excise duty in relation to cigarette price

1. 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

2. 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

3. 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)

4. Lesson 1 from South Africa
Specific taxes are good, but they have to be updated regularly,
especially in inflationary times
Excise tax increases
do not keep up with
inflation

5. Since 1994 rapid excise tax increases followed the small nominal
increases in the 1970s and 1980s
Government commits to a TC policy
based on keeping the tax burden at
50% of the retail price

6. 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

7. 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

8. 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:
Excise tax as
percentage
of retail price
Price
elasticity
Excise tax
increase
(percentage)
Net-of-tax
price
increase
(percentage)
% change
quantity
% change
govt revenue
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

9. Lesson 5 from South Africa
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%

10. 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)

11. The evidence for a large increase in illicit sales is not
convincing
• 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
11% increase in
total (legal and
illicit) sales
4.3% increase in
legal sales
Aggregate cigarette consumption in SA

12. 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. Increasing retail price (excise tax being passed through)
2. Decreasing consumption (as consumers respond to higher prices)
3. Increasing net-of-tax price (as industry wants to maintain/expand its profitability)
4. Increasing retail price (as the net-of-tax price increases)
5. Decreasing consumption (as consumers respond to higher prices)
6. Increasing excise tax (as government wants to maintain the 52% tax burden)
7. Increasing retail price (back to point 1)

13. A gradual upward ratchet of the real price of cigarettes,
with a corresponding decrease in consumption