I was reading last weekend’s (12-13 November) Financial Times when I saw an article by Tim Harford entitled “Taxing my music can’t be good, can it?” Mr. Harford is a columnist for the paper and an economist whose forte seems to be microeconomics, especially how it pertains to and drives individual decision making. He notes the the UK Treasury, starting next April, will not allow exemptions from VAT (value added tax) for low value goods shipped from the Channel Islands. This was allowed because, it was thought, the record keeping and collection of small sums made the administrative task so unwieldy as to make it not worth the trouble. Of course, this was the law before Amazon and other large online stores existed. Naturally, they located in the Islands of Jersey or Guernsey. Thus, the absence of tax drove a huge fulfillment business in what can confidently be called one of the last places this business should be started (expensive land, limited transport, and expensive workforce to name three strikes against it). Harford notes, that with a level playing field, this business will quickly shift to the UK mainland, operated by Amazon or its competitors and the jobs lost in Jersey will be added in new locations.
The same thinking can be used to encourage the decline in tobacco use in South Africa. The case (Tobacco Control in South Africa, Harvard Case Study) notes that cigarette consumption increased 139% (predominately among Black South Africans) from 1970-1990 and by 1993, 33% of adult South Africans smoked. Around the same time the real excise taxes levied had fallen 82% and there had been a 32% decline in the real retail cigarette prices. As seen in the above paragraph this is a situation ripe for changing peoples’ behavior with the use if taxes.
The case notes that the price elasticity of demand, as calculated by the Economics of Tabacco Control Project, is estimated to be -.59 in the short run and -.69 in the long run. Other studies (mentioned in van Walbbek 2001, WHO study) place the price elasticity between -.5 and -.7. What this means is that a 10% increase in the real price of cigarettes will result in a 5-7% reduction in cigarette consumption. The ANC, newly elected, decided to increase the tax on cigarettes.
The effect of the tax increase was dramamtic. According to Statistics South Africa (van Walbeek) from 1985 to 1995 the real excise tax dropped from R (rand) .91 to R.75. Cigarette consumption went from 1571 (millions of packs) to 1708. Excise revenues dropped to R1287 (millions of rands) from R1425. From 1995 to 2001, the excise tax increased to R1.99, consuption of packs decreased to 1272(millions of packs) and real excise taxes doubled to R(millions of rands) 2540. Van Walbeek notes that smoking prevalence has decreased from 33% in 1993 to 27% in 2001. He further adds that from 1994-2001 for every 10% increase in the real excise tax, real revenues increased 6%. The article states that young people tend to be more responsive to price increases which can have a greater impact on someone picking up a lifelong habit.
What has happened since 2001? Tobacco use has fallen among adult smokers to 24.1% of the population by 2004 (Saloojee 2005). He notes that it is still a high percentage and various age, gender, and racial groups have widely varying rates of tobacco use. Also worrying is the use of other tobacco products, especially women using snuff, which has a different tax regime tan cigarettes.
What about the tobacco industry claims that increased taxes will cost the country jobs and revenues and will increase cigarette smuggling? The first isuue is dealt with pretty easily. The Medical Research Council (Saloojee 2005) estimates that the use of tobacco costs South Africa twice as much im medical costs and reduced productivity as it generates in taxes. And, of course, if the money isn’t spent on tobacco it is spent on other things thereby increasing econmic activity. Van Walbeek notes that the industry itself has sharply raised their prices as the government incresed their taxes. This has helped profitability of the industry as has the savings of now prohibited promotion and advertising. Thus, the industry higher real prices have had the effect of limiting consumption as well thereby contributing to a shrinking industry. Finally, the issue of smuggling is a real one but the nature of the South African market helps control it. Since British American Tobacco (BAT) controls over 95% of the market, Philip Morris (Altria) , whose largest selling brand is Marlboro, has a very small market share. If this brand was the preferred smuggled brand, the industry, to preserve their market share, has a big incentive to try to prevent smuggling.
So, have taxes been a solution for tobacco control? Yes, they have contributed to a marked decline in cigarette consumption. However, restrictions and prohibitions in advertising and promotion, prohibition of smoking in the workplace and public places and education campaigns directed especiall at young people and pregnant women have contributed to this reduction in tobacco use.
Tim Harford, Financial Times, Nov 11, 2011 “taxing my music can’t be good, can it?”
Corne van Walbeek, 2002 “Tobacco Excise Taxation in South Africa” WHO publication
Yessef Saloojee, 2005 “Tobacco Use in South Africa”