The demand for cigarettes and other tobacco products. Anne-Marie Perucic Tobacco Control Economics Tobacco Free Initiative WHO

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1 The demand for cigarettes and other tobacco products Anne-Marie Perucic Tobacco Control Economics Tobacco Free Initiative WHO

2 Price (tax) increases and tobacco use in the words of the tobacco industry Jeffrey Harris of MIT calculated that the [US] 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). 2

3 The importance of prices for the tobacco industry Cigarette Company Marketing Expenditures, by Type United States, Source: Chaloupka for an upcoming WHO publication 3

4 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 4

5 Tobacco taxes/prices and demand

6 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 6

7 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) 7

8 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 8

9 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 9

10 Prices, demand and lung cancer deaths Cigarette Prices, Cigarette Consumption, and Male Lung Cancer Deaths France, Number cigarettes/adult/day 300 Number/adult/day Lung Cancer Deaths: males age 35-44/4 Relative Price Price/Deaths (% Relative to 1980) Source: Jha, Year 10

11 Tobacco taxes and prevalence UK example GBP % Real excise tax yield (GBP per 1000 cigarettes) Smoking prevalence, males Source: Excise tax yield: EU TAXUD; Prevalence: Cancer Research UK 11

12 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

13 Price elasticity of demand Formula: Q p / / Q P = Q P 2 2 Q P 1 1 P Q 1 1 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 13

14 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 14

15 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 15

16 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) 16

17 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) 17

18 Price elasticity estimates Estimates from countries in the EU: United Kingdom: to (2006, aggregate data) Sweden: (2004, long-run, aggregate) Netherlands: to (2000) Italy: (2009, aggregate) to (short run) to (long run) Estonia: (2004, survey data) Poland: -0.4 (short run), -0.7 (long run) (2004, survey data) 18

19 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 socioeconomic 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 19

20 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 = = 7.5 Eur Market impact: consumption goes down to Q2 = 87,000 packs Price elasticity: Q P 1 100,000 87,000 6 = , = 2 Q P 1 P Q

21 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 21

22 Government revenues

23 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 23

24 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 24

25 Example Q2 = 87,000 packs; P2 = 7.5 Eur; t2 = 5 Eur Price-elasticity = Tax increase to t3 = 6.5 leads to P3 = 9 => price increase = 20% The impact on consumption: Price-elasticity x price change = 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% 25

26 Tobacco and poverty

27 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 27

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29 But poor are more sensitive to price changes 29

30 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 Total price elasticity 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% Rich -0,45-0,37-0,82 Total -0,40-0,47-0,87 Source: Onder & Yurekli

31 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 31

32 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 32

33 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 33

34 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 34