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The role of tobacco price on The role of tobacco price on consumptionconsumption

Dr. Corné van WalbeekDr. Corné van WalbeekSenior Lecturer, School of EconomicsSenior Lecturer, School of EconomicsUniversity of Cape TownUniversity of Cape Town

Two important principles of Two important principles of economicseconomics

1.1. The law of demandThe law of demand– As the price of a commodity increases, people are As the price of a commodity increases, people are

going to consume less of the product, all other factors going to consume less of the product, all other factors held constantheld constant

– By how much will consumption decrease? Not specifiedBy how much will consumption decrease? Not specified

2.2. Price elasticityPrice elasticity– By how much does consumption decrease if the price By how much does consumption decrease if the price

increases by one per cent?increases by one per cent?

– Distinguish between relatively Distinguish between relatively elasticelastic ( (εε > 1) and > 1) and relatively relatively inelasticinelastic ( (εε < 1) demand < 1) demand

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More about price elasticityMore about price elasticity

• If price elasticity = 0.6, If price elasticity = 0.6, – For every 1 per cent increase in price, consumption For every 1 per cent increase in price, consumption

decreases by 0.6 per centdecreases by 0.6 per cent– For a 10 per cent increase in price, consumption For a 10 per cent increase in price, consumption

decreases by 6 per centdecreases by 6 per cent

• Estimates of price elasticity around the world:Estimates of price elasticity around the world:– Developed countries (Developed countries (εε of about 0.4) of about 0.4)– Developing countries (Developing countries (εε between 0.4 and 0.8) between 0.4 and 0.8)– South Africa (South Africa (εε between 0.6 and 0.8) between 0.6 and 0.8)

3Chaloupka and Jha, 2000 and Van Walbeek, 2005

How does this work in practice?How does this work in practice?

• Higher prices:Higher prices:– discourage smokers from starting to smokediscourage smokers from starting to smoke– encourage some smokers to quitencourage some smokers to quit– reduces the average number of cigarettes smoked by reduces the average number of cigarettes smoked by

smokerssmokers

• Based on SA data, a 10 per cent increase in Based on SA data, a 10 per cent increase in cigarette prices reduces cigarette consumption cigarette prices reduces cigarette consumption by about 6 per centby about 6 per cent– Number of smokers decreases by about 3 per centNumber of smokers decreases by about 3 per cent– Average consumption by remaining smokers decreases Average consumption by remaining smokers decreases

by about 3 per centby about 3 per cent

4Van Walbeek, 2005

Trends in cigarette consumption Trends in cigarette consumption and smoking prevalenceand smoking prevalence

19931993 20032003Cigarette consumption Cigarette consumption (millions of packs)(millions of packs)

18021802 12101210

Per capita consumption Per capita consumption (packs p.a. aged 15+)(packs p.a. aged 15+)

72.672.6 40.640.6

Smoking prevalence Smoking prevalence percentage (15+)percentage (15+)

32.632.6 23.823.8

Average consumption Average consumption per smoker (packs p.a.)per smoker (packs p.a.)

223223 163163

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Van Walbeek, 2005

Which demographic groups are Which demographic groups are most affected by excise tax most affected by excise tax

increases?increases?• International experience:International experience:

– Price elasticity of demand among youth is 2-3 times Price elasticity of demand among youth is 2-3 times higher than among adultshigher than among adults

– Poorer groups are more price sensitive than richer Poorer groups are more price sensitive than richer groupsgroups

• Changes in South African smoking prevalenceChanges in South African smoking prevalence

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19931993 20002000 ChangeChange

MaleMale 51.4%51.4% 43.8%43.8% -7.6%-7.6%

FemaleFemale 12.9%12.9% 11.7%11.7% -1.2%-1.2%

Aged 16-24Aged 16-24 24.0%24.0% 18.7%18.7% -5.3%-5.3%

Aged 50+Aged 50+ 23.4%23.4% 22.5%22.5% -0.9%-0.9%

Lowest income groupLowest income group 29.4%29.4% 23.5%23.5% -5.9%-5.9%

Highest income Highest income groupgroup

28.1%28.1% 31.0%31.0% +2.9%+2.9%

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The South African experienceThe South African experience

The role of governmentThe role of government

Government imposes excise and other sales Government imposes excise and other sales taxestaxes– Industry passes the higher tax onto consumers in form Industry passes the higher tax onto consumers in form

of higher retail pricesof higher retail prices

Total tax burden as a percentage of the retail Total tax burden as a percentage of the retail priceprice

8Yurekli, unpublished data

CountryCountry Tax Tax burdenburden

CountryCountry Tax Tax burdenburden

CountryCountry Tax Tax burdenburden

IsraelIsrael 84%84% GhanaGhana 63%63% ZimbabweZimbabwe 38%38%

NorwayNorway 81%81% JapanJapan 61%61% CameroonCameroon 33%33%

UKUK 80%80% South AfricaSouth Africa 52%52% NigeriaNigeria 32%32%

AustraliaAustralia 77%77% EthiopiaEthiopia 50%50% UgandaUganda 32%32%

SpainSpain 75%75% MozambiqueMozambique 48%48% Congo Congo Rep. Rep.

32%32%

NetherlandsNetherlands 73%73% MalawiMalawi 47%47% NamibiaNamibia 21%21%

How high should the tax burden How high should the tax burden be?be?

• World Bank guideline:World Bank guideline:– 75 per cent of retail price75 per cent of retail price

• European Union rule:European Union rule:– At least 57 per cent of retail priceAt least 57 per cent of retail price

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The government benefits hugely from The government benefits hugely from increases in the excise taxincreases in the excise tax

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The role of the industry: The role of the industry: An unlikely “ally” in the fight against tobaccoAn unlikely “ally” in the fight against tobacco

ConclusionConclusion

• Despite its addictiveness, tobacco obeys the law Despite its addictiveness, tobacco obeys the law of demandof demand

• In most developing countries a 10 per cent In most developing countries a 10 per cent increase in retail price reduces consumption by 4 increase in retail price reduces consumption by 4 – 8 per cent– 8 per cent

• Government is able to influence the price by Government is able to influence the price by raising the excise taxraising the excise tax

• In SA (and many other countries) industry typically In SA (and many other countries) industry typically pass more than the tax increase onto consumerspass more than the tax increase onto consumers

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