The Interdependence of the Cigarette and Liquor Demand Maury P. Zapata Econ 510, Fall 2006 Professor Dr. Castillo-Ponce

Thesis If cigarettes and liquor are complements, then public policy needs to check the consumption of only one to check the consumption of the other.

Objective Are cigarettes and liquor complements (negative cross elasticity of demand) or are they substitute goods (positive cross elasticity of demand) Should states consider changing tax rates on cigarettes and liquor as a joint decision to maximize tax revenue.

The Data A pooled time series cross-section data set on the US cigarette and liquor consumption spanning nearly three decades

Cigarettes and liquor have been frequent targets of taxes because they exhibit highly inelastic demand and are considered “sins” because of the their harmful health affects and negative externalities More than 100 state liquor tax increase by federal, state, and local governments have been passed in the 1980’s

Current Applications November 7, 2006 California voters rejected Prop 86 that would have levied a per pack surcharge of $2.60 by a NO vote of 52.2% vs. Yes vote of 47.8% in order to fund child care In 1998, California voters approved of Prop 10 that increased a per pack surcharge of $.87 for child care

Methodology CONS c =f(P C, P L, A C, Y, H C,R C ) CONS L =g(P L, P C, A L,Y, H L, R C ) Cons C =per capita consumption of cigarettes P C =price of cigarettes P L =price of liquor A=advertisement expenditures Y=real per capita disposable income H=habit-persistence effect (lagged consumption) R=regulatory changes (Control, Fairness, &Broadcast)

Regression for Liquor Cons L = P L +.924Y+.332P C (18.95)* (3.22) (15.28) (3.84) -.007A L -.030A L CONS L-1 (0.41) (2.32) (3.32) R 2 =0.95, adj. R 2 =.95, N=779, F(43,736)=330.29* *t-statistic with 5% level

Regression for Cigarettes CONS C = P C +.312Y+0.100P L (22.19)* (4.79) (6.65) (3.18) A C A C CONS C-1 (2.02) (2.29) (2.73) R 2= 0.91, Adj.=0.91, N=779, F(45, 734)= *t-statistic with a 5% level

Effectiveness of Policy Measures for Liquor CONS L = P L Y+0.360P C (19.94)* (3.75) (14.65) (4.22) A L A L CONS L-1 (4.83) (4.05) (3.77) CONTROL (5.12) *t-statistic with 5% level

Effectiveness of Policy Measures for Cigarette CONS C = P C Y (16.69)* (3.66) (7.5) P L A C A C-1 (5.27) (0.82) (3.66) CONS C FAIRNESS (2.28) (4.38) BROADCAST (3.08) *t-statistic with 5% level

Fin Salud