Oligopoly Structure and the Incidence of Cigarette Excise Taxes

The economic incidence of cigarette excise taxes in the United States is estimated for 1955-1989. The analysis simultaneously considers consumer demand and the reactions of manufacturers and the distribution industry, and contrasts the incidence of federal with state and local taxes. A cost function was estimated, and found that cigarette manufacture is subject to increasing returns to scale. The model of the market found a mean price elasticity of demand of -1.08. Price elasticity has been decreasing. The elimination of simultaneity bias may explain why this estimate is higher than that of other studies. The industry was found to be less competitive than a Cournot industry. Competition among manufacturers has decreased substantially since 1980. This may be because manufacturers have become less concerned about anti-trust scrutiny or the prospect of new competitors. A simulation shows that an increase in the federal excise tax causes a greater increase in price, and a greater decrease in consumption, than does the same increase in the average of state and local tax rates. This is consistent with the view that in the face of an increase in a state or local tax, some demand shifts to neighboring jurisdictions with lower taxes.