Estimation of price elasticity and taxation in the U.S. cigarette industry

Abstract

Based on our empirical estimates, the data did not suggest that federal tax has a larger impact on the retail price of cigarettes than does state tax since the state tax is susceptible to bootlegging bias among adjacent states. The price elasticities of demand for cigarettes are −0.675 and −0.308 in the long term and in the short term, respectively. With current price elasticity stabilizing between −0.3 and −0.5 -a value below profit-maximizing valuethere is indeed considerable room for future cigarettes tax hikes to meet the shortfall in the budgets of both federal and state governments.