State Cigarette Excise Taxes: Implications for Revenue and Tax Evasion - Assignment Example

Name: Professor: Institution: Course: Date: Q1.Using economic theory you have learned explain why the sales of the impulse items have dropped as a result of the tobacco tax According to the law of demand, the demand curve flows downwards. There are two types of changes that can occur on a demand curve: movement along the demand curve and shift of the demand curve. Changes in the prices of a commodity can result to a movement along the demand curve while a shift in the demand curve is caused by other factors other the price of that commodity. It could be as a result of changes in the income level, expectations of a price change, change in taste and preference or changes in prices of other goods. The sales of impulse goods and services have dropped as a result of changes in the prices of the cigarettes and can therefore be explained using the theory of shift in the demand curve. When the tax of cigarettes was increased, the prices of cigarettes went up. This in turn had a direct impact on the consumption of impulse goods such as chocolates, magazines, soft drinks and newspapers since consumers had to cut back on consumption of this impulse items so that they could still leave enough money to buy the same amount of cigarettes they were purchasing. This means that as the prices of the cigarettes continue to rise, the demand for the impulse product will shift to the left from Do to D1 as shown in the diagram below. Source: Kim (2010) Q2. Do you believe that smokers will bear the whole tobacco tax burden? Using diagram(s) illustrate and explain Economics states that when the price of a good or service goes up, then eventually, the demanded quantity of that commodity will go down. However, in the recent past, researchers have suggested that due to the addictive nature of tobacco, this rule is exceptional to cigarettes. They argue that smokers will pay any amount of money so as to continue enjoying smoking the same number of cigarettes they used to so as to satisfy their wants and needs. It is worth noting that through increasing the tobacco tax, it will only act as a great incentive to the smokers to try and get cheaper cigarettes through patronizing shops offering lower prices, purchase cigarettes from the states which are neighbouring them and have lower tobacco tax, switching to other cheaper cigarette brands and buying tax free cigarettes over the internet. Smokers will be forced to avoid tax which will involve them preferring to legally buy these cigarettes from duty free shops. For example, smokers who are in high taxing countries may engage legally in shopping across the border in neighbouring countries which have lower taxes. They may also buy these cigarettes from native reservation where taxes don’t apply. Selling of tax free cigarettes will make the cigarettes more available for consumption for the Australian smokers. The smokers may also opt to evade tax (Tax evasion) where they will deliberately conceal to the tax authorities their true economic activities so as to minimize their liability of tax. For instance, the importers of tobacco will evade the custom duties while the manufacturers of tobacco will evade taxes on domestic consumption through under invoicing which will reduce the tax base. Tax evasion will involve illicit production as well as illicit trade (smuggling). It is therefore clear that although consumption of cigarettes will be affected by increase in taxes, smokers will still look for other ways out to keep consuming this product. This is as shown in the diagram below. Source: Mackay (2009) Q3. Is the news agency industry in Australia perfectly competitive? Explain The Australia news agency is a perfectly competitive one. A perfectly competitive market is one in which there are many buyers and many sellers who produce a homogenous product. The action of any news agency firm in this market has no effect on the price and output levels in the market since its contribution is negligible. Other characteristics of Australia news agency industry that makes it perfectly competitive includes; There are many firms selling the same commodity in the market. Therefore, the decision of a single new agency cannot affect the over market price or output levels In this industry, there are many buyers. Therefore, the action of any single buyer has no effect on the prevailing market price or output The news agency industry deals with products that are similar in all ways. Buyers can not show preference for products of one firm over those of the other There is freedom of entry and exit in the industry The buyers are able to get the commodity at the lowest possible as they have adequate information about what is happening in the market. If one new agency raises the prices of its commodity above the prevailing market price, the agency will make no sale since customers are aware other news agencies are offering a lower price. There is no government interference since the government plays no part in the operation of the news agency industry. Prices are only determined by demand and supply forces. The factors of production are perfectly mobile Q4. Now assume that the cigarette industry is perfectly competitive and the cigarettes are identical. We also assume that cigarette companies initially earned zero economic profit. What will happen to an individual cigarette company’s profit in the short run and long run if the government’s anti-smoking campaign proves to be successful? The objective of each and every firm is to maximize its profits. The profits of cigarette companies are maximized when: The Marginal Revenue (MR) is equivalent to the firms Marginal Cost (MC) which means that the revenue earned from the sale of an extra unit of cigarette is equivalent to the cost of producing that extra cost unit of cigarette The Marginal Cost curve cuts the Marginal Revenue curve from below The determination of the price of the cigarettes and the output of the cigarette firms in a perfectly competitive market in the short run is as illustrated in the figure below. The firm will produce Qe units of output at the price of Pe. The firms can only maximize their profits at this prevailing price since price changes in this market are not significant. Source: Author (2011) However in the long run when the anti smoking campaign proves to be successful, the market conditions will be unfavourable and many firms may decide to exit the in cigarette industry. This will in turn lead to a reduction in the quantity of cigarettes supplied in the market as illustrated by the supply curve S1 S1 below. As the supply of cigarettes decreases, the market price of cigarettes increases from Pe to P1. There new price of the cigarettes firms is therefore P1 and the existing companies will only maximize their profits at these existing prices. Source: Author (2011) Q5. Discuss the unintended consequences of the cigarette tax. Critically comment on this tax as a policy to reduce the number of smokers Much progress has been achieved on a free smoking society over the last 10 years. Over half of the Australia citizens are now living in societies covered by a comprehensive smoke free law (Yurekli & Joy 2010 p 2). Despite of this success, Australia and the rest of the world have a long way to go so as to achieve the goal of a smoke-free law. In Australia, smoking remains the most preventable cause of premature death. Several policies have been put in place to cope cigarette smoking, these policies includes; product regulation, tax and price policies, accountability and performance policies, policies to limit product marketing, policies to expand clean indoor air laws and restrictions and policies to assure effective public education campaigns. This easy is going to focus on tax policy as a way to reduce cigarette smoking in Australia (WH O 2010). For years, tobacco is considered as an ideal consumer good for taxation. Cigarette taxes can be in several forms (Mackay 2009 p1). First, the taxes can be added as a fixed amount to the price of the cigarette, other forms include Ad valorem taxes such as sale taxes and value added taxes (Mackay 2009 p1). Economics states that when the price of a good or service goes up, then eventually, the demanded quantity of that commodity will go down. Researchers have suggested that due to the addictive nature of tobacco, this rule is exceptional to cigarettes. They argue that smokers will pay any amount of money so as to continue enjoying smoking the same number of cigarettes they used to so as to satisfy their wants and needs. However, in the recent past a growing number of researches now show that this argument is wrong and that the demand for tobacco is strongly affected by its price. For instance, tax increase in Australia between 2002 and 2010 has lead to a high increase in the real price of cigarettes and consumption level has fallen substantially. Similarly, high taxes have reduced cigarette consumption in United Kingdom, South Africa and other counties. This price increase through taxes have encouraged some people to stop smoking, prevented others from starting, and also reduced ex-smoker who had go back to smoking. Although taxation has been seen as one of the best tool of reducing consumption of tobacco, there has been a lot of opposing of tax increment from the tobacco companies who argue that increase in taxes are incentives to look for alternatives. The main purpose of the tobacco tax has been to curb tobacco smoking, raise revenue and to fund tobacco smoking prevention programs. However, this tax has had its unintended consequences. These taxes may have succeeded in reducing the legal sales of tobacco but not the total sales which comprise both the legal and illegal sales of tobacco (Farrelly et al 2010 p6). Tobacco taxes have led to smuggling which has in turn reduced the intended government revenue and undermined the taxation policy as a way of curbing tobacco consumption. Due to the addictive nature of tobacco, tax increment has acted as a great incentive to look for other ways to access this product at lower prices. Bootlegging which is a form of smuggling is another unintended consequence of the tobacco tax (Mackay 2009 p1). Due to the substantial differences in the prices of cigarettes between neighbouring countries, smokers may prefer to buy from those countries whose prices are lower. The vendors may also embark on the illicit business of purchasing these cigarettes from low tax area and selling them illegally to the high tax areas. Smokers may also embark on large scale smuggling where they get involved with criminal firms who have a sophisticated system which they use to distribute locally the smuggled cigarettes and have a few controls on movement of tax free cigarettes internationally (Farrelly et al 2010 p9). From the above analysis, it is clear that a lot of effort has been made to curb tobacco smoking and its consequences on our health and taxation has been one of them. However, it is clear that it is still not the best way of curbing this problem since smokers are still finding other ways to access even more harmful tobacco products. The government should therefore focus on other ways of curbing this problem such as mass education on the deadly effects of tobacco on health for the non-smokers as well as come up with rehabilitation programs for those who are already addicted. References Farrelly M.C, Nimsch C.T & James J (2010) State Cigarette Excise Taxes: Implications for Revenue and Tax Evasion Retrieved on 30th April 2011 from https://mail.google.com/mail/?ui=2&ik=288658763c&view=att&th=12f9559ed4bf5ad8&attid=0.3&disp=attd&realattid=file2&zw Kim S (2010) Explorations in Economic Demand, Part III Shifts in the Demand Curve Retrieved on 30th April 2011 from http://ecedweb.unomaha.edu/Dem_Sup/shifts.htm Mackay J (2009) chapter 4: measures to reduce the demand for tobacco Retrieved on 30th April 2011 from http://www.globalink.org/tobacco/wb/wb04.shtml WH O (2010) Technical Manual on Tobacco Tax Administration: Chapter IV The political economy of tobacco taxation Retrieved on 30th April 2011 from https://mail.google.com/mail/?ui=2&ik=288658763c&view=att&th=12f9559ed4bf5ad8&attid=0.2&disp=attd&realattid=file0&zw Yurekli A & Joy B (2010) Design and Administer Tobacco Taxes Retrieved on 30th April 2011 from https://mail.google.com/mail/?ui=2&ik=288658763c&view=att&th=12f9559ed4bf5ad8&attid=0.6&disp=attd&realattid=file6&zw Read More