USD economics professor discovers error in South Dakota tobacco measure

Travis Letellier, a USD economics professor, discovered an error in the numbers and explanation of a South Dakota measure up for a vote on November 6, 2018.

This election will include five measures and this particular measure covers an increase in taxes on tobacco products to provide financial support to postsecondary technical institutes.

Letellier was giving a presentation at the Vermillion Comber of Commerce conference “Up Next” with political science professor Julia Hellwege explaining each measure. Letellier said four of the ballot measures deal with transparency in the state government and the ethical laws. Letellier said the fifth measure, the one dealing with tobacco taxes, caught his eye.

“I thought when I first started looking at it, it was actually very straightforward because when you look at the ballot, they have what’s called the attorney general explanation,” he said. “It’s kind of a plain language explanation of this is what the ballot will do, and this is if you vote one way, this is what it will mean.”

A teaching point

Letellier said he was initially impressed by the economics in the explanation.

He was so impressed, he wrote down the equation to bring to his freshman classes as a real-world example of the impact of economics.

After attempting to solve the problem himself for three hours, Letellier and Mike Allgrunn, the dean of the economics department, determined the numbers were inaccurate.

The ballot measure will increase the tax on a pack of cigarettes from a $1.53 to $2.53. Taxes would also be increased on wholesale products, such as chewing tobacco and cigars, with an increase from a 35 percent rate to a 55 percent tax. With this increase in taxes, the state is hoping to bring in  25 million dollars in tax revenue.

Letellier said the problem he found is in the description of how the program works, described in the fiscal note.

“The fiscal note says ‘based on previous tax increases, a 65.4 percent increase on price,’” Letellier said. “This is where my brain exploded.”

A problem in the explanation

Levellier said the state is not raising the entire price but is actually raising the tax.

“The problem is when you read the description on the bill it says they want to raise the price 65 percent,” Letellier said “They’re not raising the price on cigarettes, they are raising the tax rate on cigarettes. They are actually raising the price of cigarettes by 16 percent. So when people read this, it says they are raising the price of cigarettes by 65 percent when in reality they are not.”

Letellier said that isn’t the only error in the fiscal note. The fiscal note states that this measure will produce a smoking reduction of 16.4 percent. Letellier said this analysis is based on the elasticity of demand, or how people’s behavior will change due to a price change.

“If you did the economics, you would find that the government is basically assuming that the elasticity of demand for cigarettes is a 0.25 and that is a totally fine number. It says that people who smoke aren’t very affected by price changes and I think that is a fair assumption,” Letellier said.

Letellier said the government had to solve for a variable and work backward in their analysis. They know how much they want to change the price and how much people’s demand will change. He says they need to make sure that enough people will continue to smoke to bring in the $25 million.

The fiscal note states “based on previous tax increases, a 65.4 percent increase in price should produce a smoking production of 16.4 percent.” 

“That’s where their economics completely falls apart,” Letellier said. “They are saying smoking will fall by 16 percent. Here’s their problem: in their description, they are using 64 percent and that’s not the percent change in price. The percent change in price should’ve been the 16.4. This is not the right denominator to use. They used a 64 percent change in the tax rate, not in the price of the product.”

Wholesale product taxes

The description of the measure also talks about the tax change on wholesale products. The descriptions states, “based on the previous tobacco tax increase, a 57.1 percent tax increase is unlikely to affect demand.”

Letellier said this description is confusing because there is no clarification that they switched from talking about cigarettes to wholesale products. Letellier said this description means that tobacco and cigar users’ demand for products would not be affected by a price change at all. This assumption causes an issue in the actual revenue brought in through the tax rais said Letellier. 

“Their assumptions will probably not bring in anywhere near $20 million because they are assuming people will not change their behavior by raising taxes,” Letellier said. “They are assuming they will still be getting all this revenue, the same amount of revenue that they got the last time they raised the taxes on cigarettes.”

Letellier said his concern with this assumption is that elasticity changes over time and tobacco taxes haven’t been raised in South Dakota since 2007.

“There is a different pool of people now and you are changing their tax rate again. I don’t think you can assume that this group of people will have the same reaction as the last group of people did,” Letellier said.

Allgrunn said he believes there is either an error in the explanation or the numbers. He said he predicts the numbers the government projected will not be that far off.

“They made enough mistakes in their math, that by the end they were right,” Allgrunn said. “It bothers me that they are doing economics in public and it’s incorrect. Bless their heart, they are trying to do the right thing and I applaud that. But it does appear to me that there is an error.” 

Allgrunn said South Dakota is one of the top states of predicting tax revenue and that mistakes like this one are uncommon.

“South Dakota to be fair I think a really good job to estimate those taxes, not perfect because nobody is,” Allgrunn said. “South Dakota generally tries to do a really good job at predicting the revenue, sometimes they error a little bit, usually on the conservative side.”

Concerns for voters

Hellwege said her concerns on the political side are that young voters are already critical towards the electoral system, and a mistake like this might cause more people to doubt the system.

“It becomes really challenging when (voters) can’t be confident in the system if the person who is administrating can’t give the right numbers,” Hellwege said. “And what’s worse is that they may carry this negative attitude with them for the rest of their life. We know voting is a habit, and if you don’t develop that habit early on you may never become a regular voter.”

Both Hellwege and Letiller said one of the challenges is often time voters are uneducated on measures they are voting on, and it can be even more challenging now because they may have to question the accuracy of the information given.

“It’s exceptional how rather simple sometimes election administrations information or mistakes can have an enormous effect on our confidence in voting,” Hellwege said. “When we as people become less confident in the elective administrative process, there are many things that make us want to go vote and as we are chipping away at our willingness to vote.”

While Letellier’s original intentions of looking into the economics of this measure was to have his students solve the equation, he is now using it as a teaching point on the importance of being educated on the actual effect economics has on the policy side of politics.

“It is important for students to understand economics so they can’t be fooled by economists,” Letiller said.