Building a bridge between Ministry of Health (MoH) & Ministry of Finance (MoF) for tobacco taxes Ayda A. Yurekli, PhD Coordinator Tobacco Control Economics Tobacco Free Initiative WHO Asian Focal Points for Tobacco Control Meeting, Bangkok, September 5, 2011
Why Tax Tobacco? Two major reasons MoH & MoF Promote public health Raise revenue
Tax tobacco products Promote public health "The Parties recognize that price and tax measures are an effective and important means of reducing tobacco consumption by various segments of the population, in particular young persons. (WHO Framework Convention on Tobacco Control, Article 6)
Health effects of tax & price increases Tax and price increases Induce current users to try to quit Keep former users from restarting Prevent potential users from starting Reduce consumption among those who continue to use
Objectives of Public Health With respect to reducing consumption by tax policy 1. Retail price increases via tax increases 2. Price gap among price bands reduces, so that 1. Substitution from high to cheap cigarettes is reduced 2. Expected reduction by quitting or reducing level of consumption is achieved
Excise and Retail Price in 2010 Source: WHO Report on the Global Tobacco Epidemic, 2011
Most Popular is often Mid Priced Brand Retail prices of most popular, the cheapest and Marlboro brand in 2010 14 12 10 8 6 4 2 0 Australia Singapore New Zealand Retail Price for Most Popular USD Retail Price for the Cheapest USD Retail Price for Marlboro USD Japan Malaysia Rep. Korea Brunei D. Mongolia Viet Nam China Lao PDR Philippines Cambodia Source: WHO Report on the Global Tobacco Epidemic, 2011
Establishing communication channels with MoF for tobacco control & taxes It is useful to understand The composition of price structure By price bands Types of taxes and their impact on price Existing types of tobacco products in the market and how they are treated in the tax system MoF's concerns with respect to tax increases & earmarking Administration capacity of the tax officials How to claim the costs associated with Tobacco Attributable diseases to health care system Smuggling problem
Structure of the price of a domestic cigarette RETAIL PRICE wholesale price (or ex-factory price) producer price TOTAL TAX SPECIFIC EXCISE AD VALOREM EXCISE VAT or SALES TAX production costs industry profit EXCISE TAX wholesale margin retail margin
Types of taxes imposed on tobacco products Excises Specific based on quantity (e.g. $1.50 per pack regardless of price) Ad-Valorem based on value (e.g. 45 percent of the manufacturer s price) Hybrid taxes both specific and ad-valorem VAT or Sales Taxes Customs Duty
It is essential to know how to impose types of excise taxes based on country situation Especially which excise would help achieving higher revenues while reducing consumption
Pros & Cons of Types of Excises Higher prices Incentive to increase manufacturer s price Ad valorem No: Due to multiplier effect as part of any increase in the consumer price goes to the government as tax revenue. Specific Yes Any increase in price goes to manufacturer as revenue Keeps up with inflation Better than specific. No unless automatically adjusted by the inflation rate Incentive to improve quality & variety of products No due to multiplier effect Yes
Pros & Cons of Types of Excises Ad valorem Specific Administration Difficult than specific Easier to administer Good for weak administration Easy to determine value Higher tax revenue No: Impose it on maximum retail price no guarantee (inflation, price wars etc): minimum price may be required Yes: requires a precise definition of what constitutes one unit of quantity. Yes & also protects the revenues from price wars or reductions Gives protection to domestic (cheaper) brands Yes No, unless unified specific rate is levied
Tax base Administrat ive requiremen ts Specific Excise Per unit of products (e.g., per 1000 ) Ad valorem excise The value of the products. The excise can be applied on the retail sales price, or the ex-factory price. Ad valorem with specific floor The excise is calculated on an ad valorem basis; however, if the calculated tax falls below a specified minimum floor, a specific tax rate applies. Mixed specific and ad valorem excise Both ad valorem and specific excises are applied. The tax should be collected at the point of manufacturing and on imports Low as only the volume of the products has to be ascertained The administrative burden can be high The administrative burden can be high The administrative burden is high as it requires assessing and collecting both ad valorem and specific excises. Undervalua tion Not an issue. The excise regime is susceptible to undervaluation. This can be overcome by prescribing a minimum retail sales price. This provides an easy tool to prevent the most blatant examples of undervaluation The ad valorem part of the excise collections is susceptible to undervaluation.
Specific Excise Ad valorem excise Ad valorem with specific floor Impact on product quality Upgrading effect tend to reduce the relative tax on high quality products. Multiplier effect provides a disincentive to costly quality improvement. Impact on price Tends to lead to higher prices, particularly for low-priced cigarettes. Tends to lead to lower prices (price reductions will be subsidized if the multiplier effect is strong. Tends to lead to higher prices for low-priced cigarettes. Inflation The real value of the excise will be eroded unless adjusted in line with inflation. The real value of the excise will be preserved as prices increase; at least, to the extent that tobacco prices follow inflation. The real value of the specific floors will be eroded over time unless adjusted in line with inflation. Health benefits The tax will discourage the smoking of tobacco products irrespective of the price. The tax may encourage trading down in favor of cheaper cigarettes; these potentially could have a worse health and revenue impact.
Existing tobacco products Problems: Protectionism Many governments try to levy lower taxes by differentiating taxes for other tobacco products Some gives tax exemption to a certain part of production of other tobacco products Many faces huge tax avoidance that costs to tax revenues. Best Practice: All tobacco products are equally harmful & should be treated equally in the tax system Poor can be supported better by tax revenues not by tax rates
Concerns with the differential excise system Public Health Concern Lead to other changes in tobacco use behavior & undermines the full impact of higher taxes on consumption. substitution to cheaper products or brands Revenue Concern Reduced expected revenue Changing market structure of brand share
Concerns for higher taxes As consumption reduces, the revenues decreases FALSE As tax increases, smuggling increases Partly true But Level of smuggling cannot be explained entirely by taxes.
Tax tobacco products Raise revenue Efficient revenue generation Historically, the primary motive - still true in many countries today Very efficient source of revenue given: Low share of tax in price in most countries Relatively inelastic demand for tobacco products Few producers and few close substitutes, in general
Not a strong link between higher prices/taxes and the level of smuggling Arithmetic Means of % of Smuggling in 2009 & Retail Price for Most Popular Brands in 2010 by Income Group price USD % smuggling 35% 11% 16% 13% 26% $6.00 % of smuggled cigarettes in the market 30% 25% 20% 15% 10% 5% 0% $5.65 $2.08 $1.04 $0.95 HI UMI LMI LI $5.00 $4.00 $3.00 $2.00 $1.00 $0.00 MPB Retail Price/pack USD Source: Estimated by Author by using WHO GTCR 2011 and Euromonitor data 2011
Government commitment is the key for tackling smuggling Duty paid sales billion pieces 100 95 90 85 80 75 70 65 60 55 50 84.5 59% Spain: Total sales, contraband and tax incidence Duty paid % of contraband Total tax incidence 17.5% 90.3 78% 1% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Souce: Author's estimation by data from ERC 2010, Euromonitor 2011 25% 20% 15% 10% 5% 0% % share of contraband in duty paid sales and total tax share in retail price
Better Tax Practice: Malaysia 12 10 8 6 4 2 Average retail price/pack Excise tax/pack Producer Price/pack Total tax/pack 0 2004 2005 2006 2007 2008 2009 2010 Source: Calculated by using data by Euromonitor 2011& TMA 2011
Has the smuggling been increasing in Malaysia? Why do manufacturers produce more than market can absorb? Consumption A (Production + Import - Export) Consumption B including illicit cigarettes Legal Sales % illicit (Consumption B - legal sales) 30000 % of illicit in (ConsumptionA - Consumption B) 40% Consumption and Legal Sales 25000 20000 15000 10000 5000 35% 30% 25% 20% 15% 10% 5% 0% -5% Illicit trade % 0 2005 2006 2007 2008 2009-10% Source: Estimated using Euromonitor data 2011
Conclusion MoH may lead to multi-sectoral collaboration in the government for tobacco control Although revenue generation is the focus, MoF is also sensitive to public health concerns Therefore, Reaching out MoF is the key for better tobacco tax policy implementation Speaking MoF's language is important but it is equally important to understanding MoF's concerns & constraints and finding solutions within the government