How State Borders Shape the Impact of Cigarette Taxes on Prices

The availability of lower-taxed goods in neighboring states incentivizes consumers to make cross-border purchases. Using transaction-level data from the NielsenIQ Consumer Panel, we analyze how proximity to a lower-tax state affects the pass-through of tax to cigarette prices. We analytically formulate tax pass-through to prices as the “true†passthrough rate attenuated by the “border effect†. The “border effect†refers to the impact of cross-state purchasing behavior on the extent to which excise taxes are passed on to cigarette prices. We model the border effect as an exponential function that decreases with distance from the lower-tax state, reaching the highest value at the border itself and diminishing to zero at large distances. We estimate the parameters of the “border effect†function by employing an exponential regression model with location, time, and UPC fixed effects. The results of the robustness check, where we estimate a segmented regression using separate tax pass-through estimates for a range of distance intervals, support the linear pattern observed in the exponential model. We also extend the model to account for the tax differential between the home state and the nearest lower-tax state and perform a comparative analysis of the two model specifications. In addition to geographic variation, we also analyze how the pass-through of cigarette taxes varies across different demographic groups. High-income households face the highest tax pass-through and are largely unaffected by border proximity, while middle-income households are affected by the “border effect†only when the distance from the lower-tax state does not exceed 90 kilometers. Low-income households remain sensitive to “border effects†at greater distances, though their responsiveness declines beyond 200 kilometers. Moreover, consumers who are not engaged in paid employment exhibit significantly lower pass-through, suggesting greater scope for tax avoidance through flexible shopping behavior.