Just passing through: the effect of the Master Settlement Agreement on estimated cigarette tax price pass-through

Abstract

In 1998, cigarette manufacturers and state attorneys general in the United States settled a group of lawsuits in an agreement known as the Master Settlement Agreement (MSA). Among the provisions of this agreement were a set of mandated escrow payments to the states that would be based on cigarette sales. The result of these provisions is that the apparent relationship between taxes and prices changed substantially following implementation of the MSA. This article estimates whether the MSA escrow amounts are reflected in prices and compares the pass-through rate of state and federal cigarette taxes only and the rate when one adds escrow payments. We find much different pass-through rates for the two measures. State and federal taxes are not fully passed to smokers. In years that escrow payments were made, cigarette prices increased by more than the sum of the state and federal taxes and the escrow payments.

Keywords:

• Master Settlement Agreement
• cigarette tax
• pass-through
• tax elasticity

JEL Classification:

• I10
• L66

Acknowledgements

This research is supported by a grant from the National Cancer Institute (Award #1R01 CA 120338-01A1). We thank Michael Goldwasser and Eamon Molloy for expert research assistance and Don Kenkel for valuable feedback.

The authors have no personal or financial conflicts that might bias reported results.