Efficient excise taxation: The evidence from cigarettes

We develop a model in which optimizing policy makers in adjacent government jurisdictions levy excise taxes on a commodity that has a unique point of production from which all shipments emanate. From this model we derive an unusually specific predicted geographical pattern of those excise taxes in which these taxes rise at a decreasing rate as one moves outward from the point of production. We compare these predictions to the observed pattern of cigarette taxes imposed by state governments in the United States and find the data to be fully consistent with our model. Among these predictions is the existence of a ''ripple effect,'' which reduces taxes in many other jurisdictions due to low taxes at the point of production. We estimate that these induced tax reductions in other states save cigarette producers and consumers a minimum of $110 million per year.