The demand for cigarettes and other tobacco products · The demand for cigarettes and other tobacco...

The demand for cigarettes and other tobacco products

Anne-Marie Perucic Tobacco Control Economics

Tobacco Free Initiative WHO

TobTaxy Capacity Building Workshop | 20-22 February 2012, Dublin, Ireland 2 |

– “Jeffrey Harris of MIT calculated that … the [US] 1982-83 round of price increases caused two million adults to quit smoking and prevented 600,000 teenagers from starting to smoke … We don’t need to have that happen again” (Philip Morris 1987).

– "Of all the concerns, there is one—taxation—that alarms us the

most. While marketing restrictions and public [sic] and passive smoking do depress volume, in our experience taxation depresses it much more severely. Our concern for taxation is, therefore, central to our thinking about smoking and health" (Philip Morris 1985).

Price (tax) increases and tobacco use … in the words of the tobacco industry


The importance of prices for the tobacco industry

Cigarette Company Marketing Expenditures, by Type United States, 1975-2008

Source: Chaloupka for an upcoming WHO publication


Overview

Tobacco taxes, prices and demand – Relation between tax and price – Responsiveness of demand to tax/price changes

Impact on government revenues

Tobacco and poverty

Tobacco taxes/prices and demand


Why economists care about tobacco taxes

Tobacco is NOT like most other products – Addictive – Very harmful to users and to others in society

Tobacco IS like other products – Its demand responds to

• price changes relative to the price of other products • real income changes • changes in tastes and preferences

– We can apply the lessons of economics to reduce its use

6


Few close substitutes

About 75% of tobacco leaves grown globally are used for cigarettes

Relatively small variety of tobacco products – Smoked: Cigarettes, Roll Your Own (RYO), Kreteks (clove

cigarettes), bidis, cigars, pipes, waterpies – Smokeless: Chewing tobacco (incl. Guthka), snuff (incl. Swedish

snus)


Taxes and prices

An effective tax increase should increase prices of tobacco products and make them less affordable

Tobacco industry is an oligopoly (large number of consumers and small number of producers)

– Industry tends to fully shift the tax increase to consumers rather than absorbing it,

– Often, we can see cases of overshifting (when the industry ends up increasing the price by more than the consequence of the tax increase to augment its profit margin),

• This is more the case in jurisdictions with specific excise taxes


Taxes, prices and demand

Increases in taxes that increase prices above inflation, will:

– Encourage some tobacco users to quit – Make some reduce their consumption – Prevent some formers users from starting again – Prevent some potential new users from taking up the

habit – When cheaper substitutable tobacco products/brands are

available, encourage some to substitute their consumption to those products/brands


Prices, demand and lung cancer deaths

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

1980 1985 1990 1995 2000 2005Year

Numb

er/ad

ult/da

y

50

100

150

200

250

300

Price/

Death

s (%

Relat

ive to

1980) Lung Cancer Deaths:

males age 35-44/4

Relative Price

Number cigarettes/adult/day

Cigarette Prices, Cigarette Consumption, and Male Lung Cancer Deaths France, 1980-2005

Source: Jha, 2009


Tobacco taxes and prevalence UK example

Source: Excise tax yield: EU TAXUD; Prevalence: Cancer Research UK

100

120

140

160

180

200

2003 2004 2005 2006 2007 2008 2009

GBP

1517192123252729

%

Real excise tax yield (GBP per 1000 cigarettes)Smoking prevalence, males


Prices and Consumption

Law of demand: all other factors held constant, the quantity demanded of a product falls as price rises

Higher taxes reduce tobacco consumption – By how much?

The Price elasticity of demand measures how much demand would change following a price change:

– % change in the number of cigarettes consumed that results from a one-percent increase in (the inflation adjusted) price of cigarettes.

12


Price elasticity of demand

Formula:

Sign: <0 because as P↑, Q↓ (and vice versa)

For e.g. a price elasticity of -0.4 indicates that as prices increase by 10%, demand will go down by 4%

13

1

1

12

12

//

QP

PPQQ

PpQQ

×−−

=∆∆


Relatively inelastic demand

Demand theory applies to tobacco products as well and consumption goes down when price increases

but because of addictive nature of tobacco products, tobacco demand is not very sensitive to price changes

– price elasticity is between 0 and -1 (its absolute value is smaller than 1) as % Δ consumption < % Δ price

– but as time goes by people adjust to a price change and are expected to reduce their consumption further

• In the long run, price elasticity is estimated to be higher (more sensitivity) than in the short run


Price elasticity

Total (own) price elasticity - the effect of cigarette price increase on the total amount of cigarettes bought

Combines – Effect of higher price on prevalence: how many

smokers stop smoking? – Effect on amount smoked by remaining smokers: how

many less packs per day

Demand will also be affected by changes in prices of alternative products such as fine cut tobacco for roll your own or pipes, or cigars or bidis etc

– Cross price elasticity

15


Price elasticity estimates

Estimates of price elasticites of cigarette demand in high-income ~ -0.4

For low and middle income countries, most estimates lie between -0.2 and -0.8

Effect of price: – Half is on smoking prevalence – Half on the intensity of smoking (quantity consumed)

(estimates of prevalence among adults)


Price elasticity data sources

Price elasticities can be calculated from two types of data sources: – Aggregate data (time series)

• Easy and not costly to collect • But cannot tell why consumption went down (reduction in smokers or reduction

in quantity smoked?) • Fail to provide insight in variations in age, sex, income and education

distribution in tobacco users • Looks only at the impact of change in prices on legal sales

– Survey (individual and household level) data: • Can separate the impact on consumption trough reduction in prevalence or

quantity used and measure reaction by socio economic status • Can capture total consumption (legal and illegal sales) and therefore the impact

of price changes on overall consumption • But are more costly and complicated to collect • And can suffer from reporting biases (people underreporting their consumption)


Price elasticity estimates

Estimates from countries in the EU: – United Kingdom: -0.41 to -0.48 (2006, aggregate data) – Sweden: -0.81 (2004, long-run, aggregate) – Netherlands: -0.45 to -1.03 (2000) – Italy: (2009, aggregate)

• -0.09 to -0.34 (short run) • -0.31 to -1.07 (long run)

– Estonia: -0.34 (2004, survey data) – Poland: -0.4 (short run), -0.7 (long run) (2004, survey data)


Price elasticity among the youth and the poor

Youth are more responsive to price increases – Most estimates lie between -0.5 and -1.2 in high-income

countries – Two to three times the estimates for adults

Tobacco use is inversely related to indicators of socio-economic status

– Responsiveness to price increases higher among the poor than the rich in high-income countries

– Less evident in other countries maybe due to extent of opportunity for tax avoidance and evasion


Example

Total consumption of cigarettes Q1 = 100,000 packs (20 cig)

Price (P1) = 6 Eur / pack Specific tax (t1) = 3.5 Eur

Tax increase of 1.5 Eur => t2 = 5 Eur

Tax fully passed on to consumer P2 = 6+1.5 = 7.5 Eur

Market impact: consumption goes down to Q2 = 87,000 packs

Price elasticity:

52.0000,100

665.7

000,87000,100

1

1

12

12 −=×−−

=×−−

QP

PPQQ


Income elasticity

Evidence suggests that income growth has also an influence on consumption (affordability)

– Most estimates of income-elasticity lie between 0 and 1 indicating that as income increases consumption will increase to a certain extent.

• Evidence of declining income elasticities in the USA

Government revenues


Efficient revenue generation

Historically, the primary motive - still true in many countries today

Tobacco taxes are a very efficient source of revenue given: – Low share of tax in price in most countries – Relatively inelastic demand for tobacco products

23


Efficient revenue generation: Relatively inelastic demand

Taxes increase prices, reduce demand

But if demand falls by more than the increase in price, tax revenues will decline

Relatively inelastic demand (e.g. -0.4) implies revenues actually rise.

A tax-induced increase in price – Reduces consumption : Win for public health – But reduces consumption by less than 10 percent: Win for tax revenues, certainly in the short and medium terms

24


Example

Q2 = 87,000 packs; P2 = 7.5 Eur; t2 = 5 Eur

Price-elasticity = -0.52

Tax increase to t3 = 6.5 leads to P3 = 9 => price increase = 20%

The impact on consumption: – Price-elasticity x price change = -0.52 x 20% = -10.4% – Q3 = Q2 –(10.4% x Q2 )= 77,952 packs

Revenue impact: – R2 = Q2 x t2 = 87,000 x 5 = 435,000 Eur – R3 = Q3 x t3 = 77,952 x 6.5 = 506,688 Eur – Revenue increase of 16% despite a decrease in consumption of 10.4%

Tobacco and poverty


Tobacco Taxes and the Poor

Regressive tax: A tax that takes a larger percentage of the income of low income groups than higher income groups.

Share of income spent on tobacco generally falls as income rises

• Implies tobacco taxes are regressive in that tax burden is greater on lower income

Prevalence of tobacco use is higher among the poor • Health burden of tobacco use also falls more heavily on lower income

persons • Tobacco use contributes to poverty


But poor are more sensitive to price changes


Higher price sensitivity among poor

Evidence from Turkey in 2003

Price Elasticity (sensitivity) in 2003 by expenditure group

Expenditure groups

Elasticity of smoking

participation

Conditional Demand elasticity

Total price

elasticity

The poorest -0,51 -0,60 -1,10

Poor -0,41 -0,58 -0,99

Middle -0,39 -0,46 -0,85

Upper Middle -0,41 -0,36 -0,77

Rich -0,45 -0,37 -0,82

Total -0,40 -0,47 -0,87

Total price elasticity -0.87

A 10% increase in tax would reduce consumption by 8.7%.

Within this reduction – 4% would quit smoking – Consumption would go down by

4.7%

Source: Onder & Yurekli 2006


Tax increases may be progressive

Lower SES populations are more price responsive

Tax increases

higher reductions among low SES where prevalence is highest

Higher impact in terms of life saving because mortality higher among low SES

– Implies tax increases may be progressive


Higher taxes are Pro-Poor Policy

Higher taxes lead to higher revenues which enables governments to allocate more tax revenues for social programs and health systems. This is a Pro-Poor Policy


Bottom line

Cigarette tax increases will NOT negatively impact on the lowest income populations

BECAUSE – Poor smokers bear disproportionate share of health

consequences from smoking and are more responsive to price increases

– Policy makers should consider progressivity or regressivity of overall fiscal system

– Negative impact can be offset by the use of new/extra revenue to support programs targeting vulnerable populations or protect funding for existing programs


Conclusions

There is a strong justification for taxing tobacco for the country's benefit (public health and economy):

– Tax increases raise prices in the tobacco sector – Price increases reduce consumption and improve health – And at the same time increases revenues

Price elasticity is an important instrument to measure the impact of tax/price increases on consumption

– The young and the poor have a higher price elasticity

Taxes are regressive but tax increases can be progressive

The demand for cigarettes and other tobacco products · The demand for cigarettes and other tobacco...

Documents

Transcript of The demand for cigarettes and other tobacco products · The demand for cigarettes and other tobacco...