Burning a hole in the budget: Tobacco spending and its crowd-out of other goods

Abstract

Smoking is an expensive habit. Smoking households spend, on average, more than $1000 annually on cigarettes. When a family member quits, in addition to the former smokers improved long term health, families benefit because savings from reduced cigarette expenditures can be allocated to other goods. For households in which some members continue to smoke, smoking expenditures crowd-out other purchases, which may affect other household members, as well as the smoker. We empirically analyze how expenditures on tobacco crowd out consumption of other goods, estimating the patterns of substitution and complementarity between tobacco products and other categories of household expenditure. We use the Consumer Expenditure Survey data for the years 1995 to 2001, which we complement with regional price data, and state cigarette prices. We estimate a consumer demand system that includes several main expenditure categories (cigarettes, food, alcohol, housing, apparel, transportation, medical care) and controls for socio-economic variables and other sources of observable heterogeneity. Descriptive data indicate that, comparing smokers to non-smokers, smokers spend less on housing. Results from the demand system indicate that as the price of cigarettes rises, households increase the quantity of food purchased, and reduce the quantity of apparel purchased.