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Research paper
A simulation model to predict the fiscal and public health impact of a change in cigarette excise taxes
  1. Corné van Walbeek
  1. Correspondence to Professor Corné van Walbeek, University of Cape Town, School of Economics, University of Cape Town, Private Bag, Rondebosch 7701, South Africa; cornelis.vanwalbeek{at}uct.ac.za

Abstract

Objectives (1) To present a model that predicts changes in cigarette consumption and excise revenue in response to excise tax changes, and (2) to demonstrate that, if the industry has market power, increases in specific taxes have better tobacco control consequences than increases in ad valorem taxes.

Design All model parameters are user-determined. The model calculates likely changes in cigarette consumption, smoking prevalence and excise tax revenues due to an excise tax change. The model is applicable to countries that levy excise tax as specific or ad valorem taxes.

Results For a representative low-income or middle-income country a 20% excise tax increase decreases cigarette consumption and industry revenue by 5% and increases excise tax revenues by 14%, if there is no change in the net-of-tax price. If the excise tax is levied as a specific tax, the industry has an incentive to raise the net-of-tax price, enhancing the consumption-reducing impact of the tax increase. If the excise tax is levied as an ad valorem tax, the industry has no such incentive. The industry has an incentive to reduce the net-of-tax price in response to an ad valorem excise tax increase, undermining the public health and fiscal benefits of the tax increase.

Conclusions This paper presents a simple web-based tool that allows policy makers and tobacco control advocates to estimate the likely consumption, fiscal and mortality impacts of a change in the cigarette excise tax.

If a country wishes to reduce cigarette consumption by increasing the excise tax, a specific tax structure is better than an ad valorem tax structure.

  • Taxation and price
  • economics

https://doi.org/10.1136/tc.2008.028779

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    Footnotes

    • Funding Bloomberg Initiative represented by Kelly Henning (kjhenning@aol.com).

    • Competing interests I have no competing interests to declare.

    • Provenance and peer review Not commissioned; externally peer reviewed.

    • ↵i There is currently no consensus in the literature (eg, the HNP Working Paper series published by the World Bank) on the relative magnitudes of the “participation elasticity” (which determines how smoking prevalence is affected by changes in the retail price) and the “conditional demand elasticity” (which determines how smoking intensity is affected by changes in the retail price). While the relative magnitudes of these two sub-elasticities influence the mortality impact of a change in cigarette taxes or prices, they have no fiscal or aggregate consumption impact.

    • ↵ii Using the point formula, the decrease in consumption would be −0.6×9.2=5.5%, but as indicated earlier, the point formula gives implausible results if the price changes are large, which makes the midpoint formula preferable. The midpoint formula is also used to determine the impact of the price change on smoking prevalence.

    • ↵iii In this section, unless stated otherwise, all comparative (ie, second-mentioned) values shown in parentheses refer to the percentage changes in the default scenario (ie, column (1)).

    • ↵iv Reviewing the literature, Van Walbeek1 found that less than 10% of all published |εP| estimates were greater than one. Where they were, they usually applied to sub-populations, rather than the whole population. These sub-populations were typically youths in the USA and low-skilled and/or low-income groups in other countries.

    • ↵v This belief is probably derived from the fact that an increase in the price will increase total expenditure (by consumers) only if the price elasticity is less than one. However, since the excise tax is always a fraction of the retail price, an increase in the excise tax increases the retail price by a lower percentage.

    • ↵vi Without knowledge of the industry's cost structure (and thus profit margins), one cannot calculate by how much industry profits will increase.

    • ↵vii The SCT on cigarettes is levied as a specific tax, but if the “base price” (essentially an ex-works price) is greater than a threshold value, the additional value is taxed at a much higher ad valorem rate. In 2005 the Jamaican government increased the specific tax component by 49%, but also raised the threshold where the ad valorem component became effective. In effect, the higher specific SCT component replaced the ad valorem SCT component, with the result that the SCT increased only marginally.

    • ↵viii Note that this is a 20% and not a 20 percentage point increase in the excise rate. Given the information in column (9), the initial excise tax rate is 40/(100−13.04−40)=85.2% on the net-of-tax price. The new excise tax rate is 85.2×(1+(20/100))=102.2% on the net-of-tax price, not 85.2+20=105.2%.