1 The role of tobacco price on consumption Dr. Corné van Walbeek Senior Lecturer, School of Economics University of Cape Town

Two important principles of economics 1.The law of demand – As the price of a commodity increases, people are going to consume less of the product, all other factors held constant – By how much will consumption decrease? Not specified 2.Price elasticity – By how much does consumption decrease if the price increases by one per cent? – Distinguish between relatively elastic (ε > 1) and relatively inelastic (ε 1) and relatively inelastic (ε < 1) demand 2

More about price elasticity If price elasticity = 0.6, If price elasticity = 0.6, – For every 1 per cent increase in price, consumption decreases by 0.6 per cent – For a 10 per cent increase in price, consumption decreases by 6 per cent Estimates of price elasticity around the world: Estimates of price elasticity around the world: – Developed countries (ε of about 0.4) – Developing countries (ε between 0.4 and 0.8) – South Africa (ε between 0.6 and 0.8) 3 Chaloupka and Jha, 2000 and Van Walbeek, 2005

How does this work in practice? Higher prices: Higher prices: – discourage smokers from starting to smoke – encourage some smokers to quit – reduces the average number of cigarettes smoked by smokers Based on SA data, a 10 per cent increase in cigarette prices reduces cigarette consumption by about 6 per cent Based on SA data, a 10 per cent increase in cigarette prices reduces cigarette consumption by about 6 per cent – Number of smokers decreases by about 3 per cent – Average consumption by remaining smokers decreases by about 3 per cent 4 Van Walbeek, 2005

Trends in cigarette consumption and smoking prevalence Cigarette consumption (millions of packs) Per capita consumption (packs p.a. aged 15+) Smoking prevalence percentage (15+) Average consumption per smoker (packs p.a.) Van Walbeek, 2005

Which demographic groups are most affected by excise tax increases? International experience: International experience: – Price elasticity of demand among youth is 2-3 times higher than among adults – Poorer groups are more price sensitive than richer groups Changes in South African smoking prevalence Changes in South African smoking prevalence Change Male51.4%43.8%-7.6% Female12.9%11.7%-1.2% Aged %18.7%-5.3% Aged %22.5%-0.9% Lowest income group 29.4%23.5%-5.9% Highest income group 28.1%31.0%+2.9%

7 The South African experience

The role of government Government imposes excise and other sales taxes – Industry passes the higher tax onto consumers in form of higher retail prices Total tax burden as a percentage of the retail price 8 Yurekli, unpublished data Country Tax burden Country Country Israel84%Ghana63%Zimbabwe38% Norway81%Japan61%Cameroon33% UK80% South Africa 52%Nigeria32% Australia77%Ethiopia50%Uganda32% Spain75%Mozambique48% Congo Rep. 32% Netherlands73%Malawi47%Namibia21%

How high should the tax burden be? World Bank guideline: World Bank guideline: – 75 per cent of retail price European Union rule: European Union rule: – At least 57 per cent of retail price 9

The government benefits hugely from increases in the excise tax 10

11 The role of the industry: An unlikely “ally” in the fight against tobacco

Conclusion Despite its addictiveness, tobacco obeys the law of demand Despite its addictiveness, tobacco obeys the law of demand In most developing countries a 10 per cent increase in retail price reduces consumption by 4 – 8 per cent In most developing countries a 10 per cent increase in retail price reduces consumption by 4 – 8 per cent Government is able to influence the price by raising the excise tax Government is able to influence the price by raising the excise tax In SA (and many other countries) industry typically pass more than the tax increase onto consumers In SA (and many other countries) industry typically pass more than the tax increase onto consumers 12