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 session What 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

Revenue Cigarette 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 CountryName and yearNet change as % of employment in base year Net ExportersUS (1993) 0% UK (1990) 0.5% Zimbabwe (1980) -12.4% Balanced Tobacco Economies South Africa (1995) 0.4% Scotland (1989) 0.3% Net ImportersBangladesh (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 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?

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 loss US $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 at 2000 price level. 1 RMB / Pack Tax Increase

Review What 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 discussion What 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.