Question

1. Recently the Governor of Vermont proposed that cigarette taxes in Vermont should be increased substantially, from 44 cents a pack to 66 cents a pack. He estimates that Vermont can raise $20 million in revenue from this tax hike. He also pointed out that the neighboring state of New Hampshire was considering an increase in cigarette taxes. a. How can it be that an increase in cigarette taxes will increase tax revenue, because, after all, a higher tax will increase cigarette prices and thereby decrease the quantity demanded ? b. If New Hampshire chooses not to increase cigarette taxes, is it likely that Vermont can still raise $20 million in tax revenue ? Why or Why not? Explain

Answer 1

An increase in cigarette taxes will increase tax revenue, because, even though, a higher tax will increase cigarette prices the demand for cigarettes must be inelastic so a rise in price might decrease the demand for it as people are ready to consume same quantity if the price rises or falls.

If New Hampshire does not increase its price by imposing tax, vermont can still raise its tax revenue only if the consumers of vermont cannot buy cigarettes from New hampshire. And they can only buy cigarettes from their state only then the increase in price will transform into higher tax revenue.