MA Quantitative Economics students' blog

Tobacco taxation: economic gains or health benefits?

Author: Yuliia Puzanova

In 2008, World Health Organization packaged and promoted six measures to reduce tobacco use worldwide. It is named as "MPOWER" (Figure 1) [3]. The last component of this set of measures is raising tobacco taxes.

Figure 1. MPOWER[3]

Discussions about the “right” tax rate for tobacco, maybe, never ends because of its complexity and challenging nature of tobacco control. Tobacco taxes have a very strong impact on smokers’ behavior, but not only on them. This resulted in politically hot nature of tobacco tax topic.

Overall, there are three main purposes for imposing a tax on tobacco products [1]:

Raise revenue for the government.

Tobacco taxes are very efficient for revenue increase because of large consumer market paying taxes and inelastic demand. Taxes on tobacco products are relatively easy to be collected and as well they provide limited opportunities for tax evasion.

2. Correct for externalities.

A tobacco tax helps defray the external costs of tobacco consumption, such as diseases contracted by non-smokers and the costs to treat such diseases. This can be called as the “negative externalities.” Imposing taxes on tobacco consumption helps to improve public health. Excise tax on tobacco can influence the reduction of its consumption which will infer to the reduction of mortality and morbidity. As well the generated from these taxes revenue can be directed to the health services for smokers or who was affected by tobacco use.

3. Discourage use of the product.

Tobacco is considered a product without merit; it is addictive and destructive and therefore is arguably not productive for the greater economy. Tobacco taxes discourage consumption, most particularly among the poor, the young, and new tobacco users, and provide an opportunity for more productive spending and investment elsewhere. As well the imposing taxes can protect the younger population, potential smokers from starting and, moreover, encourage the smokers to use tobacco less.

Taxation approaches

One approach for imposing a tax for tobacco is to tax products depending on their main consumers. For instance, cigars can be afforded only by the wealthier consumers who can pay an extra cost. In this case, tobacco tax will be higher in comparison with the cheapest types of cigarettes used by poor consumers. Such kind of taxation is used, for example, in India (non-taxed bidis), in Indonesia (hand-made kreteks which are used by poor population have the lower tax rate). Overall, the customization of the tax rate for tobacco depends on several factors, which are: producer’s size, quality of tobacco leaves used, type of packaging, type of tobacco product (bidis, kreteks, chewing, snuff or white sticks).

However, there are other opinions regarding the taxation rate. One of the reasons for arguing the previous approach is that the consumers will try to substitute the more taxed types of tobacco products by less taxed and cheaper. And, as well, all tobacco products harm health and that is why the equal taxation is, probably, the fairer way.

The taxation of tobacco can be differentiated also by types of excise tax: specific and ad valorem taxes. Specific taxes are levied on the quantity of the product produced or consumed and ad valorem taxes are imposed as a percentage of the value of tobacco products based on price or cost to manufacturers or importers. Sometimes, additional approach “the best of both” is used and it means that a specific tax is combined with an ad valorem tax.

The choice of taxation type depends on different macroeconomic factors. For example, the ad valorem taxes is recommended in case of high inflation, or if there is a higher imports quality/price in comparison with domestic products. If customs duties are imposed with the aim to protect local producers, specific taxes can be imposed on both domestic production and imports.

“The best of both” approach is used by the European Union (EU) members. Specific part is 5–55% of the total tax burden (excise duty plus VAT) of the most popular cigarettes sold in the country. The ad valorem term is used for cigars and cigarillos, hand-rolling tobacco, and other smoking tobacco which are taxed at the minimum rates [1]. In the United States, ad valorem taxes are imposed only on large cigars.

The tobacco taxation is now the most powerful and spread interventions for the populations’ health improvements and generating revenues for the state at the same time. On average, raising tobacco taxes to increase prices by 10% would reduce tobacco use by 4% in high-income countries and by around 5% in low- and middle-income countries [2]. And now we can observe a trend of increasing taxes for tobacco products among different countries (Figure 2) [3].

Figure 2. Raising tobacco taxes [3]

At the same time, for European Region, we can observe the trend in declining the percentage of the smoking population (Figure 3) [3].

Figure 3. Current and predicted smoking in people aged 15+ in the European Region [3]

For sure, not only the taxes rise influenced the decrease in smoking population amount, the prohibited tobacco advertising, graphic health warning on cigarette packs and prohibiting smoking in public places influence the decline as well and it is difficult to evaluate quantitatively the effect of each of these factors. But the result is very clear: the smoking is becoming less popular and the strategy which combines mentioned instruments works. And the struggle for a healthier population can also affect his wealth.