An Elasticity Lesson

San Francisco mayor Gavin Newsom

says there are far too many butts in the
City by the Bay. Not human butts, of
course, but cigarette butts. He apparent-
ly did an audit of the litter swept up by
city trash collectors and concluded that
one-fourth of the litter in the streets and
parks was comprised of cigarette butts.
That mass of discarded butts, he assert-
ed, was not only unsightly but an unfair
scal burden on the citys nonsmok-
ers. Of the $44 million a year the city
was paying for litter removal (!), Mayor
Newsom gured careless smokers were
responsible for $11 million of that cost.
To make them pay their fair share he
proposed a tax of 33 cents on every pack
of cigarettes sold in the city.
A Fee, not a Tax!
The litter-based reasoning behind
the mayors proposal was critical to its
legality. The State of California forbids
individual cities from imposing excise
taxes of their own on cigarettes. (The
State fears that municipal taxes will re-
duce cigarette sales and ultimately State
tax revenues). But the State does allow
cities to impose clean-up fees on pollut-
ing products. Sensing an opportunity,
Mayor Newsom promptly conducted an
audit of municipal trash and proposed
the 33 cents per pack cigarette clean-
up fee. A subsequent audit by the De-
partment of Public Works lowered the
cost of the cigarette butt clean-up to $6
million (14% of litter) from the mayors
$10.7 million estimate (24% of litter).
That required the mayor to reduce the
proposed fee from 33 cents per pack to
20 cents per pack. With 30 million packs
being sold in the city annually, the 20
cent fee looked high enough to cover
the costs of the butt clean-up.
The San Francisco Board of Supervi-
sors duly approved the butt fee on July 8,
effective October 1, 2009. They are now
counting on butt revenues of $6 million
a year to help close the citys $500 mil-
lion budget decit.
Zero Price Elasticity?
The Board of Supervisors shouldnt
count those revenue chickens before they
hatch. The only way the new 20 cent fee
can generate $6 million a year is if San
Franciscans continue to purchase 30 mil-
lion packs per year. That just isnt going
to happen. The Law of Demand is more
powerful than the laws of San Francisco
and the Law of Demand clearly states
that the quantity demanded goes down
when price goes up. So San Franciscans
wont be buying 30 million packs per
year at the 20 cent higher price.
How many fewer packs will they buy?
That depends on a variety of factors.
Some smokers may cut back or cease
smoking altogether if they decide the
marginal utility of smoking no lon-
ger exceeds its price. A more common
response will be to seek out substitute
goods. Rolled lettuce leaves wont do
the trick, but how about cigarettes pur-
chased outside the city limits. Buy a
carton of cigarettes in the neighboring
communities of Daly City, Oakland, or
Sausalito and you save $2.00. Buy ciga-
rettes on-line from an Indian reservation
(which does not pay federal or state tax-
es) and save even more. Or just go to the
corner grocery store or bar, which prob-
ably has a supply of cigarettes smuggled
in from low-tax states and export out-
lets.
Whatever the form of the consumer
response, the bottom line is measured
by the price elasticity of demand.
The price elasticity of demand (E) mea-
sures the extent of consumer response to
a price increase. Specically,
E =
If consumers were totally price in-
sensitive, the numerator and therefore
E would equal zero. In that event, the
demand curve would be vertical and
smokers would be in violation of the
Law of Demand. So we know E must
exceed zero (in absolute terms). Too bad
San Franciscos Supervisors and Mayor
didnt realize this.
So how high is the price elasticity of
demand in this case? We know from
empirical studies that the general E for
cigarettes is 0.4 (see Table 20.1 in The
Economy Today, 11/E, Table 5.1 in
Micro). But what about the E for San
Francisco cigarettes. From a smokers
perspective, there arent a lot of substi-
tutes for a cigarette. But there are abun-
dant substitutes for San Francisco ciga-
rettes. Mayor Bloomberg learned that
lesson when he raised the New York City
tax to $1.50 in July 2002 (see In The
News on p. 400 of The Economy To-
day, p. 96 in Micro). Unit sales in New
York City plummeted from 342 million
packs in FY2002 to only 182 million
packs in FY2003, a decline of nearly 50
percent. The implied price of elasticity
of demand was closer to 3.0 than the
general E of 0.4! NYC revenues came in
much lower than projected. The same
kind of error is implicit in the revenue
projections of San Franciscos mayor.
Two years ago, Californias tax author-
ity estimated that close to $200 million
a year in cigarette-tax revenue was be-
ing lost due to illegal smuggling (casual
cross-state purchases, organized smug-
gling) and untaxed shipments (primarily
from Indian reservations). As a quick
search on Google or Yahoo will conrm,
over 2,000 web-sites offer to facilitate
those untaxed shipments. So untaxed
substitutes for San Francisco cigarettes
are literally only a click away. Cigarettes
sold on Californias numerous military
The Economy Today
NEWS FLASH
Newsletter for Teachers of Economics to accompany Bradley R. Schillers The Economy Today and Essentials of Economics texts.
August 2009
(continued on back)
San Francisco: The Butts Stop Here
percent change in quantity demanded
percent change in price
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bases also avoid State and City taxes
(fees). When you add the Citys 20-
cent pollution fee to the States already
high 87 cents per pack tax, the incentive
for smoking untaxed or low-taxed ciga-
rettes becomes irresistible.
None of these considerations deter Califor-
nias politicians, of course. The State legis-
lature is considering doubling the State ciga-
rette tax. Mayor Newsom has also observed
so many discarded soda bottles in the citys
trash that he has proposed a clean-up fee
on stores selling high-fructose soda. The most
visible result of all these fees and taxes may
be a further exodus of retail sales out of the
Golden State.
WebNote:
The California Board of Equalization
offers data on cigarette sales and taxes
at www.boe.ca.gov
Tax rates in individual states are pro-
vided by the Campaign for Tobacco-
Free Kids at www.tobacco-freekids.org
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ISSUE: August 2009
TOPIC: San Francisco:
The Butts Stop Here
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