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HE311 Cost-Benefit Analysis

Term Paper

AY2013/2014 Semester 2

Topic

Cost-Benefit Analysis on Sin Tax

Name Matriculation Number

Alan Dai Sheng U1030562D

Lee Liang Tian U1030042J

Lee Yee Jia Jamie U1030852A

Ong Soo Yue U1030677L

Wong Li Ting U1030590D

Yap Hon Looi Jensen U1030257G

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SECTION 1: INTRODUCTION 1 SECTION 2: TOBACCO - INDIVIDUAL COSTS AND BENEFITS 3 2.1 ADDICTED SMOKERS 3 2.2 NON-ADDICTED/POTENTIAL SMOKERS 3 2.3 COSTS 4 2.3.1 DISUTILITY & DISSATISFACTION 4 2.3.2 LOSS OF ENJOYMENT 6 2.3.3 LOSS OF SOCIAL OPPORTUNITIES 6 2.3 BENEFITS 7 2.3.1 PERSONAL SAVINGS 7 2.3.2 REDUCED HEALTH RISK 7 SECTION 3: LIQUOR INDIVIDUAL COSTS AND BENEFITS 10 3.1 COSTS 10 3.1.1 LOSS OF CONSUMER SATISFACTION 10 3.1.2 PARTIAL LOSS OF HEALTH BENEFITS 12 3.2 BENEFITS 13 3.2.1 INCREASE PRODUCTIVITY 13 3.2.2 PERSONAL SAVING 14 3.2.3 HEALTH BENEFITS 14 SECTION 4: SOCIAL COSTS 16 4.1 MARKET INEFFICIENCY 16 4.2 REDUCTION IN TOTAL SURPLUS 17 4.3 THE CIGARETTE BLACK MARKET 17 4.4 INCOME DISPARITY 19

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SECTION 5: SOCIAL BENEFIT 20 5.1 ADDITIONAL TAX REVENUE 20 5.2 DETERRENCE OF NEW ENTRANTS 21 5.3 SAVING ON PRODUCTIVITY LOSS 22 5.4 FEWER EXTERNALITIES 23 5.4.1 FEWER TRAFFIC ACCIDENTS 23 5.4.2 LESSER AIR POLLUTION 25 5.5 REDUCTION OF EMOTION DISTRESS 25 6. CONCLUSION 26 APPENDIX: INDIVIDUAL CONTRIBUTIONS 29 BIBLIOGRAPHY 31

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SECTION 1:

INTRODUCTION

On 21 February 2014, Singapore Government announced its Budget statement

for 2014. The statement introduced a so-called sin tax increase on tobacco and

alcohol (Chang, 2014). The excise duties for cigarettes and other tobacco products

were raised with immediate effect by 10% and for all liquor products, 25%.

Combined, the increases in the sin tax are to yield additional revenue of

approximately 200 million for the government. (Ministry of Finance, 2014)

According to Deputy Prime minister Tharman Shanmugaratnam, the objective

of such increases is to discourage excessive consumption of both products (Channel

News Asia, 2014). It has been almost a decade since the last increase. The previous

increase in tobacco duties was introduced in 2005, while the excise duties on liquor

products have remained constant (Ministry of Finance, 2014).

During the past decade from 2006 to 2012, alcoholic beverage and tobacco

consumption has seen has been growing at a rate of 5.66% annually at 2005 constant

price, outpacing the annual total population growth rate of 3.19% (Department of

Statistics, Singapore, 2013). The per capita consumption of tobacco and alcohol

products has certainly gone up. On the other hand, the growth in consumption has

led to 33.15% more jobs, equivalent to an annual increase of 4.89%, in the related

industry during the same time period (Department of Statistics, Singapore, 2013).

The percentage of smoking population in Singapore has seen an upward trend,

starting from 12.6% in 2004, to 14.3% in 2010, and eventually reaching 16% in 2012

(Abraham, 2012). Among those who smoke, 4.5% are reported to be addicted. Over

35% of the smoking addicts are between 18 and 35 years old (Ministry of Health,

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2012). Alcohol consumption is of a different nature because non-excessive drinking

might bring net benefit. Nonetheless, as reported by World Health Organization,

1.59% of the Singapores population suffered from alcohol use disorder in 2006.

Besides, among every 100,000 people, 4.4 cases of liver cirrhosis, a recognized

consequence of excessive drinking, are reported (World Health Organisation, 2011).

The imposition of higher excise duties is expected to reduce the consumption of

both demerit goods. However, the impact of higher taxes goes beyond the reduction

of health risks among individuals and extends to other socioeconomic aspects.

Leveraging the tool of cost-benefit analysis, this report aims to provide a

comprehensive albeit preliminary view of how the increase in excise duties for

tobacco and alcohol affect various aspects of the economy. For the purpose of

discussion, the report begins with individual cost-benefit analyses of tobacco and

liquor tax respectively, before diving into social costs and benefits of the sin tax

increase as a whole.

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SECTION 2:

TOBACCO - INDIVIDUAL COSTS AND BENEFITS

The recent Budget 2014 has announced a 10% increase in tax for tobacco

product, which is aimed to reduce the prevalence of smoking among Singaporeans.

This section presents a cost-benefit analysis of the tobacco tax increase from an

individuals perspective. For the purpose of the analysis, smokers are classified into

two categories, namely (i) addicted smokers and (ii) non-addicted smokers.

2.1 ADDICTED SMOKERS

Addicted smokers are defined as those highly addicted to the habit of smoking

and certainly have the expenditure on cigarettes integrated in their consumption

decision model. Their demand for cigarettes is presumed to be highly inelastic.

Therefore, a 10% increase in tax, equivalent to a price increase of $0.7 to $1.1 per

pack of cigarettes, is unlikely to alter their consumption pattern. This suggests that

the tax policy is ineffective in deterring the smoking habits of this group. In other

words, this tax policy is predicted to only result in additional costs to this group,

without generating remarkable benefits.

2.2 NON-ADDICTED/POTENTIAL SMOKERS

Non-addicted smokers include those who smoke socially and lightly, those who

just started to smoke, and those who might start to smoke in the near future. Young

adults account for the majority of this category, with a certain percentage being

students and other low-income demographic groups. They are yet addicted, which

allows them to refrain from smoking rather easily. For those with relatively low

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income, the increase in tax further move them up their elastic demand curves,

prompting them to discontinue the habit.

2.3 COSTS

2.3.1 DISUTILITY & DISSATISFACTION

According to National Health Survey 2010, the mean number of cigarettes

consumed by an addicted smoker is 12 cigarettes per day. With the tax increase, the

price of cigarette per stick is expected to increase by 3.6 cents (Ministry of Finance,

2014). It is calculated that the estimated increment in a regular smokers expenditure

per month is 12.96 dollars.

Estimated total increment in individual expenditure on cigarettes per month

= 12 x $0.036 x 30 = $12.96

As shown in Figure 2.1 below, the demand curve has a steep slope due to the

highly inelastic demand of regular smokers. Thus, when a tax is imposed, price has a

noticeable jump from P1 to P2, while the decrease in the number of cigarettes

consumed daily is relatively smaller in scale. This effect is most pronounced in the

short-term, where the demand is virtually close to perfectly inelastic. In such an

extreme case, there is only jump in price with no reduction in quantity consumed.

Therefore, for an addicted smoker, an increment in the expenditure on cigarettes is

certainly taking place and cannot be easily avoided without a change in his

consumption pattern.

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FIGURE 2.1 HIGHLY INELASTIC DEMAND (ADDICTED SMOKER)

Figure 2.2 illustrates the impact of the tax on an addicted smoker with perfectly

inelastic demand. The shaded area represents the decrease in consumer surplus,

which is equivalent to the increment in the consumers expenditure in this case, at

$12.96. In reality, with imperfectly inelastic demand, the actual loss in consumer

surplus is slightly smaller than $12.96. However, the deviation is expected to be

little.

FIGURE 2.2 PERFECTLY INELASTIC DEMAND (ADDICTED SMOKER)

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Consumer surplus could be defined as the satisfaction or utility consumers

receive for which they dont have to pay for. Therefore, the reduction in consumer

surplus suggests a corresponding decrease in the satisfaction or utility level of

addicted smokers.

2.3.2 LOSS OF ENJOYMENT

Smoking is an enjoyable activity to most smokers, addicted or non-addicted. It

can help one relax and relieve from tension. However, smoking has negative and

widely recognized impacts on health.

It is assumed that an individual smoker, as a rational consumer, weighs both the

individual cost and benefit before buying a pack of cigarettes. As illustrated in the

equation below, the value of this enjoyment is indicated by the willingness to pay

for such a habit, which equals to the sum of the price of cigarette and the health-

related risk one is willing to take when smoking. For social smokers who do not to

smoke daily, they probably aware of the risk of prolonged smoking, so their

willingness to undertake health risk is small. As a result, the cost for them to forgo

this enjoyment of smoking is small.

Total value of smoking = Willingness to pay for smoking

= Price of cigarettes

+ Health risks

2.3.3 LOSS OF SOCIAL OPPORTUNITIES

Another reasons that people start smoking is that they can integrate better into a

social circle, or they use it as an opportunity to carry out social interaction. In some

circumstances, smoking is a stepping-stone for one to join a particular social circle.

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Not smoking might seem as an unfriendly gesture to the smoking peers, alienating

oneself from them, and thus hindering integration. The value of this cost is hard to

determine and it varies on an individual basis. Some will find this cost substantial in

a business social context and some are just going to lose some smoking friends.

2.3 BENEFITS

2.3.1 PERSONAL SAVINGS

Smoking is an expensive activity as it can cost hundreds of dollars monthly if

addicted. A regular smoker consumes approximately 18 packs of cigarettes a month

with the current price ranging at $9.00 to $12.00 per pack. The expense is between

$162 and $216 per month. For social/potential smokers, the consumption is lower

but the rate of consumption can increase exponentially when the addiction is built.

In the long run, not smoking is able to save quite a significant amount of money.

We estimate the expenditure on cigarettes in a 10-year horizon. Assume ceteris

paribus and take average annual inflation rate over the past 10 years (approximately

2%):

Annual expenditure of cigarette would be $ !"#!!"#! 12 = 2,268 = $",!"#!.!"! =!!!! $20,780

2.3.2 REDUCED HEALTH RISK

Long-term smoking is a major cause for health problems such as cancer, heart

disease, stroke and Chronic Obstructive Pulmonary Disease (COPD). According to

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Singapore Chinese Health Study, smokers generally have greater Hazard Ratio (HR)

in these diseases. Besides, the report has also proven that the prevalence of stroke

and cancer is higher among smokers (Sin How, Bee Choo et al. 2013). Most notable

disease among smokers is lung cancer. Study shows that probability of getting lung

cancer with smoking is 3.4% which is much higher than non-smokers 0.35%

(Wong, Seow et al. 2010).

TABLE 2.1. ADMISSIONS FOR LUNG CANCER (EXCL. SURGERIES)

Ward Type Hospital Volume Average Length of Stay (days)

50th percentile Bill ($)

90th percentile Bill ($)

A SGH 52 3.3 4498 10093

Private (2 Bedded)

MEH 40 1.4 5587 20494

Private (4 Bedded)

MEH 40 1.7 4268 12099

B2 NUH 64 6.8 2074 3993

SGH 217 3.8 1201 2697

TTSH 114 2.6 621 2808

C NUH 76 6.3 1268 2930

SGH 122 4.8 898 2058

TTSH 72 8.1 1209 2675

Day Surgery (Private)

MEH 50 1 3945 5030

Source: Ministry of Health

Total costs of treatments such as radiotherapy, chemotherapy, drugs and etc. is

difficult to gauge, as it depends on the combinations of treatments that each patient

requires. Plus, advancement in medical technologies further complicates the true

estimation for the treatment cost. In general, treatment cost can be amount up to tens

of thousands depending on individual condition in a month. In United States, the

average monthly total cost of lung cancer for patient of a standardized age of 72

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(with treatment) is about USD 16,000 in the year of 2000 (Cipriano, Romanus et al.

2011). According to this information, we roughly estimate that average monthly

total cost for lung cancer in Singapore in 2014: US$ 16,000 * (1.02)13 = US$

20,678, with an error term subjected to country differences and medical

advancement. Not smoking is able to reduce the risk of getting these diseases and

hence avoiding the hefty medical bill.

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SECTION 3:

LIQUOR INDIVIDUAL COSTS AND BENEFITS

3.1 COSTS

3.1.1 LOSS OF CONSUMER SATISFACTION

Alcohol is widely known for its muscle relaxing and anxiety reducing effects.

This is due to the depression of the central nervous system resulting in slower

communication to the brain. Also, drinking alcohol releases feel-good chemicals into

the area of the human brain otherwise known as the pleasure center. This rush of

chemicals leads to great surges of satisfaction and happiness (The Indian Express,

2012). With the tax hike, this avenue of stress reduction and happiness will result in

a likely loss in consumer satisfaction. Also, this tax hike is implemented at the

expense of leisure attained from alcohol consumption.

Furthermore, a survey carried out in a Northeastern liberal arts college in the US

concluded that students who were engaged in binge drinking were reportedly happier

than their non-binge drinking counterparts. This form of happiness derived from

binge drinking was also associated with an elevated perception of social status

amongst peers (Szalavitz, 2012).

At the individual level, this loss in consumer satisfaction can be directly

assumed to be the price increase in alcohol. For instance, before the tax hike, an

individual is willing to pay $10 for a round of drinks at a bar. After the tax hike, the

individual has to pay $10 (1 + Y) for the same round of drinks, where Y is the

increase in alcohol costs due to tax hike. Assuming this individual decides to cap his

expenditure at $10, he would be lowering his consumer satisfaction by Y%. Hence,

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the value of consumer satisfaction lost can be assumed to be the elevation in alcohol

costs due to the tax hike, because the minimum amount of money this individual

requires is $10Y to bring him up to at least the original level of satisfaction.

A United Nations Socioeconomic survey was conducted from 1990 to 2006.

From the data, the latest observation on local alcohol consumption in 2006 was 2.6

liters of pure alcohol per capita.

Excise tax as a per cent of total retail price for 1 liter of pure alcohol = 2.1%

Total value of excise tax = $70.00 per liter of pure alcohol

Total retail price for 1 liter of pure alcohol: (70/2.1) X 100 = $3,333

Based on the above illustration and the latest observation of local alcohol

consumption of 2.6 liters of pure alcohol in 2006, as well as the retail price for 1 liter

of pure alcohol, the value of consumer satisfaction lost on average per capita is (0.25

* 2.6 * 3,333) = $2,166. Present Value equals to 2166 * (1.032)6 = $2,700

The following table shows the increase in price of alcohol due to the tax hike.

Source: Ministry of Finance, ST Graphics

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3.1.2 PARTIAL LOSS OF HEALTH BENEFITS

A reduction in alcohol consumption may also lead to a fall in health benefits.

Moderate amounts of alcohol raise levels of high-density lipoprotein (HDL, or

good cholesterol), and higher HDL levels are associated with greater protection

against heart disease. Moderate alcohol consumption has also been linked with

beneficial changes ranging from better sensitivity to insulin to improvements in

factors that influence blood clotting. Such changes would tend to prevent the

formation of small blood clots that can block arteries in the heart, neck, and brain,

the ultimate cause of many heart attacks and the most common kind of stroke

(Harvard School of Public Health, 2014).

Based on a health study compiled by Professor David J. Hanson from 1997 to

2013, moderate drinking is categorized by an average of 3.55 liters of pure alcohol in

a year. Studies have shown that moderate drinking leads to 29% reduction in

cardiovascular diseases and 37% reduction in coronary heart diseases. It contributes

to 33% to 56% lower incidence of risk of diabetes and also 34% to 55% lowered

incidence of diabetic-related coronary heart diseases. This reduction in risks for the

several diseases is expected to result in approximately 2 years of additional life

expectancy.

As mentioned earlier, the average consumption of pure alcohol per capita is

around 2.6 liters, lower than the level of moderate drinking recommended. Thus, the

tax levied leads to an even lower consumption of alcohol among those who dont

drink excessively. For every person that used to drink occasionally but discouraged

by the tax increase, his statistical life expectancy is shortened by 2 years. With the

statistical value of a human life being $1.45 million and Singapores average life

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expectancy being 82 years, it is calculated that the cost of health benefit per capita is

1.45 million * 2 years / 82 years = $35365.85 (Quah, Wai-Mun, & Ying, 2009).

3.2 BENEFITS

3.2.1 INCREASE PRODUCTIVITY

It has also been estimated that productivity loss is the main social cost of

harmful drinking (Collins & Lapsley, 2008; Rehm et al., 2006; Saar, 2009), costing

the U.S. $134 billion in 2008 (Harwood, 2010). Absenteeism and poor job

performance often led to accidents and injuries. The following calculation illustrates

the saving in productivity loss, resulted from a decrease in alcohol consumption

among binge drinkers in Singapore.

Average Price Elasticity of demand for alcohol in developed countries: -0.38

Percentage of binge drinkers in US: 20% of total population = 62.78 million

Percentage of binge drinkers in Singapore before tax hike: 12.6% of total population

= 0.68 million

Tax hike of 25% ! Increase in retail price of alcohol beverages by approximately 24%

Increase retail price by 24% ! demand falls by (24 * 0.38) = 9.12%

Estimated decrease of binge drinkers in Singapore due to tax hike: 0.062 million

Estimated savings in productivity loss in Singapore: (0.062m/62.78m) * 134billion X

1.26 SGD/USD = $0.166 billion

Estimated savings in productivity loss in Singapore per capita: 0.174b/5.3m = $31.47

Present Value: 31.47 * (1.032)4 = $35.70

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Former binge drinkers in Singapore are expected to be more productive at work and

contribute an additional value of approximately $31.47 to the firms output.

3.2.2 PERSONAL SAVING

A United Nations Socioeconomic survey conducted from 1990 to 2006. From

the data, the latest observation on alcohol consumption in 2006 was 2.6 liters of pure

alcohol per capita.

Since the estimated price elasticity of demand is -0.38, a tax hike of 25% will

lead to a decrease in consumption of alcohol by 9.5%. This will lead to an estimated

0.247-liter reduction in pure alcohol consumption.

Excise tax as a per cent of total retail price for 1 liter of pure alcohol = 2.1%

Total value of excise tax = $70.00 per liter of pure alcohol

Total retail price for 1 liter of pure alcohol: (70/2.1) * 100 = $3,333

Total estimated economic savings per capita: 3,333 * 0.247 = $823.33

Present Value: 823.33 * (1.032)6 = $994.61

3.2.3 HEALTH BENEFITS

When sin taxes are high, it deters the consumption of alcohol among those who

drink excessively. It would indirectly lead to more health benefits as well

(Chaloupka, Grossman, & Saffer, 2002).

Some examples of health benefits include less mortality from liver cirrhosis,

cardiovascular diseases, sexually transmitted diseases and even depression. In fact, in

a study conducted, using data from 1961 to 1984, Grossman estimated that a 10 per

cent increase in tax rates would reduce cirrhosis mortality by 8.3 to 12.8 per cent in

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the long run (Grossman, 1998). In 2013, OECD also released a new Health Working

Paper, which concludes that using taxes on alcohol to attain public health objectives

are effective (OECD, 2013).

Thus, in this case, we can establish that having a higher alcohol would raise

health benefits for those with excessive drinking habits in Singapore. We calculate

this increase in health benefit by Grossmans estimate. Using the average values, we

find that a 25 per cent increase in Singapores alcohol tax would lead to an estimated

26.38 per cent decrease in cirrhosis mortality.

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SECTION 4:

SOCIAL COSTS

4.1 MARKET INEFFICIENCY

Rising rents, together with foreign labor restrictions, have already pushed up

operating costs of businesses, especially Small and Medium Enterprises (SMEs)

across Singapore. The tax hike is likely to deliver a further and direct blow to bars,

clubs and coffee shops, where the sales of cigarettes and liquor products constitute a

substantial proportion of the revenue. Inevitably, profit margins will be slashed in

accordance with the increase in vice taxes, as costs have increased but sales are

forecasted to plummet.

Endowed with greater bargaining power and economies of scale, large firms are

more likely to cope better with the increased tax burden. In theory, those with greater

flexibility in their cost structures could absorb higher proportion of the tax compared

to their competitors. This could effectively provide these companies with the option

to undercut their competitors for the purpose of boosting sales and increasing market

share. Such an option could serve as a temporary competitive advantage to phase out

the weaker and usually smaller firms. In other words, Small and Medium Enterprises

(SMEs) are likely to be the losers in this situation, which can be detrimental to

Singapores economy because we have a significant bulk of SMEs here. This will

undermine all the efforts that the government is putting in to help these SMEs all

these years.

Whoever the losers is, the tax is expected to lead to some degrees of market

inefficiency due to the reduced competition, since neither tobacco nor liquor industry

is a natural monopoly or oligopoly.

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4.2 REDUCTION IN TOTAL SURPLUS

Smaller firms, with little bargaining power with their suppliers, are expected to

pass on the tax burden partially, if not entirely, to consumers. And thus, this results

in reduced total surplus, as well as dead weight loss. In fact, most coffee shops in

Singapore have already started charging higher beer prices since the announcement

of the tax (Chow, 2014), undoubtedly causing customer disutility (Aripin, 2014).

4.3 THE CIGARETTE BLACK MARKET

With higher taxes, smokers seeking alternatives will turn to the black market for

more affordable options. In fact, higher sin taxes are often associated with a booming

cigarettes black market (Hartnett, 2014). In 2013, Singapore Customs seized 2.9

million packets of cigarettes; almost double that in 2012 and 1 million more in the

previous year (Yeo, 2014). In light of rising cigarette prices triggered by sin taxes,

more smokers would be driven to the black market; therefore cigarette smuggling is

expected to increase.

TABLE 4.1: ESTIMATION OF CIGARETTE CONFISCATION

Year 2011 2012 2013 2014*

Number of cigarettes seized (in millions) 1.9 1.4 2.9 2.0

*Figures for 2014 are estimated.

We use a conservative estimate in predicting cigarette smuggling for 2014. By

using the average of the previous years, we estimate Singapore Customs can seize

2.0 million packets in 2014, as shown in Table 4.1. Implications on society include

tax revenue that went unpaid and manpower resources to clamp down on such

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smuggling. The estimated evaded tax in 2014 will be valued using figures from the

latest cigarette hauls from 2013.

In late 2013, the authority conducted the second largest contraband cigarettes

haul and confiscated a total of 17600 cartons and 8 packets, with a total value of

$1.6million and total duty and tax evasion of over $1.3million (Sim, 2013). These

figures are used as a proxy for potential tax duties evaded in 2014 based on the

estimated 2 million packets Singapore Customs can expect to seize.

TABLE 4.2: TAX RELATED TO CIGARETTE SMUGGLING

2nd largest haul in 2013 2014*

Number of cigarettes seized (in packets)

(17,600 x 10) + 8 = 176,008

2,000,000 x 1% = 20,000**

Total Tax evaded $1,300,000 $7.38 x 20,000 = $147,600

Tax/Packet $1,300,000 / 176,008 = $7.38

$7.38

*Figures for 2014 are estimated. ** Assuming 10% increase in tax causes 1% increase in black market trading volume.

Table 4.2 summarized the estimated tax revenue forgone as a result of increased

cigarette smuggling. We assume that the 10% increase in tobacco tax leads to 1% in

crease in the illegal trading. The rise in the black market trading volume is likely to

cost $147,600 a year in tax revenue that could have gone towards nation-building

instead. Other than the forgone revenue, increased cigarette smuggling will require

higher enforcement costs to clamp down on smugglers and more importantly, the rise

of organized crime in Singapore.

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4.4 INCOME DISPARITY

Assuming smoking and excessive drinking activities are the only differences

that separate these consumers from the rest of the consumers, heavy smokers and

drinkers are significantly penalized through these increases in vice taxes which will

in turn use up an even bigger portion of their income in order to sustain this habit.

This may result in an income disparity between consumers that smoke or/and drink,

and consumers that do not.

According to the Adam Smith Institute, the average smoker spends 1,660 a

year on cigarettes, which is 20% of the income of the bottom 10%. The effects of

rising cigarette prices usually do spill over to the smokers families, especially low-

income earners, thereby putting unnecessary financial stress and burden on them

(Venkatesh, 2013). While the figures may not be that of Singapores, it is intuitive

that such habits actually take up a significant portion of income of the lower-income

group in the country, and sometimes even the working class. With the increase in

excise duties, the income gap will thus continue to widen.

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SECTION 5:

SOCIAL BENEFIT

This section covers the social benefits generated by the tax hike on both goods.

5.1 ADDITIONAL TAX REVENUE

The biggest benefit of an increase in tax is the additional tax revenue generated.

The rise in liquor duties is expected to yield another S$120 million a year, while the

tax increase in tobacco is to result in an estimated S$70 million. Therefore, the tax

hike is expected to lead to additional revenue, totaling approximately S$200 million,

for the government.

As mentioned earlier and shown in the Table 5.1 below, the incremental in

alcohol price due to the tax hike depends on both the volume and alcohol percentage

of each beverage. This means that a small can of Anchor beer is able to cause an

increase in price by $0.19. This demonstrates the severity of this tax; making its

point that tax revenue is bound to increase tremendously.

TABLE 5.1: IMPACT OF ALCOHOL TAX ON PRICES

Source: Ministry of Finance, ST Graphics

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5.2 DETERRENCE OF NEW ENTRANTS

We acknowledged that there are different demand functions for goods such as

alcohol and cigarettes, due to different levels of addiction.

For heavy smokers and drinkers, the demand for alcohol and cigarettes is

inelastic (Collis, Czubek, & Johal, 2010). This is due largely to the addictive nature

of both consumer goods. In this case, when the demand for a good is inelastic, tax

on these goods would mean that the costs are highly likely to be passed on to

consumers, as sellers know that an increase in price does not stop most of the

buyers. This leads to a successful transfer of burden from producers to consumers.

Consumers, thus, are the ones who face rising prices.

When prices are increased, demand for the good, theoretically, falls. However,

due to the price inelastic nature of the good, an increase in tax may not force

consumers to quit. This is especially true for heavy users, who are addicted to either

cigarettes or alcohol. It is difficult to reduce the overall number of drinkers and

smokers.

Instead, a high sin tax is more likely to deter new entrants. This means that

ideally, a sin tax will reduce the growth rate of new smokers and drinkers. It may

even force moderate and mild users out of the market. This is depicted in a study

conducted by Grossman, 1989, where it is proven that the use of alcohol by youths

is inversely related to the prices of alcoholic beverages (Michael & Grossman,

1989).

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5.3 SAVING ON PRODUCTIVITY LOSS

In 2013, the first comprehensive report was done to investigate costs of

smoking at the workplace in the United States (Berman, Crane, Seiber, & Munur,

2013)

TABLE 5.2: COST OF SMOKING INCURRED BY EMPLOYERS

United States (USD)* Singapore (SGD)**

Smoking Breaks $3,077 $3,077 x 1.25 = $3,846.25

Health Insurance $2,055 -nil-

Absenteeism $517 $517 x 1.25 = $646.25

Total estimated costs ~$5,816 ~$ 4,492.50

* Figures for United States are referenced from the report Tobacco Control. ** Figures for Singapore are estimated costs based on current exchange rate USD1=SGD1.25

Table 5.2 shows that it is more expensive to hire smokers since they incur costs

in the form of smoke breaks, health insurance and absenteeism. There is no

comprehensive study that calculates the cost of smoking to employers in Singapore.

However, one can use the associated figures from Tobacco Control as a proxy to the

Singapore context.

Healthcare insurance is usually not directly provided by companies in

Singapore. Instead, companies can opt to contribute to their employees Medisave

accounts, at a pre-determined rate, for both smoking and no-smoking employees.

Therefore there are no healthcare insurance costs in Singapore context. Assuming

smokers from both countries take similar smoking breaks and absenteeism from

work, each Singaporean smoker will cost their bosses an estimated $4,492 more

than their non-smoking coworkers.

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With the tax hike, smoking at the workplace will be reduced. We assume equal

proportions of both types of smokers since there are no official statistics available.

As per earlier analysis, the social smokers will cut out smoking completely due to

higher prices but the regular smoker will not. The benefit of the tax is thus savings

of $4,492 / 2 = $2,256 per smoking employee to the average firm.

5.4 FEWER EXTERNALITIES

Tobacco products and alcoholic beverages are deemed as demerit goods,

because of the negative externalities generated. Negative externalities occur when

third parties, who are not involved in the production and consumption of the good,

incur external costs and are not compensated.

With fewer drinkers and smokers, it would lead to a fall in negative externalities

on the whole. These could include lower crime rate, fewer road accidents, lesser

vandalism and even an overall drop in disruptions in society.

5.4.1 FEWER TRAFFIC ACCIDENTS

Research has indicated that higher alcohol taxes affect not only alcohol

consumption but also various alcohol-related problems as well. One example would

be traffic fatalities.

There have been numerous studies investigating the relationship of alcohol

taxes and traffic fatalities. With U.S. data from 1982 to 1988, a study has confirmed

findings that a higher alcohol tax is associated with lower rates of traffic fatalities.

(Ruhm, 1996) This means that higher alcohol taxes are indirectly linked to lower

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traffic fatality rates. They found that for every 1% increase in the price of beer, the

traffic fatality rates fell by the same proportion.

TABLE 5.3 ROAD ACCIDENT CASUALTIES AND CASUALTY RATES

Source: Singapore Police Force, 2012

The table above shows that Singapores road accident rates for a 10-year period

have been steadily decreasing. For a conservative estimate, we take the average of

the 10-year period and arrive at 2.33 casualties per 10,000 vehicles. After taking into

account the 25 % increase in alcohol tax, the eventual retail price for beer increased

by 24%. When coupled with results that a 1% increase in price of beer causes a

corresponding fall in traffic fatalities, then the traffic fatality rate is calculated to fall

to 1.77/10,000 vehicles. Thus the benefit of this tax is the additional 0.55 lives

gained from lesser traffic fatalities. We use the same measure for the value of one

life ($1.45million), arriving at the equivalent of $0.79 million.

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5.4.2 LESSER AIR POLLUTION

Air pollution that caused by smoking is known as Environmental Tobacco

Smoke (ETS), which is actually the smoke from other people's cigarettes.

Secondhand smoke is the combination of smoke from the burning end of a cigarette

and the smoke breathed out by smokers. Secondhand smoke contains more than

7,000 chemicals. Hundreds are toxic and about 70 can cause cancer.

According to Pope (2002), an elevation of 10 mg/m3 of long-term exposure to

fine particle air pollution (particulate matter (PM2.5)), including that from tobacco

smoke, is associated with 6%, 9% and 14% increased risk for all cause,

cardiopulmonary and lung cancer mortality respectively.

With lesser smoking, emission of PM2.5 into the air will be lesser.

5.5 REDUCTION OF EMOTION DISTRESS

When a family member falls sick, it is human nature that the whole family gets

emotionally affected. Such a spillover phenomenon becomes a social cost when the

family members of those who are suffering the consequences of smoking and

excessive drinking become upset, depressed or absent-minded. The health condition

of one person in a family could have a multiplier effect that decreases other

members productivity and physical wellbeing, of which the extent and value is

beyond the scope of this paper.

26

6. CONCLUSION

As is with the case of other government policies, the increase in excise duties

on tobacco and alcoholic products introduced in Budget 2014 has various costs and

benefits incurred by targeted individuals and the society as a whole.

For individual smokers, the 10% tax increase will raise the cost of lighting up

each cigarette, especially among addicted smokers whose demand curves are

inelastic; therefore resulting in loss of consumer surplus and disutility. Non-addicted

smokers are predicted to consume fewer tobacco products at the cost of foregone

enjoyment. As the non-addicted adjust their consumption pattern, it is possible that

they bear the cost of fewer smoking-related social opportunities. On the other hand,

both types of smokers enjoy the personal savings on cigarette consumption and

ensuing reduction in health risks in the long term, where demand curves are

relatively elastic.

For individual drinkers, they can obtain less consumer satisfaction since less

liquor can be bought given the same budget. With its most pronounced effect on

excessive drinking, the liquor tax forces binge drinkers to give up some, however

minor, personal satisfaction associated with the social perception of being able to

drink. In terms of cost, first and foremost, it should not be neglected that the tax

could discourage normal and healthy consumption of alcohol, resulting in foregone

health benefits, such as lower risk of cardiovascular diseases. Besides, for those

drinkers on track to developing alcohol use disorder, the tax increase deters the

development of an addiction and brings them many benefits, including reduced

health risks, saving on consumption, and preservation of working ability. Moreover,

27

for who have yet developed a habit out of drinking but are indeed consuming

alcohol excessively, the benefit is mainly realized in health benefits.

From a social perspective, the increase in sin tax could substantially reduce

the profit margin of small and medium enterprises that rely on the sales of cigarettes

and alcohol, as the enterprises are unable to shift the major part of the tax burden to

consumers. Therefore, companies that are more flexible in absorbing the tax could

tap on this opportunity to drive out their competitors, resulting in market

inefficiency. Besides, both tax increases, to some extent, cause decrease in supplier

surplus and give rise to deadweight losses. Moreover, the tax on tobacco, to be

specific, is expected to add to the prevalence of black market trading, therefore

leading to tax evasion. There is also law enforcement cost incurred by the

government to regulate against tobacco smuggling. Furthermore, the increases in

excise duties drive a wedge between the already wide income gap between those

who consume cigarettes and alcohol and those who dont.

In terms of social benefits, the tax change is expected to add an additional 200

million to the governments budget, which would be presumably well spent to

improve the society. Secondly, the rising costs reduce the prevalence of smoking

and drinking. Since many new entrants are likely to place substantial value on the

social benefits of these demerit goods, fewer smoking buddies and drinking

buddies are expected to deter new entrants through negative multiplier effect.

Thirdly, for companies who hire smokers that cut down smoking due to the sin tax

policy, the time wasted and productivity lost is saved. Last but no least, fewer

externalities, including road accidents, air pollution, and emotional distress, will be

curbed to a certain extent thanks to the policy.

28

Despite the indicative calculations and estimations in this paper, it is

recommended one that aims to evaluate the costs and benefits of such tax increases

should conduct more robust data collection and quantitative analyses. Nonetheless,

this paper has dedicated its effort in providing a preliminary and comprehensive

cost-benefit analysis of the issue at hand.

29

APPENDIX:

INDIVIDUAL CONTRIBUTIONS

** Due to final restructuring of contents and editing, the individual sections of

the report no longer exactly coordinates with what is initially stated below in this

appendix.

Liang Tian:

Explored the costs and benefits to individual smokers. Identified the different

types of smokers and drafted the demand curves that they face, and thus the slightly

differentiating costs that they face, from their respective perspective. And then

discussed the benefits to be enjoyed by smokers as a result of this tax hike.

Jensen:

Researched and examined the individual perspectives of a drinker, and

categorizing them clearly for better understanding. Analyzing the costs and benefits

faced by them as a result of the tax rise, which stretches beyond what conventional

economic theories can predict.

Soo Yue:

Reviewed different articles to gain a comprehensive scope of the impacts of a

vice tax increase on society, and applying it into Singapores context. She discussed

mainly on the social costs incurred from the tax increase of tobacco and liquor. And

used economic theories to explain certain inclinations of the economy.

30

Jamie:

Her focus area is on the social benefits of this recent sin tax hike. With several

references to different sources, examples were given to back up discussions. Taking

on the macroeconomic perspective, she listed the improvements to be enjoyed in

Singapore if the sin tax rise is to be effective.

Li Ting:

She compiled and edited the works of the above four members to ensure the

coherence within and across the different sections, to avoid any contradictions or

overlaps. Makes sure that each part is communicated effectively, which adds to the

overall soundness of the analysis of this paper.

Alan Dai Sheng

He edited the paper for the final round; verified key arguments and reasoning

presented; and made necessary changes, such as adding in novel content,

restructuring contents, and substantiating argument. He also wrote the Introduction

and Conclusion to give readers a clear direction and summary of the paper. On top

of that, he works on the cover, content and bibliography pages, and produce the final

presentation of our term paper.

31

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