Wednesday, September 1, 2010

N.Y. to Try Again to Tax Indian's Cigarette Sales

New York Times article "N.Y. to Try Again to Tax Indians' Cigarette Sales (August 31st, 2010) fails to note why a government tax program is ill-concieved.  New York is currently considering attempting to tax the cigarette sales of Indian reservations.  In an attempt not to tax reservation consumption of cigarettes, it will give vendors a lump-sum tax break.  This is the reverse of efficient taxation.
The state’s plan does make exceptions for cigarettes sold to tribal members, estimating, based on the population of an Indian reservation, what portion of the sales are made to them. Taxes are charged on the remaining packs, on the assumption that they are bought by customers who are not Indians.
In fact, this does not make reservations for tribal members.  Vendor prices should be the same for all cigarettes, sold to Indians on reservation or not.  The reason is that it appears stamps must be on all cigarette packs--there is no "dual supply" problem.  In this case, vendors will raise the price of all cigarettes by whatever the tax is (recognizing competition and constant returns to scale production) and simply take the tax cut as pure producer surplus.  The supply-and-demand equilibrium before and after is depicted below (click to enlarge).  The upper blue-to-red supply line depicts the taxed supply.  The red line depicts supply without tax.  As we can see, because of the law of one price, producers have in effect been given a lump sum transfer, which will not be reflected in their prices.

The structure of taxation will make this effectively a tax on on-reservation Indian consumption of cigarettes.


  1. If there is an ability to price discriminate (since vendors may be able to identify tribal members from non-tribal members), couldn't competition within the tribal cigarette sellers drive down prices for tribal members to pre-tax levels (depending on how competitive that market is)?

  2. As Corrections understands the law, vendors are essentially given a tax break ex-post--their marginal costs are not impacted at all. (They are made to sell only cigarette packs with tax stamps, and then not made to pay a given quota). The price will be set by the marginal cost to a vendor. The marginal cost is now equal to a full taxed cigarette bundle.

    This is why the rightmost ("aggregate supply") graph is important--it shows a leap in marginal cost of selling a unit. To understand why competition won't lower the price, examine what would happen if we are at the equilibrium Corrections proposes--that of selling a cigarette pack at the taxed rate. No other vendor is willing to cut prices below that, as their marginal cost is the same as yours--they would go from zero profits at the margin to negative.

    It may be that Correction's understanding of the tax law is incorrect. However, our analysis and response to your suggestion is as follows: profits under competition are zero at the margin. The "tax cut" is infra-marginal, and therefore will not impact prices as compared to having all cigarettes be taxed.