How would an increase in cigarette taxes succeed according to the following criteria: collecting a large amount of tax revenue; distorting demand as little as possible; discouraging consumption of harmful commodities?

Question

What will be an ideal response?

Answer 1

Assuming demand for cigarettes is fairly inelastic among adults, the tax is a good candidate for collecting a lot of revenue. As price increases as a consequence of the additional tax, quantity demanded will not decrease much. So the government will get additional tax revenue on a large quantity. The cigarette tax also does well by not distorting demand very much since higher price causes only a small change in consumption for the inelastic case. The tax also discourages consumption of a harmful commodity, although by a small amount if demand is inelastic.Since the demand for cigarettes is more elastic among younger smokers, the effects would be different. The tax causes the price of cigarettes to rise, causing a greater reduction in smoking among teens, and thus the government will not increase its revenues very much—in fact, revenues may actually decrease. In this case the tax does distort demand considerably.