Optimal Taxation of Cigarettes and E-Cigarettes: Principles for Taxing Reduced-Harm Tobacco Products

As the tax base for traditional tobacco excise taxes continues to erode, policymakers have growing interest to expand taxation to novel and reduced-risk tobacco products. Chief among the latter are electronic nicotine delivery systems (ENDS; commonly known as e-cigarettes), although other reduced-risk tobacco products such as heated tobacco and smokeless tobacco products are also being considered for taxation. There are many possible rationales for taxing such products: to raise revenue, to correct for health externalities, to improve public health, to correct for internalities caused by irrationality or misinformation, and to redistribute income. Although each rationale leads to a different objective function, the conclusions regarding relative tax rates are largely the same. The relatively higher price elasticity of demand for e-cigarettes (compared to cigarettes) and the lower marginal harms from use imply in each case that taxes on e-cigarettes and other harm-reduced products should be relatively lower, and likely much lower, than those on cigarettes. Additional considerations concerning the policy goal of discouraging use of any tobacco product by youth are discussed as well.