Slate published this article, “Sweet Surrender: Taxing soda to make you stop drinking it.” This is another example of using an excise tax to change consumer behavior. If one believes that there are negative externalities to the consumption of sugar-laden, artificially-flavored, carbonated water, then these taxes fall under the Pigovian Tax label.

The report mentions an estimate that a 10% rise in cigarette prices results in a 7% drop in smoking among youth and a 4% drop in smoking among adults.

There are a variety of studies on the price elasticity of demand for cigarettes, with varying estimates. The Surgeon General’s office issued a report summarizing the findings from a number of published studies. While the estimates differ some, the difference of elasticity between adults and youth smokers remains significant.

So, let’s review what price elasticity measures. The value of E is the ratio of the percent change in quantity demanded over the percent change in price. For a normal good, E should be negative – i.e. an increase in price yields a drop in quantity demanded, and a decrease in price yields an increase in quantity demanded. In either case one part of the ratio is negative, so the value of E is negative.

The figures reported by NBC (and many of the studies summarized by the Surgeon General’s office) show price elasticity for adults and children to be less than one. More accurately, the absolute value of E is less than 1.0. That means that quantity will change, percentage-wise, less than the change in price. OK – that makes sense. Smoking is understood to be addictive, and so we would expect that smokers might cut down on smoking as prices rise, but not by much.

What, then, is the explanation for youth smokers being “less inelastic”? Perhaps they are less addicted, since their experience with smoking is shorter. They also probably have less disposable income, and so even a modest price rise cuts into their budget more deeply. Are there other explanations?

By the way, the cigarette tax is an excise tax. Given the inelastic demand, we will expect only modest declines in smoking, but the government can expect to generate significant tax revenue.

First, let’s get a couple of quotes:

As reported in The New York Times:

Mrs. Clinton said at a rally on Monday morning in Graham, N.C., that she would introduce legislation to impose a windfall-profits tax on oil companies and use the revenue to suspend the gasoline tax temporarily.

“At the heart of my approach is a simple belief,” Mrs. Clinton said. “Middle-class families are paying too much and oil companies aren’t paying their fair share to help us solve the problems at the pump.”

…still looking for a primary source on McCain’s position… which mirrors Sen. Clinton on the part about the gas tax holiday, but may differ on the issue of an additional tax on oil companies to pay for it…

Let’s start with a little economic theory – when an excise tax, like the gas tax, is imposed, the burden is shared by both the buyer and the seller. An additional tax reduces demand (slightly in the case of gasoline) and the market must adjust. The result is that the sellers can’t pass the whole tax along as higher prices. So the seller loses some profits and the buyer pays somewhat higher prices. If we go the opposite direction – lowering a tax – the windfall is also shared by the buyer and seller. If we stop there, the full amount of the tax break is not passed along to the buyer.

There is a special consideration at work here – and that is the expectation that gasoline supplies during the summer cannot change much with a change in price. Many argue that refineries run full tilt during the summer vacation. A drop in price, spurring a small increase in demand would be met by the same amount of gas supplied, with a resulting potential shortage. The result: gas prices climb back to their original levels. So the oil companies enjoy higher profits and the government sees some reduced tax revenue. Under Clinton’s proposal there would be a tax on oil companies to offset the lost tax revenue. So everything nets out the same, political points are made, but no real change. See Mankiw and Paul Krugman’s blogs for more detail. [Here's another post from Mankiw on the subject - dated May 6.]

Sen. Obama points out that even gaining the whole savings results in pretty modest impact on daily expenses. If we assume a twenty mile roundtrip commute or other driving, with a car that gets 15 miles to the gallon, the savings would be under $.25 a day. This figure would be less if you subscribe to my argument that prices won’t fall a full $.18 per gallon.

Finally – those most interested in seeing less reliance on oil (foreign or domestic) and a reduced carbon footprint on this plant by Man or Woman, argue persuasively that reducing gasoline prices is a step in the wrong direction. They argue for higher taxes – sometimes with relief for low income drivers – to speed up our conservation efforts and to more permanently change behavior. See Justin Wolfers’ comments in the Freaknomics blog for a taste of this.

In the interest of equal time, here is a lukewarm endorsement of the gas tax holiday.

And more from Colbert…