A study of the causes of the real net- of-tax cigarette price increases in South Africa ( ) Diana Nyabongo

Background It is well known that South Africa has used excise tax policy as a tobacco control tool since the early 1990s The increases in excise tax resulted in increases in price, reduced consumption and smoking prevalence, and increased tax revenues The key economic relationship is the price elasticity of demand However, of interest to policy makers is how their tool (excise) influences prices

What are the industry options? First, what is the net-of-tax price? Net-of-tax price + Excise + VAT = Retail price The industry may respond to an increase in excise tax by: – Increasing the net-of-tax price – Not changing the net-of-tax price – Decreasing the net-of-tax price

How concentrated is the market? CompanyShare British American Tobacco89.5% Japan Tobacco4.2% Philip Morris International1.7% Other4.6%

The endogeneity problem While South Africa’s excise tax is, in principle, a uniform specific tax, it is implemented as a hybrid excise tax The National Treasury set the specific tax so that the total tax burden (excise plus VAT) equals 52% of the retail price

International trade liberalization Post apartheid, South Africa embarked on a fairly aggressive trade liberalization policy This led to the lowering of import tariffs Let us inspect some tariff lines

Import tariffs on raw tobacco SADC37.09%17.37%0% EFTA37.09%17.37%-15% EU37.09%17.37%13.92%3.75% RoW37.09%17.37%15.82%15%

Import tariffs on manufactured cigarettes SADC30.59%30.07%0% EFTA30.59%30.07%22.55%40.85% EU30.59%30.07%26.45%11.21% RoW30.59%30.07%30.06%45%

Value of imports of raw tobacco SADC$ 37.3$ 26.2$ 23.0$ 39.0 EFTA$ 1.3$ 0.3$ 0.1$ 0.0 EU$ 0.2$ 1.4$ 12.2$ 88 RoW$ 12.2$ 14.2$ 42.3$ 122.9

Value of imports of manufactured cigarettes SADC$ 0.0$ 0.1$ 2.3$ 7.1 EFTA$ 0.4 $ 1.5$ 3.5 EU$ 1.0$ 1.6$ 8.3$ 9.1 RoW$ 10.0$ 2.5$ 2.0$ 10.2

A model Time series Autoregressive Distributed Lag Model (ARDL, 1 1 1) Price is a function of: – Raw tobacco prices – Private consumption – Tariff – Excise

Results Lagged prices (-), raw tobacco prices (+), private consumption (+) and excise tax rate (+) are statistically significant In the difference term only excise rate (+) is statistically significant Tariff is not statistically significant!

Results VariableCoefficientShare of variation of dependent variable Raw tobacco % Private consumption % Tariff % Excise rate % Unexplained7.1%

Some concluding thoughts It is clear that excise taxes are the predominant driver of retail prices in South Africa The industry have clearly over-shifted excise tax increases This has occurred even in the face of an endogenous tax policy A key point is how trade policy, while not changing the market for manufactured cigarettes significantly, has altered the source of tobacco leaf imports