This paper documents the rise of the Internet as a source of cigarette tax competition for states in the United States. Using data on the cigarette tax rates, taxable sales and individual smoking by state from 1980 to 2001 merged to data on the rise of Internet use, the paper documents that there has been a substantial increase in the sensitivity of the sales of cigarettes in a state to changes in the state’s cigarette tax. It then shows that this increase in sensitivity is directly correlated with the rise of Internet usage across states and that the increase in the Internet may have almost doubled the tax sensitivity of within-state cigarette sales. Data on cigarette usage, however, documents that Internet growth has not made actual smoking any more sensitive to tax rates. If anything, rising Internet usage has made it less sensitive to tax rates as smokers now have another way to avoid high taxes. The impact of the Internet appears to be concentrated entirely in the amount of smuggled cigarettes. Overall, with the tax sensitivity of taxable cigarette sales having almost doubled, this has lessened the revenue generating potential of recent cigarette tax increases by 33 percent compared to the traditional, older demand estimates. Given the continuing growth of the Internet and of Internet cigarette merchants, the results imply serious problems for state revenue authorities.
The workshop is from 3:00 – 5:00 pm PST in Room 2448 at UCLA.
