Using information on the purchases of cigarettes and the use of the Internet across states and time since 1990, this paper has presented evidence suggesting that the rise of the Internet and the associated increase in the ability of individuals to purchase tax-free cigarettes has significantly increased the tax sensitivity of consumers. The elasticity of sales may have doubled due to the growth of cigarette sellers online. The evidence also suggests that this is due to smuggling and not due to any greater sensitivity of cigarette consumption. We find no evidence that the increasing sensitivity is due to spuriously correlated factors that differ across states, although our data do not allow us to distinguish the Internet hypothesis from a model with both state-specific elasticities and either year-specific or linearly increasing elasticities. The large estimates imply major reductions in the ability of states to raise revenue by increasing the cigarette tax.
