Question

After economic class one day, your friend suggests that taxing tobacco would be a good way to raise revenue. In what sense is taxing tobacco a "good" way to raise revenue? In what sense is it not a "good" way to raise revenue?

Answer 1

Taxing tobacco is a good way to raise revenue because it has inelastic demand. In this manner, when it is taxed, the price of tobacco rises but the reduction in quantity consumed is proportionately lower so overall revenue is increased.

Taxing tobacco is not a good way to raise revenue because it is a main input used in various tobacco products such as cigarettes. If tobacco is taxed, its price rise and this reduces the production of tobacco products. On one side, tax on tobacco raises revenue and on the other products, reduction in quantity will reduce tax revenue. Hence overall tax revenue reduces.