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Unformatted text preview: Economics 487
Brunton
Fall 2009 Project #1  Demand Estimation, Elasticity, Tax Revenue, and Teen
Smoking The Commonwealth of Virginia had a cigarette excise tax of 2.5 cents per
pack for many years; the lowest rate of any state in the US. In the 2003
ﬁscal year this tax rate brought in about $15 million in revenue. The tax was
raised to 20 cents per pack in August 2004 and 30 cents per pack in July
2005. The annual tax revenue estimate is now about $170 million. The state
believes it can increase tax revenue by raising the tax rate further. To help reduce the state revenue shortfall, Virginia is considering raising its
annualcigarette tax revenue to $600 million. While the local power of the
tobacco industry may be able to negate the move up on tax rates, we are
assuming for this scenario that Governor Kane and Virginia politicians
approve the tax rate increase. One way to help sell a plan to raise the
cigarette tax is to point out how it will help curb teen smoking. The state
contracts for a consulting evaluation of this potential tax raising strategy.
You will need to: 0 Estimate a demand function for cigarettes and calculate a price elasticity
of demand. 0 Determine the state excise tax rate on cigarettes necessary for the state
of Virginia to reach a target of $600 million in revenue from this source. 0 Estimate the reduction in teen smoking that will occur once the higher
tax is imposed. Some of the data that will be needed for this project will be given to you. A
cigarette revenue data series is being provided by the VA Department of
Taxation. The best source for statelevel price and quantity data had been
the Tobacco Institute. They are now defunct (as of 1998) but their data
series has been updated by a consulting ﬁrm in northern Virginia and we
have a copy of the most recent release (on Blackboard). You are
responsible for ﬁnding any other data you deem relevant for this project.
Your analysis must be informed by a review of the literature on this topic.
The project completion date is September 30th. Sarah DiAntonio
Sean DeWyngaert
Angel Brockenbrough September 2, 2009 Proiect Plan 1. Research and gather data:
a. Estimate number of smokers in the state of Virginia
b. Average price of cigarettes in Virginia and neighboring states
c. Prices of compliments/substitutes
i. Alcohol
ii. Nicorette
d. Average income of smokers
Past trends of fluctuating demand due to:
i. Raise in prices
ii. Lifestyle changes
iii. Rise in health interests
f. Habits of teen smokers
g. Demographics of smokers
i. Regions
ii. Teen
iii. Gender
2. Organize data and create demand models
a. Determine statistically significant variables
b. Compare models
3. Price elasticity of demand
4. Determine new tax rate on cigarettes
a. Interpret data to maximize revenue and minimize teenage smoking
b. Estimate rate of reduction of teenage smoking
5. Publish report Sarah DiAntonio
Angel Brockenbrough Sean DeWyngaert Time Line for Project #1 1). Brainstorming: ALL (by 9/7) — think of strategies to most effeciently raise taxes and curb teen
smoking 2). Gather Data: All (by 9/8) — After choosing variables involved and planning strategy meet and try to
find relevant data to use for models and prove strategy effeciency 3). Organize Data: All ( by 9/14) —After gathering data look through to find significant portions of data
needed for models/presentation... make adjustments to data needed for model if needed 4). Build Models: Sarah/Sean(assist) (work from 9/159/22) — build econometric models based on data
and generate an appropriate answer to the given problem and provide estimated drop in teen smoking 5). Start Powerpoint/Build Reports: Angel/Sean(assist) (work from 9/159/22) — start presentation
build/plan and compile reactions and reports to with data given 6). Practice Presentation: All (9/289/29) — Meet to go over and practice presentation and make needed
adjustments 7). Turn in report/ present findings: All (9/30) — turn in report and present findings to other
groups(students) and boss(professor) Sarah DiAntonio
Angel Brockenbrough
Sean DeWyngaert 1St Progress Report We are still in the process of gaining potential IV’s to add to our demand model. After we gather
sufficient variables we would like to look at including we will take the historical data of per capita sales
(yearly) and plot it out so we can begin attempting to build a model which will give us a line of best fit.
We have yet to decide how far back we should take our data as this may skew our line of best fit
unnecessarily. So far the variables we are looking at be considered as possible vital variables in the building of the model are: 0 Retail price of cigarettes + total taxes 0 Income 0 Addictive behavior (lagged consumption) 0 State excise tax rate — mean value of neighboring states (bootlegging incentive)
0 Warning labels 0 Advertising ban 0 Tobacco states 0 Age groups (16—17,1822,2344,4565,65+) At this point we are a day behind ofour timeline at most as we have most of our data present. Our
delay from our timeline is only due to a very recent scheduling conflict. This implies that our delay is only temporary and not an issue stemming from a poor timeline model. Sarah DiAntonio
Angel Brockenbrough
Sean DeWyngaert 2"“I Progress Report We have gathered hard data from different reliable sources on the internet that was pertinent
to our variables so that we could create a model in SAS to run. After gathering all data we sorted it into
excel in two different sheets, one which contains all data we have gathered that is going to be important
for write—up and conclusion purposes. The next sheet contained only data that was to be used directly
in or model for observation purposes. Next we ran a basic SAS model that is currently without one or
two variables we hope to include in our final product (bootlegging effects and the effects on targeted
age groups the dummy variable of the effect of changes given that Virginia is a tobacco state). Our goal
is to finish up all models within the next day and then turn our focus onto writing up the report of our
findings to be turned in the following week. While Sarah (being assisted by Sean) will focus on the
report itself, the responsibilities of the presentation will be upon Angel (again being assisted by Sean).
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Hootan Kaboli
Kelly Abbott Project #1: Demand Estimation, Elasticity, Tax Revenue, and Teen Smoking The Plan: 1. Research: Our group plans to research the tobacco cigarette industry extensively
to have a better understanding of general economic markets and elasticity.
Questions we discussed that should be focused on include: How what percentage and total number of people smoke in Virginia? What percentage of the total percentage of smokers are teen smokers? What is the historical content regarding the tobacco industry in Virginia? Who will the tax increase affect beyond the obvious purchasers of tobacco cigarettes in Virginia? e. What are the bordering state’s and other state’s (such as New York)
policies and taxes on cigarettes? f. How will Virginia’s tax increase effect bordering state’s sales? 9‘.“ 9"?” 2. Tax increase: Our group decided to take ratios from the numbers given on the
project to determine the amount that tax would have to increase to attain the $600
million goal. 3. Demand and Price Elasticity: From our research, we will determine the demand
function and price elasticity for tobacco cigarettes in Virginia. Our group decided
it would be in the project’s best interest to make two demand function graphs and
determine two price elasticities for the: a. General Population
b. Teen Population 4. Cost Benefit Analysis: Our group decided to determine the decrease of teen
smoking and the general public’s smoking from the increase of tobacco cigarette
tax. Group 2
Svetlana Lakutina, Hootan Khaboli, Kelly Abbot
Progress Report # 1. 1. According to the plan, we’ve completed the first part of the project in which we gathered
background information about smoking in Virginia. We were able to find the most uptodate
information on smoking rates not only in Virginia but also in the neighboring states. We also
found information on what percentage of the smoking populations is made up by teens. 2. In terms Of the second part of the project we’ve considered the following issues:
Border issues: 0 Level of excise taxes to increase government revenues vs. increased taxes to reduce
smoking; _ o cigarette demand is price elastic then increasing taxes will reduce the amount of
smoking but will be less effective in raising revenue vs. if cigarette demand is inelastic
tax increases will succeed in raising revenues but not in smoking behavior; 0 ignoring smuggling causes overstatement of price elasticity of cigarettes between .45
and .47 In his research Peterson (2003) estimates a demand model for cigarettes including a variable
that measures the price of cigarettes in the bordering states. He finds that if an increase in a
state price by 10% will lead to 0.8% reduction in cigarette sales within a state. Cigarette Sales: We've constructed a model with three variables to assess a secular trend, secular trend and
population, and the trend population.
Regression model for Price elasticity:
nY=alpha + Beta2(lnX)+v1
where:
slope of Beta2 is the elasticity we want to estimate
dependent "y" is the various means of smoking consumption (intensity)
single independent variable "x" is the real price of a cigarette pack
All of this measures the elasticity of demand for cigarettes with respect to the real price. The Youth Smoking Having surveyed some literature on youth smoking, we’ve come to the conclusion that most
researchers agree that the price elasticity of youth smoking is approximately 0.7. However, the issue of
teen smoking is a little more complicated than that of adult smoking. When we try to estimate a model
for adults, there are only two main factors that have to be taken into account: that some people will quit
smoking and some people will cut down their consumption. However, a large percentage of new smokers are the teens, and so we should consider that fact that increase in excise tax will deter some
teens from smoking altogether. In a study by DeCicca, Kenkel & Malthios (2002) the authors present
some interesting findings. For example, they claim that in the major tobaccoproducing states, which
include Virginia, the percentage of smoking teens is higher than the national average because of the low
excise taxes and relatively favorable attitudes towards smoking. Further they construct a few models,
and find that it is possible that increase in excise tax will not have any effect on teen smoking because
teens view smoking as necessary for peer acceptance. The authors use NELS:88 dataset, which is a
comprehensive survey of teens’ attitudes, which contains both timeseries and cross section data. We
plan to use a new ELS:2002 dataset in order to estimate a model of price elasticity for teens.  DeCicca P., Kenkel D. & Mathios A. (2002). Putting out the Fires: Will Higher Taxes Reduce the
Onset of Youth Smoking? The Journal of Political Economy. Vol. 110(1), pp. 144169. Peterson, D. (2003). Some Preliminary Estimates of the Border Price Effect on Cigarette Sales.
FTA Conference on Revenue Estimating and Tax Research. Wisconsin Department of Revenue. Group 2 Svetlana Lakutina, Hootan Kaboli, Kelly Abbott Progress Report #2 1. We have derived a demand function with quantity sold as the dependent variable and average
price of a cigarette pack as the independent variable. Our data included the years 19902008.
We constructed the basic model for Virginia by logging both variables. Our model included only
two variables because most other variables are relevant only in cross section research whereas
we used times series data for Virginia. The model:
Quantity = q + (3(Price) + e Parameter Estimates Parameter Standard
Variable DF Estimate Error t Value Pr > t
Intercept 1 20.28273 0.02090 970.28 <.0001
lnPr‘ice 1 0.07741 0.02444 3.17 0.0056 2. Evans, Ringel & Stech (1999) research a very relevant question that has to deal with increasing
excise taxes on cigarettes: price elasticity of a tax in relation to the retail price of cigarettes.
According to the others, in a competitive environment part of a tax would be absorbed by
producers therefore reducing their profits and part ofa tax would be paid by consumers.
However, since tobacco industry represents a monopolized market, the producers have enough
market power to push the tax burden to consumers entirely. The researchers estimate that
100% of a tax hike would be reflected in the retail price of cigarettes. Given that and the price
elasticity of demand, calculated in the first part we figured out the tax raise needed to achieve
roughly 600 million dollars. By our estimates the tax raise should equal 2.10 dollars. Evans, W. , Ringel, J. & Stech, D. (1999). Tobacco Taxes and Public Policy to Discourage Smoking.
Tax Policy and the Economy. Vol. 13, pp. 1—55. Regarding teen smoking based on research we got approximately the same estimate of .07. Carpenter, C & Cook, P. (2007). Cigarette Taxes and Youth Smoking: New Evidence From
National, State and Local Youth Risk Behavior Surveys. Journal of Health Economics. Vol. 27, pp.
28729. ...
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This note was uploaded on 05/24/2011 for the course ECON 488 taught by Professor Brunton during the Spring '11 term at James Madison University.
 Spring '11
 BRUNTON

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