Assuming the basic purpose is to raise additional revenue, should government levy an excise tax on cigarettes whose demand is highly inelastic or on a product whose demand is highly elastic? Are there any other reasons to levy such a tax?

Question

What will be an ideal response?

Answer 1

The government should levy the tax on a good with inelastic demand if its purpose is to raise revenue. If the tax raised the price of the good by 10% and demand is inelastic, consumption would drop by less than 10%. Thus total revenue and tax collections would rise. If demand were elastic, consumption would drop by more than 10% in this situation, and total revenue would fall. The tax portion of a smaller revenue would therefore be less than if demand were inelastic.
Government may use the tax to modify behavior. Taxes on cigarettes and alcoholic beverages are so-called “sin taxes.” This means that, in part, the government is trying to discourage their use by increasing the price with an excise tax.