Given the apparent significance of Internet use on tax sensitivity, it is clear that there will be major revenue implications for the states. We present two types of calculations. The first is to estimate the overall impact of Internet growth on the volume of taxable cigarette purchases in the state. This combines the coefficients on the Internet alone with the coefficient on the interaction term of prices with the Internet. Using the average log of the real price in 2001, reducing Internet usage from its average in that year (about .5) to zero indicates that the growth of the Internet has reduced overall sales by a little less than 4 percent, although the standard errors associated with the point estimates do not allow us to say with high confidence that the true effect is not zero.
While the overall impact of the Internet has probably been modest thus far, the impact on revenue coming from recent tax increases has almost certainly not been. Here, we need to look at the impact of changing the tax rate for a given level of Internet use, which is a large number. To get a feel for the magnitude of this effect, we gathered data on the cigarette tax increases that occurred between the end of our sample and September 2003. This included 30 states plus the District of Columbia. Among that group, average real taxes doubled in the intervening two years. For each state, we compute the change in log revenue that would occur under different assumptions of the elasticity according to the formula
where η is the price elasticity. We hold all the other covariates constant from our empirical model and keep the real price fixed at its 2001 level and then examine the change in the real tax rate assuming three levels of elasticity. The first is the baseline elasticity in our paper of -1.28. The second is the consensus elasticity in the previous literature or around -.45 as described in Evans et al. (1999) or Gruber and Koszegi (2001). The third is, for each state, the estimated elasticity in our model given the state's internet usage in 2001. We saw above that, on average, this had increased the elasticity to around -2.
The average change in log tax rates among the states with a tax increase was .740. The average change in log p+t was .126. The predicted log revenue gain should have averaged something like .68 using the consensus elasticity or .58 using the no-internet baseline from our model. Using the full elasticity for taxable purchases including the effect of Internet smuggling, however, yields an average revenue gain 21 percent lower than our baseline and 33 percent lower than conventional revenue estimates. In the extreme cases where Internet usage was high and where taxes rose a great deal like New Jersey (where taxes rose from 80 cents per pack to 205 cents per pack) or Connecticut (45 cents to 151 cents), the revenue gains from the tax increases will be 60 and 45 percent lower than using standard elasticities, respectively (or 44 and 30 percent lower using our -1.28, no-internet baseline). Interestingly, in New York, where the tax went from 56 cents to 150 cents, one industry group has claimed that the revenues from this tax increase were some 50 percent smaller than originally forecast (SBSC, 2003). This general effect has been clearly noted among anti-tax advocates looking at the cigarette tax increases (Bartlett, 2003).
While it is true that the cigarette tax increases of the last two years have been especially large and that may have contributed to the revenue discrepancies being so large, our findings suggest that there is a significant shift underway in the ability of states to raise money through tobacco taxes.
While the overall impact of the Internet has probably been modest thus far, the impact on revenue coming from recent tax increases has almost certainly not been. Here, we need to look at the impact of changing the tax rate for a given level of Internet use, which is a large number. To get a feel for the magnitude of this effect, we gathered data on the cigarette tax increases that occurred between the end of our sample and September 2003. This included 30 states plus the District of Columbia. Among that group, average real taxes doubled in the intervening two years. For each state, we compute the change in log revenue that would occur under different assumptions of the elasticity according to the formula
where η is the price elasticity. We hold all the other covariates constant from our empirical model and keep the real price fixed at its 2001 level and then examine the change in the real tax rate assuming three levels of elasticity. The first is the baseline elasticity in our paper of -1.28. The second is the consensus elasticity in the previous literature or around -.45 as described in Evans et al. (1999) or Gruber and Koszegi (2001). The third is, for each state, the estimated elasticity in our model given the state's internet usage in 2001. We saw above that, on average, this had increased the elasticity to around -2.
The average change in log tax rates among the states with a tax increase was .740. The average change in log p+t was .126. The predicted log revenue gain should have averaged something like .68 using the consensus elasticity or .58 using the no-internet baseline from our model. Using the full elasticity for taxable purchases including the effect of Internet smuggling, however, yields an average revenue gain 21 percent lower than our baseline and 33 percent lower than conventional revenue estimates. In the extreme cases where Internet usage was high and where taxes rose a great deal like New Jersey (where taxes rose from 80 cents per pack to 205 cents per pack) or Connecticut (45 cents to 151 cents), the revenue gains from the tax increases will be 60 and 45 percent lower than using standard elasticities, respectively (or 44 and 30 percent lower using our -1.28, no-internet baseline). Interestingly, in New York, where the tax went from 56 cents to 150 cents, one industry group has claimed that the revenues from this tax increase were some 50 percent smaller than originally forecast (SBSC, 2003). This general effect has been clearly noted among anti-tax advocates looking at the cigarette tax increases (Bartlett, 2003).
While it is true that the cigarette tax increases of the last two years have been especially large and that may have contributed to the revenue discrepancies being so large, our findings suggest that there is a significant shift underway in the ability of states to raise money through tobacco taxes.
