Background The current tobacco taxation scheme in Turkey, a mix of high ad valorem tax and low specific tax, contains incentives for firms and consumers to change pricing and consumption patterns, respectively. The association between tax structure and price and tax revenue stability has not been studied in detail with micro data containing price segment information.
Objectives In this study, we analyse whether incentives for firms and consumers undermine the effectiveness of tax policy in reducing consumption.
Methods We calculate alternative taxation scheme outcomes using differing ad valorem and specific tax rates through simulation analysis. We also estimate price elasticity of demand using detailed price and volume statistics between segments via regression analysis.
Findings A very high ad valorem rate provides strong incentives to firms to reduce prices. Therefore, this sort of tax strategy may induce even more consumption despite its initial aim of discouraging consumption. While higher prices dramatically reduce consumption of economy and medium price segment cigarettes, demand for premium segment cigarettes is found to be highly price-inelastic.
Conclusions The current tax scheme, based on both ad valorem and specific components, introduces various incentives to firms as well as to consumers which reduce the effectiveness of the tax policy. Therefore, on the basis of our theoretical predictions, an appropriate tax scheme should involve a balanced combination of ad valorem and specific rates, away from extreme (ad valorem or specific dominant) cases to enhance the effectiveness of tax policy for curbing consumption.
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