Blogpost: The Rationale for Tobacco Excise Tax Beyond Revenue Raising

Knowledge Hub Members are targeting tobacco harm in Africa and Asia
August 15, 2017
TV Interview with Knowledge Hub’s Prof Corne van Walbeek on illicit trade in South Africa
September 7, 2017

By Alfred Mukong

The industry has in many instances strongly opposed several tobacco regulatory policies, especially the large increase in taxes. Opposition to excise tax is a clear indication and acknowledgement that excise taxes are effective in reducing smoking. If most economists are ill-informed about the tobacco market the way I was two years ago, they would doubt the economic rationale for government intervention or see excise tax as way of raising revenue only. Joining the economics of tobacco control project in 2015, one of the fundamental questions was why the increasing interference in the tobacco market relative to other harmful products such as alcohol. Relating to microeconomic principles, the question was, if smoking is voluntary and legal like any other harmful product, if there is consumer sovereignty, and if markets are competitive, what justify government influence in the tobacco market.

The external costs of smoking are ignored by smokers, and the social benefits are less than private benefits (welfare loss for consuming beyond social optimum). Informative failure about health risks and addictive potentials are additional market failures that justify the rationale for government intervention. The question is no longer why governments should intervene, but understanding the effectiveness and the potentials of respective interventions in offsetting the social costs of tobacco use.

While most anti-smoking regulations could be considered a win-win solution to the state (as a public health gain in that they reduce smoking and smoking-related premature death and disabilities and a financial gain through reduction in smoking-caused health care costs), raising excise tax on tobacco has long been noted as a win-win-win solution. The additional win from excise tax is the political win because revenue raised from tobacco taxes strongly support public expenditure.

The tobacco industry has a history of arguing against tax rises, noting that excessive taxation leads to increase smuggling, amongst other unintended consequences. Unfortunately to them, the recommendations by tobacco activists to raise excise tax and the decision of the state to increase tobacco taxes consider the expected impact on: tax evasion (smuggling) and tax avoidance; employment; inflation; affordability among low income smokers and the relative prices of foreign and domestic brands.

A 50% increase in inflation-adjusted tobacco prices reduces tobacco use by 20% in low- and middle-income countries[1]. The poorest socioeconomic groups bear only a relatively small part of the increased tax burdens, but reap a substantial proportion of the health benefits of reduced smoking. Large increases in the cigarette tax can be viewed as pro-poor in their health benefits.

Most recent evidence noted[2] that the degree of excise tax pass-through, and the magnitude of discretionary increases in cigarette prices, depend significantly on the competitiveness in the cigarette market. It took some developed countries like the United State of America and United Kingdom over 30 years to halve cigarette consumption per adult, but with the use of large tax increases, it took South Africa less than 15 years to halve consumption per adult. With the frequent tax increases and decreasing volumes the dominant tobacco industry (British American Tobacco (BAT)) in South Africa remained more profitable than it was 20 years after the tax policy, until in 2010 that small cigarette manufacturers and distributors were attracted by the high profit.

The South Africa situation indicates that the changing market structure rather than the tobacco tax policy reduced the profit of incumbent companies. Tobacco excise taxes are important for addressing the negative externalities from tobacco use and can equally be seen as a win-win strategy for all parties (the government, users, and the industry).

[1]  http://www.nejm.org/doi/full/10.1056/NEJMra1308383

[2] Linegar, D. J. and van Walbeek, C.: 2017, The effect of excise tax increases on cigarette prices in South                 Africa, Tobacco Control pp. tobaccocontrol-2016.