Some people argue that the excise taxes on tobacco improve economic efficiency because consumption of these products imposes costs on third parties, i.e. involve negative consumption externalities.

1. Give an example of another product that is both taxed and in your view involves a negative consumption externality; explain what you think the externality is.

A negative externality exists when a cost is imposed on a third party who is neither the buyer nor the seller. Examples students gave included:

Alcohol: costs imposed on third parties via, e.g., motor vehicle crashes caused by drunk driving (many other possibilities as well);

Tires and lead-acid batteries: disposal costs for batteries, both disposal costs and environmental pollution in use (bits of rubber come off) for tires;

Gasoline and other motor fuels: pollution costs in use.

2. If you were given data that showed that low income people were more likely to smoke than high income people, would the tax on tobacco be called in the jargon progressive, proportional, or regressive? Why?

Progressive means that as income increases, proportion of income paid in tax (Average Tax Rate, ATR) increases;

Proportional means that as income increases, proportion of income paid in tax ATR) is constant;

Regressive means that as income increases, proportion of income paid in tax (ATR) decreases.

OK, the tax on cigarettes is so much per pack.. Suppose all smokers smoke the same quantity; then they all pay the same amount of tax.. So, a high income smoker would pay less in cigarette tax as a proportion of income than a low income smoker, because they each pay the same dollar amount and the high income smoker has a higher income. If in addition, low income people are more likely to smoke [true in the US], then even if actually high income smokers smoke more, it is likely that as groups, (cigarette tax)/(income) will be a higher fraction for low income people than for high income people. So the cigarette tax is regressive in the jargon terms.