douglas Coate, Department of Economics, Newark College of Arts and Sciences, Rutgers University; and Michael Grossman, Department of Economics, City University of New York Graduate School.

2 Some of the findings reported in the paper are as follows: 14 Most researchers, myself included, have calculated that the best estimate of the price elasticity of cigarettes is about -0.4, i.e. that a ten percent increase in the retail price of cigarettes will cause a decline of about four percent in cigarette sales. Many of us have hypothesized that price elasticities are different for different demographic or socio- economic groups, e.g., that price increases would have less effect on the higher income groups and on the older and therefore more habituated smokers, than on other smokers. Because of the lack of any reliable data, this has remained until now strictly a hypothesis. The authors of this paper, however, have used the results of the 1966-1970 Health I Examination Survey of the National Center for Health Statistics, and have constructed an elegant longitudinal and cross-sectional model of teenage smoking behavior. This has made it possible for them to calculate the price elasticity for teenagers and compare it with the generally accepted price elasticity of cigarettes for the total smoking population. The authors conclude that the anti-smoking commercials represented a shock to the underlying upward trend in teenage smoking in the mid-1960's and early 1970's, particularly in the first year in which they were aired, but that the trend reassertedl itself the following year, although teenage smoking remained at a lower level than would have been the case in the absence of the anti-smoking commercials. This is consistent with my findings that random shocks, such as the report of the Royal College of Physicians and Surgeons, the Readers Digest articles, and the reports of the Surgeon General, have brief effects, an6that sales subsequently resume the upward trend, but more slowly and from a lower base. The authors also conclude that the cigarette advertising ban had a relatively minor effect in d!iscouraging teenage smoking. The most important finding, and the one of greatest signifficance to the company, is their calculation of the price elasticity of cigarettes among teenagers. They calculate that the smoking participation elasticity is -1.2, which means that a ten percent increase in the price of cigarettes would lead to a decline of 12 percent in the number of teenagers who would otherwise begin to smoke. Their calculation,of the quantity smoked elasticity for teenagers is -1.4, which means that a ten percent increase in price would lead to a 14 percent decline in cigarette consumption by teenagers. This is in contrast to the aforementioned -0.4 elasticity for the total smoking,population. In another paper, two of these authors, Lewit and Coate, found that smoking by young adults 20 to 24 is much more responsive to price than smoking by older adults, which again is consistent withithe hypothesis mentioned above.

• 3 The authors concede that one reason for the large price elasticities they found among teenagers is that the ellasticities incorporate income effects and substitution effects, i.e., cross-el!asticities. This, of course, is true of virtually all calculations of price elasticities. As a result of some of the relationships I discovered while working onimy report on teenage smoking,* I am incliined~to believe that cross-eliasticities are particularly important in the case of teenagers. Among teenagers the prevalence of cigarette smoking is highly correlated with income (from either allowances or working) while there is no similar correlation betweenismoking prevalence and income among adults. Teenage smoking prevalence appears to have begun to decliine among boys at about the time of the high teenage unemployment rates of the early 1970's, at which time the smoking prevalence among girls was still increasing, and~it is the males who would be most likely to feel the impact of unemployment. Further- more, it was among the older boys that the decline was greatest, and, again, one would expect that the older boys would feell the impact of unemployment more thanithe younger ones. With regard to the substitution effects, or cross-elasticities, I think the most important substitution effect is with gasol'ine. In my study, I found that the cumulative smoking incidence among boys in 1976 was about the same as ini1979 up to the age of 16, but past the age of 16 (the age at which many of them would~have access to a car), the 1979 incidence was substantially below that of 1976. Consider also that in 1967, for one dollar, a teenager could buy two gallons of gasoline and a pack of cigarettes. As recently as 1978, if teenage incomes kept pace with inflation, the same purchasing power would still! buy a pack of cigarettes and two gallons of gasoline. With income continuing to increase with inflation, this was no longer possible for the 1979 teenager, and the 1980 teenager could not even afford the two gallons of gasoline. I think it is more than coincidental that the sharpest declines in smoking prevalence among,teenage males occurred in 1979 and 1980, the years in which the price of gasoline rose most sharply. When it comes to a choice betweeng smoking cigarettes or cruising around~in his car, the average teenage male would' probably choose the latter. If this cross-elasticity between cigarettes and gasoline is, indeed, related tolthe decline in smoking prevalence among teenagers, we would expect to see some moderation in the rate of decline in smoking among,boys when.the 1981 data become available. In any event, and for whatever reason, it is clear that price has a pronounced effect on the smoking prevalence of teenagers, and that the goals of reducing teenage smoking and'. ballancing, the budget would both be served by increasing the Federal excise tax on cigarettes. It is worth quoting the authors some- what extensively onione point: "Such a policy [increasing. the Federal excise tax] may also be an effective way to curb~ the d'eteriimental (sic) health effects of smokingi in the long run without substantiially harming the cigarette industry in the short run. Since youth and young, adulit price el'asticitiies are much larger thaniadult price elasticities while adult smokers account for the bulk of cigarette sales, a substantial excise tax increase would substantially *"Young Smokers: Prevalence, Trends, Implications, and Related Demographics," March 31, 1981 1000797546

4 reduce smoking participation by young new smokers but leave industry sales largely unchanged. Given the evidence that individuals are considerably less likely to initiate smoking after age 25, it is quite possible that the cohort of young smokers who never begin to smoke as a result of the tax increase would, never become regular smokers. As a consequence, over a period of several decades, aggregate smoking and its associated detrimental heal~th effects would decline substantially." It is worth noting that government actions designed to reduce smoking in the late 1960's and early 1970's served to moderate ani underlying upward trend in teenage smoking, while any government action taken now will accellerate its present downward trend. Given a price elasticity of -01.4 for totali cigarette sales and -1.2 for teenage smoking participation, a 25 percent increase in the excise tax could be expected to reduce industry sales to about 1.2 percent below what would be expected'in the absence of such an increase, and to reduce the number of teenage smokers to 3.5 to 4.0 percent below the number that would otherwise be expected. The almost certainty of improved economic conditions, lower inflation rates, and increasing,discretionary incomes over the next few years, however, should serve to moderate the adverse effect on sales of an excise tax increase. We caninever look with equanimity on increases in the excise tax, but because of demographic trends and the improved economic outlook an increase at this time would probably be less harmful than it would have been at any other time in the past decade. MEJ:f cc: R. N. Thomson J. T. C. L. N. T. H. F. Zoler Goodale Rowe Meyer