Why People Smoke?
People smoke because they like to smoke and they can afford to smoke. Their decisions to buy cigarettes are influenced by price of cigarettes and their available income. Economists describe affordability as the percentage of a worker’s income or duration of work time required to buy the product.
The more income required for purchasing cigarettes the less affordable cigarettes are. Also the more one must work to earn money to buy cigarettes; the lower is the demand for cigarettes.
Even though cigarette prices are much higher in high-income countries, cigarettes on average are affordable due to their higher income. In low-and middle-income countries, cigarettes are generally becoming more affordable as economies develop and increase in income per capita increases. The growth in average income is significantly contributing to higher demand for cigarettes.
How To Make Cigarette Less Affordable?
“If real cigarette prices do not rise faster than consumer purchasing power tobacco becomes relatively more affordable and consumption increases.” WHO reported on the global tobacco epidemic, 2011. Purchasing power reflects the affordability to purchase things. If real income raises faster then the real cigarette prices, hence cigarettes become more affordable. Consumption of cigarettes is expected to increase. The best way to make cigarette less affordable is to increase cigarette taxes and prices.
“Among the revenue proposal I have examined, tobacco taxes are especially attractive because they encourage smokers to quit and discourage people from starting to smoke. It also generates significant revenues. It’s a win-win for global health.” Bill Gate, G20 Summit, France, 2011.
From the economic perspective, taxation is one of the effective methods to deter smoking. Increases in cigarette taxes lead to higher cigarette prices. Higher cigarette prices reduce cigarette consumption, encourage smokers to quit and prevent initiation among youth.
There are two types of excise taxes; unit tax or ad valorem tax. Regardless of price, unit tax is a fixed amount of tax such as a specific amount of tax per pack or per 1000 sticks. Ad valorem tax is a percentage of the value of the product at retail price. Premium brands would pay higher tax than lower priced brands such as the generic brands. Therefore, smokers may have the choice to substitute for cheaper brands. On contrary, if unit tax is levied, premium and lower priced cigarettes will consequently pay the same amount of tax.
Cigarette tax is collected from cigarette manufacturers or cigarette importers. There are two different tax structures for domestic and imported cigarettes. Excise tax per stick is levied on locally produced cigarettes sold in Malaysia, while import duty is levied on imported cigarettes. Both domestic and imported cigarettes are subjected to sales tax.
In economic model, excise taxes on cigarettes are passed to the consumer in terms of higher price. In Malaysia, the increase in retail price of cigarette is more than the increase in the excise tax. This is because the tobacco company has to consider other factors such as trade margin, royalties and inflation.
Table 1 shows that excise tax and the import tax imposed on cigarettes are increasing. However, the sales tax remained fixed at 15% from 1990 to 1999 and increased to 25% from 2001 to 2007.
Table 1: Cigarette Taxes 1990 – 2010
|Year||Import Tax||Nominal Excise Tax||Sales Tax|
|(RM/kg or RM/stick)||(RM/kg or RM/stick)||( % )|
*Specific tax per stick was introduced (1 kg = 1100 sticks)
Source: Royal Custom Malaysia and Confederation of Malaysia Tobacco (CMTM), various years
Studies done in Malaysia found that a 10% increase in cigarette prices reduces cigarette demand by four percent to nine percent . Even though higher excise tax rate on cigarette has continually increased the cigarette retail price but it leads to only a slight decrease in cigarettes consumption.
Figure 1: The relationship among excise tax rate, retail price and consumption of cigarette.
It shows that demand for cigarette in Malaysia is inelastic. Inelastic demand means consumers are not very responsive to changes in price. It may be due to less awareness of the effect of cigarette on health, addiction and perhaps availability of illegal cigarettes as substitutes.
However in addition to reducing cigarette consumption, higher cigarette taxes increase tax revenue. It is estimated that an increase of 10 percent in cigarette tax would lead to an increase of almost seven percent in government revenue (World Bank, 1999). Figure 2 shows a positive relationship between excise tax rate on cigarette and the tax revenue generated by the government.
Figure 2: Tax Revenue and Excise Tax Rate in Malaysia (1980 – 2009)
Increase in excise tax has a significant effect in reducing cigarette consumption but the inelastic demand for cigarette will continue to generate higher tax revenue to the government. This is a win-win situation for the policy maker.
Optimal Cigarette Tax
Currently the proportion of tax rate to a retail price of cigarette is only about 52%. It is still lower than 65% suggested by the Frame Convention on Tobacco Control (FCTF). The government should continuously increase the excise tax rate on cigarette. Therefore, estimation of an optimal tax rate is important. Theoretically if the current tax rate is below the optimal level, government should continually increase the excise tax rate on cigarettes. Higher tax rate will not only further reduce the consumption of cigarette but will also generate more revenue to the government.
Earmarking of the expected revenue from the optimal cigarette tax can be channeled to finance several tobacco control activities. Many countries have used part of the revenue from cigarette taxes to support anti-smoking activities; such as health education programs, medical research on tobacco related diseases and anti smoking media campaigns.
- WHO (2011), WHO report on the global tobacco epidemic, 2011: warning about the danger of tobacco. http://whqlibdoc.who.int/publications/2011
- World Bank. 1999. Curbing the epidemic: governments and the economics of tobacco control. Series: Development in practice. Washington DC: The World Bank, URL: http://www1.worldbank.org/tobacco/reports.htm
- Norashidah M.N., (2011), “Cigarette Demand and Optimal Tax”. PhD. Dissertation, FEP, UPM.
|Last Reviewed||:||7 February 2017|
|Translator||:||Dr. Norashidah binti Mohamed Nor|
|Accreditor||:||Dr. Sallehudin bin Abu Bakar|