Taxation & price issues

Taxation & price issues Burke Fishburn Technical Adviser International Union Against Tuberculosis & Lung Disease April 2011

Sources • Campaign for Tobacco-free Kids International Resource Center/Taxation & Price websitehttp://tobaccofreecenter.org/resources/taxation_price/fact_sheets • The Tobacco Atlashttp://www.tobaccoatlas.org/pricesandtaxes.html

Increased prices of tobacco through taxes reduce consumption • Increasing the price of tobacco through tax increases will: • Decrease its consumption • Save lives • Raise tax revenue. • Higher tobacco prices • Encourage cessation among existing tobacco users; • Prevent initiation among potential users; and • Reduce the quantity of tobacco consumed among continuing users. • Higher taxes are particularly effective in reducing smoking among vulnerable populations: • youth • pregnant women • low-income smokers

World Bank recommendations • World Bank recommends adopting tax policies of countries with comprehensive tobacco control policies where tobacco consumption has fallen. • Such countries have tobacco taxes between two-thirds to four-fifths of retail price. • Few low- and middle-income countries achieve this level of taxation, and most can significantly increase their tax levels.

Higher tobacco taxes decrease consumption • Increasing tobacco taxes to achieve a 10% increase in tobacco prices will decrease tobacco consumption by • ~4% in high-income countries • ~ 8% in low- and middle-income countries.

Higher tobacco taxes save lives • If tax increases result in a 10% increase in cigarette prices, the number of smokers worldwide would decline by 42 million • 38 million in low/middle-income countries • 4 million in high-income countries • This would save 10 million lives: • 9 million in low/middle-income countries • 1 million in high-income countries. • A 70% increase in the price of tobacco could prevent up to a quarter of all deaths caused by smoking worldwide.

Higher tobacco taxes help the young and the poor • Youth and low-income people are much more sensitive to the price of goods than those with higher incomes. • Youth have less money to spend, and higher tobacco taxes make tobacco products less affordable for them • People with low incomes spend a larger percentage of their income on tobacco than those in higher income brackets. • Tobacco tax increases can help motivate low-income groups to reduce the amount of tobacco consumed or to stop using tobacco • BUT they also spend this money on other things: food, shelter, education and health care….

Higher tobacco taxes increase government revenue • Every nation and sub-national entity with an efficient tax system that has significantly increased its cigarette tax has enjoyed substantial increases in revenue, even while reducing smoking. • In South Africa • every 10• % increase in excise tax on cigarettes has been associated with an approximate 6% increase in cigarette excise revenues. • From 1994 to 2001, excise revenues more than doubled as a result of tobacco tax increase in South Africa. • In Thailand tax increases between 1994 and 2007 • raised cigarette excise taxes from 60% to 80% of wholesale price, increasing tax revenue from 20,002 million THB in 1994 to 41,528 million THB in 2007 even as consumption decreased

Key components • Increase tobacco taxes to international standards. • All countries should attain tax rates of at least two-thirds to four-fifths of the retail price of tobacco products. • Tax all tobacco products equally. • All products must be taxed at equivalent rates to prevent tobacco users from switching tobacco brands and types due to price differences. • Ensure that tobacco taxes are passed on to the consumer in the form of increased prices. • Tie tobacco tax to the rate of inflation and consumer purchasing power. • Adjust taxes so that retail prices of tobacco products increase by at least the sum of the inflation rate and the per capita GDP growth. • Allocate tobacco tax revenues to tobacco control or other health programs. • High income countries have found that the public will supports tobacco tax increases more strongly when the tax revenue is directed towards tobacco prevention or other health programs. • By supporting programs that prevent youth from starting to use tobacco and help people quit, countries can further reduce tobacco use and save lives.

WHO FCTC Art. 6 • Recommends parties take into account tax policies and price polices as a part of their overall national health policy • More precise guidelines may be forthcoming

Types of taxes • 3 different types of taxes generally applied to tobacco products: • Specific excise • Ad valorem excise • Value-added tax (VAT)

Excise tax • Tax on selected goods which are produced within a country, or imported and sold in that country. • Tax can be collected from the producer, manufacturer, wholesaler, importer, or at the point of final sale to the consumer. • Excise taxes can be either specific or ad valorem. • Specific excise taxes • Charged per quantity, such as per cigarette, pack, or kilogram (e.g., $1.50 per pack regardless of price). • Ad valorem excise taxes • Charged as a percentage of the value of the product. The value of the product is measured by the manufacturer’s price (e.g., 80% of the manufacturer’s price) or by the price paid by consumers (e.g., 70% of retail price).

SPECIFIC EXCISE TAX: Advantages • Predictable. • Because the tax is not sensitive to changes in price, tax revenues do not change when manufacturers change prices. • The government revenue is therefore protected against industry’s price wars or price manipulations. • Government can predict tobacco tax revenue based on tobacco demand. • Raises all product prices. • Specific taxes are fixed and do not depend on tobacco industry pricing strategy • Since the tax is, in most cases, applied to all products at the same rate, a higher tax usually results in similar prices increase across the board, regardless of product. • Easier to administer. • Costs of administering specific excise taxes are low because it is easier to count the number of products than to estimate their value. • Unlike the VAT tax, which is collected at many points of production, specific taxes are only collected once, either from producers/importers or from retailers, thus making tax evasion less likely and collection more efficient. • Easy to determine value. • It only requires a precise definition of what constitutes “one unit” or quantity.

SPECIFIC EXCISE TAX: Disadvantages • Inflation erodes its value. • Because the tax rate is not tied to the product price, it does not automatically adjust with inflation. • Instead, the government must periodically implement additional rate increases, or add into the tax law that the specific excise tax rate will automatically adjust with inflation. • Can be reduced by changing products characteristics • Tobacco industry can reduce the impact of specific taxes on consumption • For example, producing bigger or longer size cigarettes if the tax is applied per stick, or by increasing the size of a pack if the tax is per pack.

AD VALOREM EXCISE TAX: Advantages • Automatic adjustment for inflation. • Since the tax is tied to the product price, the tax automatically adjusts with inflation. • Higher profit margin is taxed. • Ad valorem tax reduces the industry profit margin since a part of any price/profit increase goes to the government as tax revenue.

AD VALOREM EXCISE TAX: Disadvantages • Less predictable revenue stream. • As ad valorem taxes are based on value, it is difficult to predict tax revenue over time. • Difficult to determine value. • As opposed to specific taxes, which can easily be applied to products merely by determining the quantity, ad valorem taxes require more effort to calculate the payment. Manufacturers can easily manipulate their product prices to avoid higher tax payments. • Low prices. • There is an incentive for manufacturers to produce low-priced products because ad valorem taxes are tied to product prices. This, in turn, makes the products more accessible to youth and other low-income populations. • Leads to large price differences between products. • Ad valorem taxation widens the gap in prices between cheap products and more expensive products. More smokers may purchase cheaper products or switch from the more expensive products to cheaper ones, and this may reduce the impact of higher tax on consumption. • Difficult to administer. • Auditing the value of multiple types of tobacco products declared by the manufacturers requires strong tax administration capacity. In countries where tax administration may be weak, the full tax revenue potential may not be realized if the market prices are not well established or verified.

Value added tax • General tax on consumption of products and it is applied proportionally to their prices. • VAT is charged as a percentage of the value added/generated at each stage of production. • For instance, tobacco growers and cigarette manufacturers are each charged a tax on the value they add/generate to the total value of a cigarette.

Total taxes and retail price • Total taxes = Excise + VAT+ Import Duty + Other Taxes • Retail Price = Total Taxes+ Producer's Price+ Retailers and Wholesalers' Margin (Profit)

Conclusion • In most low/middle-income countries, specific taxes that automatically adjust for inflation are preferred to ad valorem taxes • Specific taxes • Minimize substitution and are more effective than ad valorem taxes at reducing consumption after a tax increase. • Easier to administer and assures a predictable income for the government. • Should be adjusted such that the nominal retail price of cigarettes increases by at least the sum of the inflation rate and the per capita income growth rate.

Countering industry claims against tobacco price and tax increases

Claim: Higher tobacco taxes will hurt the economy. • They say: Tax increases will lead to significant reductions in employment in tobacco growing and manufacturing, as well as more general wholesale, retail, and other economic sectors. Consequently, increases will have an adverse impact on the entire economy. • TRUTH • Farming and manufacturing account for a small and, in most countries, declining share of economic activities. • Decline in the demand will be gradual allowing farmers time to transition from tobacco to alternative crops • Tobacco manufacturing generates very few jobs, and those jobs are declining due to the tobacco industry’s automation / mechanization of the manufacturing • Positive impacts on other sectors as the money smokers • would have spent on tobacco products will be spent on other goods and services. The net employment effect of this shift in consumers’ preferences will most likely be positive, producing more jobs in other sectors

Claim: Higher tobacco taxes will increase smuggling. • They say: Tax increases on tobacco products will lead to increased smuggling, illegal cigarette production, and related criminal activity. • TRUTH: • Tobacco taxes are not the primary reason for cigarette smuggling and cigarette tax avoidance. The World Bank has demonstrated that levels of smuggling tend to increase with the degree of corruption in a country. • Smuggling can be controlled by legal means (e.g. tax stamps, serial numbers, special package markings, health warning labels in local languages) and by law enforcement (e.g. improving corporate auditing, better tracking systems, and good governance). Revenue generated by a tax increase can finance these activities. • Higher taxes reduce consumption and increase government revenue, even in the presence of cigarette smuggling.

Claim: Higher tobacco taxes will reduce tax revenues • They say: reductions in tobacco sales caused by tax increases will be so large that it will offset the impact of the increased tax rate • TRUTH • Higher tobacco taxes produce higher tax revenues. The demand for tobacco products is inelastic which means that the proportionate reduction in demand for tobacco is smaller than the proportionate size of tax increase • Even though demand is reduced when taxes and prices increase, the higher tax rate will result in overall increases in tax revenues.

Claim: Higher tobacco taxes will hurt the poor • They say: Tobacco tax increases are regressive and fall disproportionately on the poor. Poor people have only few pleasures, and higher taxes will make tobacco unaffordable to them. • TRUTH • Tobacco industry aggressively targets the poor with its advertising (and pricing) • Rates of tobacco use are higher among low-income groups • Lower income populations are more responsive to increases in tobacco prices than people with higher income. Increased tobacco taxes will reduce tobacco use among lower income people, therefore reducing the burden tobacco disproportionally imposes on the poor

Claim: Higher cigarette taxes will encourage smokers to switch to cheaper brandsor other tobacco products • They say: Smokers will switch to cheaper brands or cheaper tobacco products. There will be no overall reduction in tobacco use. • TRUTH • Some will switch, but not all AND… • Higher taxes will still prevent most from starting to smoke, encourage them to quit, and reduce the quantity of cigarettes smoked • Specific excise taxes reduce price differences among the various brands, thus limiting substitution among tobacco products when taxes go up

Claim: Tax rates are already too high • They say: Most countries already have very high rates of taxes on tobacco products. • TRUTH • NOT TRUE! Taxes remain low and tobacco is cheap. • Tobacco products in many countries have become more affordable over time as economies have grown and household incomes have increased, even when prices, adjusted for inflation, have remained stable or increased • Tobacco taxes are not high enough to cover the huge costs tobacco imposes on individuals, families and countries, including health care costs for tobacco related diseases, lost productivity due to premature deaths, fires due to tobacco use, and environmental deforestation for tobacco farming

Claim: Higher tobacco taxes punish tobacco users • They Say: Tobacco is a pleasure to use. Raising tobacco taxes means tobacco users will pay more money for their pleasure • TRUTH • Tobacco use kills. Most tobacco users start using and become addicted to tobacco before the age of 20 when they are too young to realize the risks of tobacco use.10 • Among tobacco users who understand the risks of tobacco, a majority report wanting to quithowever the addictive nature of tobacco makes this difficult. • Tobacco taxes encourage tobacco users to quit, positively impacting their health.

Claim: Taxes interfere with consumers’ freedom of choice • They say: Governments’ responsibility should end with making the risks of tobacco use widely known to people • TRUTH • Many tobacco users underestimate the risks of tobacco or are unaware of them • When used as intended, tobacco kills • Tobacco is an addictive substance and, by the time users try to quit, they are addicted • Tobacco use imposes costs on families and governments in the form of health care costs for tobacco-related diseases and lost productivity due to pre-mature deaths • Smoking imposes costs on nonsmokers who develop diseases and/or die prematurely due to secondhand smoke exposure • Therefore, Government has responsibility to act

Taxation & price issues