Excise tax increases, cigarette
consumption and government revenue:
A win-win-win situation in South Africa
Corne van Walbeek
School of Economics
University of Cape Town
This research was made possible with funding from the American Cancer Society
Win-win-win in South Africa
• Win 1: Public health
• Win 2: Government revenue
• Win 3: Tobacco industry benefits through their
pricing strategy and this pricing strategy has
had a positive impact on public health and
government revenue
Why are excise tax increases so effective in
reducing tobacco consumption?
• Despite its addictiveness, people respond to changes in the price of
cigarettes
• Price elasticity of demand for cigarettes in SA (and many low- and
middle-income countries is around -0.6)
• Thus a 10% increase in cigarette prices reduces consumption by 6%
• Not all people respond to changes in cigarette prices, but the poor
and youth are typically more responsive than the better-off and the
old
• Some indicative numbers:
– 1000 smokers initially
– If price increases by 10%, we would expect 3% (= 30) smokers to quit
– Remaining smokers will cut down their consumption by an average of
3% (some more and some less)
0.80
0.40
1960/1961
1961/1962
1962/1963
1963/1964
1964/1965
1965/1966
1966/1967
1967/1968
1968/1969
1969/1970
1970/1971
1971/1972
1972/1973
1973/1974
1974/1975
1975/1976
1976/1977
1977/1978
1978/1979
1979/1980
1980/1981
1981/1982
1982/1983
1983/1984
1984/1985
1985/1986
1986/1987
1987/1988
1988/1989
1989/1990
1990/1991
1991/1992
1992/1993
1993/1994
Excise tax, Rand per 10 cigarettes, constant 2010 prices
1.00
Nominal excise tax per
pack of 20
Excise tax increases
do not keep up with
inflation
0.00
30
Consumer Price Index
25
0.60
20
15
10
0.20
5
0
Consumer Price Index (2010 = 100)
Lesson 1 from South Africa
Specific taxes are good, but they have to be updated regularly, especially
in inflationary times
40
35
2008/2009
2006/2007
2004/2005
2002/2003
2000/2001
1998/1999
1996/1997
1994/1995
1992/1993
1990/1991
1988/1989
1986/1987
1984/1985
1982/1983
1980/1981
1978/1979
1976/1977
1974/1975
5.00
1972/1973
1970/1971
2.00
1968/1969
3.00
1966/1967
4.00
1964/1965
1962/1963
1960/1961
Excise tax, Rand per 20 cigarettes, nominal values
9.00
200
8.00
180
7.00
160
6.00
Nominal excise tax per pack of 20
140
Consumer Price Index
120
100
Government commits to a TC policy
based on keeping the tax burden at
50% of the retail price
80
60
40
1.00
20
0.00
0
Consumer Price Index (2010 = 100)
Since 1994 rapid excise tax increases followed the small nominal
increases in the 1970s and 1980s
Lesson 2 from South Africa
Don’t make the tobacco industry your tax advisor on
excise tax matters
Minister of Finance, 1983: “The Tobacco Board has
presented justified arguments for the maintenance of
the status quo regarding the excise taxes on tobacco,
and I do not intend to wake sleeping dogs”
Minister of Finance, 1986: “any increases in excise duties
at present could be counter-productive, since it could
in fact – on account of the potentially adverse effect
on consumption – lead to a reduction of revenue
from this source”
Article 5.3 of the FCTC:
In setting and implementing their public health
policies with respect to tobacco control, Parties shall
act to protect these policies from commercial and
other vested interests of the tobacco industry in
accordance with national law
Lesson 3 from South Africa
Keep the tax system simple
Specific tax is administratively best, and does not actively encourage the creation of
low-price market
Complicated tax systems are likely to be used by the tobacco industry to their benefit,
and against the public health and/or fiscal interests of the government
Example of a complicated excise tax regime: Jamaica
– Special consumption tax (SCT):
• A specific amount per 100 cigarettes PLUS
• An ad valorem tax of X % on cigarettes in excess of specified benchmark value
– “Excise levy” payable to the National Health Fund: 23 % of the sum of the ex factory
price and the SCT
– General Consumption Tax (GCT): Like VAT, an ad valorem tax
Lesson 4 from South Africa
The math is quite simple
Ignoring the impact of changes in income, the impact of a 20% increase in
the (specific) excise tax is as follows:
Net-of-tax
Excise tax
price
increase
increase
(percentage) (percentage)
Excise tax as
percentage
of retail price
Price
elasticity
40
-0.6
20
0
-4.5
14.6
40
-0.3
20
0
-2.3
17.3
40
-1.1
20
0
-8.1
10.3
40
-0.6
20
10
-7.6
10.9
40
-1.1
20
10
-13.4
3.9
70
-0.6
20
0
-7.6
10.9
70
-0.6
20
10
-9.0
9.2
% change
% change
quantity govt revenue
Lesson 5 from South Africa
6000
500
5000
400
4000
300
3000
200
2000
100
1000
Real excise rate
Real excise revenue
2009
2005
2001
1997
1993
1989
1985
1981
1977
1973
1969
0
1965
0
Real excise revenue
(R million, 2000 prices)
600
1961
Real excise rate
(in constant 2000 cents)
Big increases in the excise tax have resulted in big increases in tax
revenue
Between
1993 and
2011 real
excise tax
increases by
487% and real
excise tax
revenue
increases by
249%
Lesson 6 from South Africa
The industry has a very strong interest in exaggerating the threat of illicit
trade
– “The increase in the excise tax will encourage illicit trade” (TISA and BAT, numerous years)
– “The illicit market has grown from nothing ten years ago to 20% of the total SA market”
(TISA, 2006)
– “Illicit trade has doubled over the past two years” (BAT CEO, 2010)
– “The government loses R2.6 billion each year to illegal sales” (TISA, 2011)
The evidence for a large increase in illicit sales is not
convincing
40
35
35
30
30
25
25
20
20
15
15
10
10
5
5
0
0
Illicit market share (Euromonitor)
Aggregate cigarette consumption in SA
11% increase in
total (legal and
illicit) sales
4.3% increase in
legal sales
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Cigarette consumption (billion sticks)
40
"Illicit market share"
•
Total cigarette consumption
Legal cigarette consumption
In an environment of rapidly increasing average prices and strong
tobacco control legislation it seems unlikely that total cigarette
consumption would increase by 11% between 2003 and 2009
Bottom line: While illicit trade may be a real issue in many countries, and
one should always be vigilant, the industry is not a credible source about
the magnitude of the problem
Lesson 7 from South Africa
The tobacco industry’s pricing model may have beneficial long-run fiscal and
public health consequences
•
The third WIN in the equation: Tobacco industry in SA is more profitable now than
before, despite the decrease in cigarette consumption
•
•
•
Sharp increase in the net-of-tax price (and thus profit) per cigarette
Can do this because tobacco industry in SA, as in most countries, is highly concentrated
Low price elasticity works in the industry’s favour
•
Excise tax in SA is specific but set such that tax burden is 52% of the retail price
•
Substantially increasing the excise tax initiated a cycle of
1.
2.
3.
4.
5.
6.
7.
Increasing retail price (excise tax being passed through)
Decreasing consumption (as consumers respond to higher prices)
Increasing net-of-tax price (as industry wants to maintain/expand its profitability)
Increasing retail price (as the net-of-tax price increases)
Decreasing consumption (as consumers respond to higher prices)
Increasing excise tax (as government wants to maintain the 52% tax burden)
Increasing retail price (back to point 1)
A gradual upward ratchet of the real price of cigarettes,
with a corresponding decrease in consumption
1200
2000
1000
1500
800
600
1000
400
500
200
Net-of-tax price
Excise tax
Sales tax (GST/VAT)
2010
2006
2002
1998
0
1994
0
Cigarette Consumption (million packs)
2500
1990
Cents/pack
(constant 2000 prices)
1400
Cigarette consumption