PRESENTATION 2

What are the factors considered in determining the “right” tax rate for

tobacco products? Workshop on tobacco prices and tax

World Health Organization (WHO) and International Union Against Tuberculosis and

Lung Disease (The Union)

Questions for the end of the sessionWhat factors do governments consider in deciding

the “right” tax rates for tobacco products?

In addition to health, what other social welfare goals may be achieved through tobacco taxation?

What is a market failure? How does this apply to the tobacco market?

What is an externality? How does this apply to tobacco consumption?

What is the “right” tax rate?Factors that government use to decide the

optimal (tobacco) tax rates include -revenue, employment and other economic

goals-compliance with existing legislation-health and social welfare goals -correcting for market failures

RevenueCigarette tax revenues can form an important and stable

part of government revenues. In some countries, tax rates are based on annual

revenue targets in the government’s annual budget.

World Bank, 1999

Employment and support to domestic industry may be a factor –particularly where some production is

not mechanized, i.e, Indonesia

In Indonesia, the government established preferential tax rates for hand-rolled kretek firms, to promote employment.

They also apply tariffs for imported tobacco products, which increase the prices for imported products and provide some protection for the domestic industry.

Studies on the employment effects of reductions in tobacco consumption

Type of Country Name and year Net change as % of employment in base year

Net Exporters US (1993) 0%

UK (1990) 0.5%

Zimbabwe (1980) -12.4%

Balanced Tobacco Economies

South Africa (1995)

0.4%

Scotland (1989) 0.3%

Net Importers Bangladesh (1994) 18.7%

Source:Buck and others, 1995; Irvine and Sims, 1997; McNicoll and Boyle 1992, van der Merwe and others, background paper; Warner and others 1996

The impact of an 1-2 RMB (US$1.30) tax increase on the Chinese tobacco industry

1 RMB 2 RMB Reduction in cigarette consumption (billion packs) -0.15* 3.1 6.2 Total sales revenue loss (billion RMB)** -0.15 8.4 16.8 Industry net revenue loss (billion RMB) -0.15 4.72 9.44 Industry employment Loss (number of employees) -0.15 1,656 3,312

TW Hu et al 2009

Legislation increase? Revenue impact? Effect on deaths?• Domestic legislation may specify

maximum excise tax rates, i.e, Indonesia• Countries that have ratified the WHO FCTC

will need to consider tax and price measures

WHO FCTC Article 6

• Implement.. tax policies and, where appropriate, price policies on tobacco products so as to contribute to the health objectives aimed at reducing tobacco consumption and

• Prohibit.. or restrict..as appropriate, sales to and/or importations by, international travellers of tax-and duty-free tobacco products

Health and social welfare goals increase? Revenue impact? Effect on deaths?• Promoting health by reducing prevalence

and consumption • Reducing poverty. Through its negative

effect on health, tobacco consumption would be expected to reduce labor productivity, and possibly reduce earnings and savings.

• Protecting children. Children and adolescents may be up to three times more sensitive to price changes. Therefore, higher tobacco prices tend to have strong impact on their uptake and consumption.

Taxes are used to correct for market failures increase? Revenue impact? Effect on deaths?A market failure results when the market fails

to allocate resources efficiently from what is optimal for the society

In the tobacco market, market failure occurs because

• Knowledge is not perfect• Existence of “externalities” or external costs

and benefits• Market power

Imperfect knowledge increase? Revenue impact? Effect on deaths?Governments intervene in the tobacco market

because

Consumers are unlikely to have full knowledge of the health risks and the risks of addition when they start smoking. The majority of smokers start < 19 years of age.

Advertising can mislead or mis-inform-- i.e, “light,” “low tar” may mislead consumers to believe that they are using less dangerous products.

Time inconsistent behaviors increase? Revenue impact? Effect on deaths?• People place a higher value on the present

vs the future• This results in decisions with short-term

gains (smoking, eating desserts, overconsumption of alcohol) over much greater long-term gains (years of additional life)

• US study that takes into consideration the value of health damage for smokers suggest that the price of cigarettes should be US$ 35 per pack (Gruber 2008).

Correcting for externalities– or external costs and benefits

increase? Revenue impact? Effect on deaths?Individuals do not solely bear the risks of

their consumption decisions related to tobacco.

Smokers impose physical and financial costs on others, and on the society as a whole-environmental tobacco smoke-costs of health care for tobacco-related conditions that

is paid for by public funds-diminished work productivity and increases in sick days-workplace maintenance, fires

Market power increase? Revenue impact? Effect on deaths?Governments can intervene in the tobacco

market because: • It is usually an oligopoly – that is, a few

firms hold the majority market share.• When there may be collusion and price

fixing• Significant barriers to entry exist

Indonesian tobacco market:3 firms hold >70% of market share

increase? Revenue impact? Effect on deaths?Table 5.2. Market share, major cigarette firms, 1979-2005

Cigarette manufacturer (year established) 1979 1989 1998 2005 Gudang Garam (1958)

12

28

47

41

Djarum (1951) 13 28 13 15 British American Tobacco (BAT, 1905) 15 3 NA 4 Bentoel (1930) 8 11 3 3 Sampoerna (1913) 1 3 12 - Sampoerna/Philip Morris International (2005) - - - 15 Philip Morris Indonesia (1998) NA NA NA 6 Sumatra Tobacco Trading Company (STTC) 10 4 NA NA Noyorono 4 3 2 4 Total 63 80 77 88 Other 37 20 23 12

Sources: Euromonitor International 2007, Jardin Fleming Research 1999, Bird 2002. NA is not available

What about equity: do higher tobacco taxes hurt poor smokers?

• Poor smokers tend to spend the highest percent of their income on tobacco

• How do they react to a tax/price rise ? more likely to quit/reduce consumption,

which will improve health outcomes, release income for other uses

Government can use increased tax revenue in ways that benefit poor

18

It is important to weigh the benefits and costs: example of a tobacco tax increase in China

Cigarette consumption reduction

3 billion packs

Central government tax revenue increase

US $10.4 billion

Cigarette industry gross revenue loss

US $0.57 billion

Farmers tobacco leaf sale reduction

26,053 metric tons

Quitting smoking

4.1 million smokers

Employment loss

1656 workers

Reduction in plantation

14,400 hectares

Income lossUS $0.03 billion

Local government tax revenue loss US $0.006 billion

Lives saved

1 million

Medical cost savings

$US 100 million

Productivity gain

US $360 million

*Assuming additional 1 RMB per pack at the price elasticity of the demand for cigarette is -0.15 at 2000 price level.

1 RMB / Pack TaxIncrease

ReviewWhat factors do governments consider in deciding

optimal tax rates for tobacco products?

In addition to health, what other social welfare goals may be achieved through tobacco taxation?

What is a market failure? How does this apply to the tobacco market?

What is an externality? How does this apply to tobacco consumption?

Small group discussionWhat are the benefits and costs of a tobacco tax

increase in your country?

• Break into small groups• Compare and contrast your countries in terms of

the most important factors that your governments consider when setting the tobacco tax rates (20 minutes)

• Make a short presentation identifying common factors across countries in your group.