POLICY NOTE IS TOBACCO TAXATION REGRESSIVE? EVIDENCE ON PUBLIC HEALTH, DOMESTIC RESOURCE MOBILIZATION, AND EQUITY IMPROVEMENTS Alan Fuchs, Patricio V. Márquez, Sheila Dutta, Fernanda González Icaza TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN POLICY NOTE IS TOBACCO TAXATION REGRESSIVE? EVIDENCE ON PUBLIC HEALTH, DOMESTIC RESOURCE MOBILIZATION, AND EQUITY IMPROVEMENTS Alan Fuchs, Patricio V. Márquez, Sheila Dutta, Fernanda González Icaza1 1 Fuchs: Poverty and Equity Global Practice, World Bank (afuchs@worldbank.org); Marquez: Health Nutrition and Population Global Practice, World Bank (pmarquez@worldbank.org); Dutta: Health Nutrition and Population Global Practice, World Bank (sdutta@world- bank.org); González Icaza: Poverty and Equity Global Practice, World Bank (mgonzalezicaza@worldbank.org). Support in the preparation of this policy note has been provided by the World Bank’s Global Tobacco Control Program, co-financed by the Bill and Melinda Gates Foundation and Bloomberg Philanthropies. The team wants to thank Enis Baris, Carlos Silva-Jauregui, Tim Evans, Olena Doroshenko, Irina Guban, Sevil Salakhutdinova, Alberto Gonima, Konstantin Krasovsky, Tatiana Andreeva Darko Paranos, Mikhail Matytsin, Cesar Cancho, Giselle del Carmen, Robert Zimmermann, and Daniela Paz for comments and contributions. The findings, interpretations, and conclusions in this policy note are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the countries they represent. This report was prepared over the March-April 2019 period and published on April 8, 2019, for distribution at the 4th Annual Health Financing Forum, organized by the World Bank Group, USAID and GFF in Washington D.C. on April 9-10, 2019. I TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN CONTENTS Abstract VII 1. Introduction 1 2. Health and Economic Impact of Tobacco Use 5 The Health Impacts of Tobacco Use 5 The Economic Burden of Tobacco 8 Policy Instruments for Tobacco Control 9 3. Taxing Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity 11 The Effectiveness of Taxes on Tobacco 11 Higher Tobacco Taxes Boost Government Revenues 12 Recent Country Experiences: Fiscal and Health Impact 13 Empirical Findings Contradict Traditional Arguments of Illicit Trade, Employment and Regressive Effects 20 The Price Elasticity of Tobacco Consumption 23 The Extended Cost Benefit Analysis Methodology 24 Costs of Tobacco Taxes: Short-Term Direct Price Effect (A) 25 Benefits of Tobacco Taxes: Reduced Medical Costs (B) and Additional Years of Working Life (C) 25 4. Empirical Results: Lessons from Country Case Studies 29 Chile 29 Indonesia 30 Bosnia and Herzegovina 31 Ukraine 31 Russian Federation 32 Moldova 32 Bangladesh 33 South Africa 33 New Comparative Evidence 34 Limitations of the Empirical Findings 35 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements 5. Key Takeaways 39 6. Conclusion 43 References 44 Annex 55 A. Model 55 Change in Tobacco Expenditures 55 Medical Expenditures 56 The Increase in Working Life Years 56 B. Tobacco Price Elasticity, by Decile 56 IV // Table of Contents LIST OF FIGURES Figure 1. Philippine Sin Tax Reform: Higher Tobacco Tax Revenue (As % of GDP) and Budgetary Allocation for Public Health 13 Figure 2. Results of Tobacco Excise Policy Reform in Ukraine, 2008-2018 14 Figure 3. Results/Projections of Tobacco Excise Policy Reform in Moldova, 2007-2025 15 Figure 4. Tax and Price Increases in Colombia, 2017-2018 16 Figure 5. Effect of Increasing Tobacco Prices, Extended Cost-Benefit Analysis 24 Figure 6. Benefits of Increasing Tobacco Taxes: Channels of Transmission 26 Figure 7. Comparative Net Income Effects of Increasing Tobacco Prices 35 LIST OF TABLES Table 1. Countries With the Highest Number of Deaths from Smoking, and the Highest Prevalence of Daily Smokers, 2015 2 Table 2. Trends in Prices and Taxes on Tobacco Products, Selected Countries in Europe and Central Asia 18 LIST OF BOXES Box 1. Policies and Institutional Measures to Confront Illicit Tobacco Trade 21 V TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN ABSTRACT Tobacco taxes are recognized as an effective particularly the poor—can benefit from policy tool to reduce tobacco consumption positive income gains by reducing tobac- and improve health outcomes; however, co-related medical expenses and avoiding policy makers often hesitate to use them premature deaths. Moreover, there will be because of their possible regressive effects. additional fiscal revenues generated that This report assesses the ability of taxes can be used to further enhance measures on tobacco to improve future health and to control tobacco use and promote equity. welfare outcomes, with a focus on their dis- Additionally, the generally positive benefits tributional impact and effects on the poor. In and impact of raising taxes on tobacco can addition to adverse consequences on health be enhanced by a set of complementary and quality of life of smokers and their family policies to leverage consumers’ responses members, tobacco-related illnesses cost toward quitting tobacco, and to target com- billions of dollars in medical expenditures prehensive interventions to help the most and losses in human capital and produc- vulnerable groups. tivity, imposing heavy economic tolls on households and governments. Developing countries bear a high and increasing share of the economic burden of tobacco. However, traditional analyses often overlook the many economic benefits of reducing tobacco consumption. This report presents empirical findings using an extended cost benefit analysis (ECBA) methodology, to incorporate a more comprehensive view of the costs and benefits of increasing prices of tobacco on household welfare, and to assess their distributional impact by accounting for dif- ferent consumer behaviors across income groups. Evidence for several countries shows that large price shocks on cigarettes can generate progressive and welfare-improv- ing medium and long-term net impacts, that particularly improve welfare of lower-income households. Large shares of societies—and VII TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN ‘Sugar, rum, and tobacco, are commodities which are nowhere necessaries of life, [but] which are ... objects of almost universal consumption, and which are therefore extremely proper subjects of taxation.” Adam Smith, “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776) “Cigarettes are among the most addictive substances of abuse and by far the most deadly.” Thomas C. Shelling, 2005 Nobel Prize Laureate in Economics “In significant ways, sellers play to our weaknesses. They are “phishing for phools.” “Humans think in terms of stories, and decisions are consequently determined by the stories we tell ourselves. Advertisers use this to their advantage by “graph[ing] their story” onto ours, and thereby influencing the decisions we make"—in this case, to get us addicted to tobacco use, particularly teenagers and low-income people. George A. Akerlof and Robert J. Shiller, Nobel Price Laureates, 2001 and 2013, respectively “Phishing for Phools: The Economics of Manipulation and Deception” (2015) IX TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN 1 INTRODUCTION With the entering into force of the (GBD 2015 Tobacco Collaborators 2017). Most Framework Convention for Tobacco Control DALYs attributable to daily smoking were (FCTC) in 2005, the first negotiated global due to cardiovascular diseases (41 percent), public health treaty, significant progress cancers (28 percent), and chronic respiratory has been observed in controlling tobacco diseases (21 percent). As observed in the use. Worldwide, the age-standardized preva- GBD 2015 study, unless daily smoking is signifi- lence of daily smoking was estimated at 25.0 cantly reduced from current levels, the total percent among men and 5.4 percent among number of smokers will continue to rise and women in 2015, representing 28.4 percent place tremendous burden on health systems. and 34.4 percent reductions, respectively, Among tobacco control interventions, since 1990 (GBD 2015 Tobacco Collaborators substantial tax and price increases are 2017). Nonetheless, nearly 1 billion people the most cost-effective policy measures still smoke daily around the world. As shown (Marquez and Moreno-Dodson 2017; NCI and in Table 1, the countries with the most male WHO 2016; World Bank 1999). By increasing daily smokers in 2015 were China, India, and prices and reducing the affordability of Indonesia, while the countries with the most tobacco products, taxes encourage current female daily smokers were the United States, smokers to quit and discourage potential China and India. In 2015, 11.5 percent of consumers, particularly the youth, to initiate global deaths were attributable to smoking, smoking, while simultaneously reducing the of which 52.2 percent took place in four health risk of secondhand smoking. They also countries (China, India, the United States, contribute to raising government revenues. and Russia). Nonetheless, policy makers often hesitate In addition, daily smoking contributes to to increase taxes on tobacco because of a significant amount of the world’s overall claims of the potentially regressive impact health burden, measured using the dis- of taxes—it is often argued that since low-in- ability-adjusted life years (DALYs) metric, come smokers spend a greater share of their which combines years of healthy life lost income on tobacco, increases in cigarette due to illness with those lost due to pre- taxes will have a disproportionately larger mature death. Smoking was ranked among impact on poor consumers' income than of the five leading risk factors by disability rich consumers. adjusted life years in 109 countries and Reducing tobacco consumption is associ- territories in 2015, rising from 88 locations ated with several economic benefits that in 1990, and 11.5 percent of global deaths are often overlooked, in addition to better were attributable to smoking worldwide 1 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements Table 1. Countries With the Highest Number of Deaths from Smoking, and the Highest Prevalence of Daily Smokers, 2015 COUNTRIES WITH THE HIGHEST NUMBER OF DEATHS FROM SMOKING (ROUNDED): China (1.8 million) India (743,000) US (472,000) Russia (283,000) Indonesia (180,000) Japan (166,000) Bangladesh (153,000) Brazil (149,000) Germany (130,000) Pakistan (124,000) COUNTRIES WITH THE HIGHEST PREVALENCE OF MALE DAILY SMOKERS: Kiribati (48%) Indonesia (47%) Laos (47%) Northern Mariana Islands (46%) Armenia (43%) Greenland (43%) Belarus (42%) Ukraine (41%) Azerbaijan (40%) Timor-Leste (40%) COUNTRIES WITH THE HIGHEST PREVALENCE OF FEMALE DAILY SMOKERS: Greenland (44%) Bulgaria (28%) Greece (27%) Montenegro (26%) Croatia (26%) Northern Mariana Islands (25%) Kiribati (25%) Macedonia (23%) Hungary (23%) Austria (23%) Source: GBD 2015 Tobacco Collaborators. 2 // Introduction health and longer lives for smokers and their budgets. Overall, empirical applications of family members (Lancet Editorial 2017 , NCI this more comprehensive view of costs and and WHO 2016). Among other economic benefits consistently find that the effects of benefits, households and governments raising taxes on tobacco are progressive and face lower medical bills associated with the welfare-increasing. treatment of tobacco-attributable diseases The report proceeds as follows. Section 2 and workers increase their productive life reviews the literature on the well-established due to an expanded healthy life expectancy, negative health effects of tobacco, their reflected in higher earnings. Accurately economic burden, and the most common assessing the burden of tobacco and the policy instruments to control tobacco benefits of taxing tobacco products requires consumption. Section 3 summarizes the accounting for the distribution of these bene- theoretical mechanisms that allow taxes fits across the population. on tobacco to reduce consumption and This report summarizes the rapidly potentially to induce progressive and growing evidence of the ability of taxes welfare-enhancing outcomes. Section 4 on tobacco to improve future health presents results on the distributional effects and welfare outcomes, with a focus on of increasing taxes on tobacco in a set of understanding the distributional impact countries at different income levels, using and equity implications of these taxes. an extended cost-benefit analysis (ECBA) Empirical studies in a variety of low- and methodology, as well as emerging new middle-income countries show that increas- comparative evidence. Section 5 concludes ing tobacco prices is unlikely to result in with a discussion on the main policy regressive outcomes. In contrast, accounting implications of the theoretical and empirical for different behavioral responses to knowledge on taxes on tobacco. the price shock can show progressive distributional effects because poorer households are more likely to cut back on the consumption of tobacco as prices rise. Moreover, other medium- and long-term benefits of reducing tobacco consumption are often overlooked. Accounting for these benefits—such as reduced medical bills associated with the treatment of tobacco-at- tributable diseases and additional years of productive life—can increase household welfare and offset the short-term negative price shock of raising taxes on household 3 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN 2 HEALTH AND ECONOMIC IMPACT OF TOBACCO USE The Health Impacts of Smoking is the second-leading cause of Tobacco Use death globally (GBD 2015 Collaborators). Both active smoking and exposure to The scientific evidence accumulated over secondhand smoke cause disease and kill the past five decades is clear: tobacco prematurely (Marquez and Moreno-Dodson kills. Smokers who begin early in adult life 2017). More than 7 million people die from and do not stop smoking face a three-fold tobacco use every year, a figure that is higher risk of death compared to otherwise predicted to grow to more than 8 million a similar non-smokers, resulting in a loss, year by 2030, in the absence of intensified on average, of at least one decade of life global action (WHO 2017). Annually, the (Jha and Peto 2014). The landmark Surgeon number of deaths from tobacco-attributable General’s Report on Smoking and Health, diseases exceeds the deaths from HIV/AIDS, issued in 1964 by the U.S. Surgeon General tuberculosis, and malaria combined (WHO Dr. Luther Terry, first drew wide public atten- 2008). Most of these deaths are due to direct tion to the evidence linking smoking and tobacco use, while close to 10 percent of ill health, including lung cancer and heart deaths are the result of non-smokers’ expo- disease. Since then, a vast, rigorous body of sure to secondhand smoke. Smoking also evidence has accumulated, showing that leaves chemical residue on surfaces where tobacco use imposes an unparalleled health smoking has occurred, which can persist and economic burden across countries, long after the smoke itself has cleared from hindering human capital development the environment. This phenomenon, known and economic gains worldwide (Marquez as "thirdhand smoke," is increasingly recog- and Moreno-Dodson 2017; NCI and WHO nized as a potential danger, especially to 2016; U.S. Department of Health, Education children, who not only inhale fumes released and Welfare 1964). The uptake of cigarette by these residues but also ingest residues that consumption has been influenced by get on their hands after crawling on floors or advertising and promotional expenses of touching walls and furniture (Martins-Green, tobacco companies (in 2016, for example, Adhami, Frankos et al. 2014). tobacco companies spent US$9.5 billion in marketing cigarettes and smokeless tobacco Tobacco consumption is causally linked to in the United States alone) (Federal Trade diseases of nearly all organs of the body Commission 2016). (U.S. Department of Health and Human Services 2014). The evidence is enough 5 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements to conclude that the risk of developing congenital malformations (e.g., cleft lips or lung cancer from cigarette smoking has palates); and (4) during fetal development increased since the 1950s, due to changes and adolescence has lasting adverse in the design and composition of cigarettes. consequences for brain development. Most There is also evidence for a causal relation- smokers use tobacco regularly because they ship between smoking and other types of are addicted to nicotine (addiction is charac- cancer, including liver, colorectal, and pros- terized by compulsive drug-seeking and use, tate cancers. Smoking or chewing tobacco even in the face of negative health conse- can immediately raise blood pressure, albeit quences) (Balfour 2015; Picciotto and Mineur temporarily, as the chemicals in tobacco can 2014). Research has shown that the majority damage the lining of artery walls, causing of smokers would like to stop smoking, and arteries to narrow, and increasing blood pres- each year about half try to quit permanently, sure (Marquez 2018). Secondhand smoke can but, only about 6 percent of smokers are able increase blood pressure, as well. Smoking to quit in a given year (Centers for Disease is the dominant cause of chronic obstruc- Control and Prevention (CDC) 2011). Although tive pulmonary disease (COPD), including nicotine itself does not cause cancer, at emphysema and chronic bronchitis. Smok- least 69 chemicals in tobacco smoke are ing also increases the risk of tuberculosis. carcinogenic (U.S. Department of Health and Research continues to identify diseases Human Services 2014). Evidence also shows caused or exacerbated by smoking, includ- that tar, the resinous, partially combusted ing common diseases as diabetes. Scien- particulate matter produced by the burning tists now know that the risk of developing of tobacco, is toxic and damages the smok- diabetes is 30–40 percent higher for active er’s lungs over time. Carbon monoxide, a smokers than nonsmokers. It is estimated colorless, odorless gas produced from the that for every person who dies as a result incomplete burning of tobacco, accumulates of smoking, at least 30 people live with a indoors and reduces the oxygen-carrying serious smoking-related illness (U.S. Depart- capacity of the blood. ment of Health and Human Services 2014). E-cigarettes pose similar threats to public Chemicals in tobacco have harmful health health. In recent years, the issue of whether impacts. Accumulated evidence shows that e-cigarettes and other smoke-free nicotine nicotine (a chemical in tobacco): (1) is a highly delivery systems should be classified as addictive stimulant that at high levels pro- tobacco products—and hence be regulated duces acute toxicity; (2) activates multiple in the same way as cigarettes—has biological pathways through which smoking acquired great importance (Marquez 2017). increases risk for disease; (3) adversely affects The production and marketing of these maternal and fetal health during pregnancy, products is at the core of new diversified contributing to adverse outcomes such as business plans of tobacco companies preterm delivery and stillbirth, as well as alongside the production and marketing of 6 // Health and Economic Impact of Tobacco Use cigarettes. E-cigarettes, a battery-powder Low- and middle-income countries (LMICs) device that heats a liquid containing nicotine face an increasing burden of noncommu- into a vapor that is inhaled like a cigarette, is nicable diseases (NCDs), which are now being touted as a harm-reducing technolog- the leading cause of death in the world, ical innovation to protect smokers from the killing 40 million people each year and ill-effects of cigarettes. However, a compre- representing 70 percent of all annual deaths hensive review of available evidence done (WHO 2018). Eighty percent of deaths due by U.S. Surgeon General (2016) concluded to tobacco-related NCDs—cancer, cardio- that tobacco use among youth and young vascular disease, chronic lung disease, and adults in any form, including e-cigarettes, is diabetes— occur in LMICs, straining health not safe. This report further indicated that in care systems, contributing to poverty, and recent years, e-cigarette use by youth and posing a major barrier to development. young adults has increased at an alarming An estimated 40 percent of the global eco- rate, becoming the most commonly used nomic costs of tobacco use are already borne tobacco product among youth in the United by these countries, and there is a risk that the States. The report also warned that since costs will escalate if effective and sustained e-cigarettes are tobacco products that tobacco control action is not supported over deliver nicotine, they may pose the risk that the short and medium term. many of today’s youth who are using e-cig- Global trends in smoking-prevalence arettes could become tomorrow’s cigarette reduction also mask important differences smokers to continue to feed their nicotine within countries, such as rising smoking rates addiction; using nicotine in adolescence also among youth and women in some urban can increase risk of future addiction to other areas of Latin America and Eastern Europe, drugs. The regulatory response to e-cigarettes or the marked change in South Asia from in the United States and the European Union consuming local bidis (small, hand-rolled, (EU) is clear in signaling the potential health generally untaxed cigarettes) to consuming risks of e-cigarettes.2 cigarettes (Mishra et al. 2016). This poses a Developing countries and vulnerable major challenge for developing countries groups face health risks associated with with sizable younger populations vulnerable tobacco use, and with e-cigarettes. to tobacco advertisement and marketing, and where smoking is on the rise, or that lack the resource base, health systems, or social 2  E-cigarettes, like other cigarette products, now fall under the regulatory jurisdiction of the U.S. Food and Drug Administra- safety nets to protect populations from tion (FDA). This is in accordance with the U.S. Surgeon General the negative health, social, and economic Report recommendations that comprehensive tobacco control and prevention strategies for youth and young adults should consequences of tobacco-related chronic address all tobacco products, including e-cigarettes. In May 2017, the EU's Court of Justice cleared new legislation that also places e-cigarettes under similar regulatory pressures as traditional cigarettes, including a broad ban on advertising and other promotional activity. 7 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements diseases (Marquez and Farrington 2013).3 In where more than 80 percent of smokers live high-income countries, smoking rates are also (Jha, Marquez, and Dutta 2017). substantially higher among some of the most vulnerable people in society. In the United The Economic Burden of Tobacco States, for example, the 25 percent of the pop- Smoking-related illness costs billions ulation with mental disorders, including sub- of dollars each year, imposing a heavy stance use disorders, account for 40 percent economic toll on households and govern- of the cigarettes smoked (Substance Abuse ments, both in terms of direct medical care and Mental Health Services Administration costs and productivity losses (NCI and WHO 2013), while over 40 percent of people with 2016). Calculations by Lightwood et al. (2000) low educational attainment (i.e., with only a indicate that the health cost of tobacco General Education Development certificate use in high-income countries is between 0.1 [GED]) smoke, the highest prevalence of any percent and 1.0 percent of gross domestic socioeconomic group (Jamal, Homa, O'Con- product (GDP). In the United States, for exam- nor et al. 2015). Additionally, people who live ple, smoking-related illness costs more than in rural areas use all forms of tobacco at higher US$300 billion each year, including nearly rates than people who live in urban areas US$170 billion for direct medical care for (Roberts, Doogan, Kurti et al. 2016). adults, as well as more than US$156 billion in While the hazards of smoking accumulate lost productivity, which includes US$5.6 bil- slowly, cessation is effective, helping to lion in lost productivity due to secondhand reduce tobacco-related mortality and smoke exposure (U.S. Department of Health inequality of mortality. People who quit and Human Services 2014; Xu et al. 2015). by age 40 get back nearly the full decade ing-related In high-income countries, smok­ of life they would have lost from continued care already places a signif­icant burden on smoking (Jha and Peto 2014). Cessation is health care systems. As shown by the expe- now common among adults in high-income rience in the United States, it accounts for countries. For example, in Canada, there are an estimated 8.7 percent of annual health now over one million more ex-smokers than care spending (more than 60 percent of this only a decade ago. However, largely because spending is covered by public programs of the advertising, marketing and pricing such as Medicare and Medicaid) (Xu et al. strategies of the tobacco industry, including 2015). Worldwide, recent estimates suggest the use of social media to promote e-ciga- that the global burden of tobacco-related rettes among the youth, cessation remains a diseases accounts for US$422 billion in health major public health challenge in most LMICs, care expenditures annually, representing almost 6 percent of total global spending on health. The total economic cost of smok- 3  For a discussion on the economics of deception and manip- ing—including health care expenditures ulation, see the work of Nobel Laureates in Economics George Akerlof and Robert Schiller (2015). and productivity losses—is estimated at 8 // Health and Economic Impact of Tobacco Use more than US$1.4 trillion per year, equiv- promotion, and sponsorship; protecting alent to 1.8 percent of the world’s annual people from secondhand smoke; warning GDP (Goodchild, Nargis, and Tursan d’Es- everyone about the dangers of tobacco; paignet 2018). offering help to people who want to quit; and carefully monitoring the epidemic and Developing countries bear a high and prevention policies (WHO 2008). Recent increasing share of the economic burden of studies, as noted before, show that the smoking. The highest share of the estimated accelerated implementation of all key FCTC total economic costs of smoking occurs in demand-reduction measures since 2005 high-income countries (US$1.12 trillion in has been significantly associated with a PPP dollars), where the tobacco epidemic is decrease in smoking prevalence worldwide most advanced. However, nearly 40 percent (GBD 2015 Tobacco Collaborators 2017; of the health and productivity costs related Gravely et al. 2017). to tobacco use are already concentrated in developing countries (Goodchild, Nargis, However, despite the progress observed and Tursan d’Espaignet 2018). Those shares in many countries, much more needs to are expected to increase along with the be done to reduce the human, social and demographic and epidemiological transition economic toll of tobacco use. A scaled occurring in these countries. up and stronger tobacco control effort is needed to achieve the WHO-recommended Policy Instruments for target of at least a 30 percent reduction in Tobacco Control smoking prevalence by 2025, which would Since 2005, 181 countries have become avoid at least 200 million deaths among parties to the FCTC. The FCTC now covers current and future smokers by the end of nearly 90 percent of the world’s population. the 21st century (WHO 2013). A reduction Over the past decade, progress has been in smoking prevalence of this magnitude is made in expanding the coverage of the also critical to reaching the health and social FCTC’s supply- and demand-reduction targets of the United Nations Sustainable tobacco control measures (WHO 2015). More Development Goals (SDGs) by 2030 (United than half the world’s countries, accounting Nations 2015). for 40 percent of the total global population, have implemented at least one tobacco control policy measure supported under the MPOWER technical assistance package of the World Health Organization (WHO). MPOWER includes the six most important and effective tobacco control policies: raising taxes and prices; banning advertising, 9 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN 3 TAXING TOBACCO: A POLICY MEASURE TO IMPROVE HEALTH, DOMESTIC RESOURCE MOBILIZATION, AND EQUITY needed also to reduce the number of former "As the success in rich countries shows, smokers who return to cigarettes. However, there is no mystery about how to get as discussed below, the ultimate changes in people to stop smoking: a combination tobacco use depend on both the price shock of taxes and public-health education and the behavioral responses of consumers does the job. This makes the abysmal facing higher retail prices for tobacco. record in poor countries a grave failure of Taxes work by increasing prices and reduc- public policy. The good news is that, fol- ing the affordability of tobacco products lowing recent research, it is one that has (Gruber 2008; Sunley 2009). Higher tobacco just become easier to put right." taxes help boost cigarette prices, which The Economist (2017). are highly effective in reducing demand. Currently, in high-and middle-income coun- tries, taxes average about two-thirds or more of the average retail price of a pack of ciga- The Effectiveness of Taxes rettes, while in low-income countries, they on Tobacco amount to not more than half the average Tobacco taxes are recognized as an effec- retail price of a pack of cigarettes (WHO tive policy tool to reduce tobacco use. As 2015, 2017). Evidence of cigarette taxes such, the prime objective of tobacco taxes translating to increased consumer prices is is to improve health outcomes (World Bank available globally (WHO 2015, 2017). However, 1999; Petit and Nagy 2016; Marquez and tobacco taxes only reduce tobacco consump- Moreno-Dodson 2017). To achieve this aim, tion if they reduce cigarette affordability. In aggressive increases in tobacco taxes are most LMICs, wages are rising. Thus, cigarettes required to influence cigarette smokers to will become de facto more affordable for stop or sharply cut back their tobacco con- consumers, increasing consumption, unless sumption and to persuade young people tobacco taxes rise even faster. Effective strat- not to initiate this addictive habit. This is 11 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements egies will generally involve combining big health gains and indirect benefits such initial tax increases with recurrent hikes over as reduced health care expenditures time, to keep cigarette prices climbing more and higher productivity (Furman 2016). steeply than per capita real income growth Increasing tobacco taxes can also enlarge (including inflation). In some countries, a country’s tax base to augment domestic such as the United Kingdom, governments resource mobilization (Marquez 2016a, have adopted a “tobacco tax escalator” that 2016b, 2016c). This can expand the fiscal automatically increases tobacco taxes by a space for priority investments and programs, certain percentage above the inflation rate including the expansion of universal health (HM Revenue and Customs 2018). Going coverage, education for all, and other activi- too slowly or timidly on tax increases or ties to help countries achieve the SDGs. allowing affordability to increase should be The United Nations has recognized that recognized as condemning large numbers of tax and price measures on tobacco are an people to tobacco addiction and the risk of effective means to reduce tobacco use, ill health and premature death (Marquez and as well as related illnesses and premature Moreno-Dodson 2017). death and escalating health care costs. Beginning with its landmark report “Curbing These measures can also represent a the Epidemic” (1999), the World Bank Group revenue stream to finance development has advised policy makers who seek to reduce in many countries. This double impact of smoking to use as a yardstick tax levels that tobacco taxes was acknowledged in the amount to two-thirds and four-fifths of Financing for Development Action Agenda, the retail price of a pack of 20-cigarettes, approved by country leaders at the Third as adopted as part of the comprehensive International Conference on Financing for tobacco control policies of countries where Development in Addis Ababa (UN 2015), and cigarette consumption has fallen. Similarly, subsequently endorsed by the United Nations the WHO recommends countries to adopt at General Assembly as part of the strategies to least 70 percent excise tax share in final con- achieve the SDGs, in September 2015. Today, sumer price of a pack of 20-cigarettes, and policy practitioners concur that domestic a 75 percent total tax burden (including resource mobilization in LMICs’ will be the excise taxes, VAT, and other duties) on the primary financing engine for the next wave retail price of a pack of 20-cigarettes (WHO of development, and they point to tobacco 2015, 2017). taxation as a potentially important contribu- tor (Junquera-Varela et al. 2017). Higher Tobacco Taxes Boost Since 2013, multisectoral teams supported Government Revenues under the World Bank’s Global Tobacco The positive impacts of higher tobacco Control Program have assisted national taxes and prices go beyond direct governments in adopting tobacco tax 12 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity Figure 1. Philippine Sin Tax Reform: Higher Tobacco Tax Revenue (As % of GDP) and Budgetary Allocation for Public Health 1.2% 1.1% 200.00 1.1% 1.2% 1.0% 1.0% 142.98 150.00 122.63 0.7% 0.7% 100.00 0.6% 0.6% 0.6% 83.72 86.97 0.7% 0.5% 53.23 50.00 42.16 11.40 18.91 23.67 24.65 31.83 0.00 0.2% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Department of Health Budget (In B PhP) Source: Paul, J. 2018. reforms, often as part of fiscal consolida- reconfiguration of the tobacco tax struc- tion programs, and working with other ture can be good for both fiscal revenues international partners. This has occurred in and public health. As shown in Figure 1, countries across the income spectrum, such excise tax revenue on tobacco and alcohol as Armenia, Azerbaijan, Belarus, Botswana, products has more than doubled since 2012, Colombia, El Salvador, Gabon, Georgia, Ghana, reaching US$5.2 billion in additional revenues Indonesia, Kazakhstan, Lesotho, Moldova, during the first 4 years of the Sin Tax Law Mongolia, Montenegro, Nigeria, Peru, the implementation (about 1 percent of GDP). Philippines, Senegal, Sierra Leone, Tonga, Tobacco accounts for about 80 percent of Tuvalu, Ukraine, Vietnam, and Uzbekistan, these additional tax revenues. The expanded covering approximately 934 million people. fiscal space created by the Sin Tax reform increased the Department of Health budget Recent Country Experiences: threefold. The number of households whose Fiscal and Health Impact health insurance premiums were paid by the The experience of the Philippines since national government rose from 5.2 million pri- the adoption of the Sin Tax Law of 2012 mary members in 2012 to 15.2 million in 2017. is one of the most compelling examples Smoking prevalence among current daily of ambitious national tobacco tax reform tobacco smokers also decreased signifi- (Kaiser, Bredenkamp, and Iglesias 2016). cantly over the 2009-2015 period, from The Philippines’ bold effort—supported by 22.5 percent to 18.7 percent (GATS 2009 and the World Bank, the WHO, and other inter- 2015). The Philippines’ success confirms that national partners—involved a fundamental tobacco taxation may be a low-hanging restructuring of the country’s tobacco excise fruit for governments that want to increase tax structure, including reduction in the domestic resources to attain the SDGs. number of tax tiers, indexation of tax rates to inflation, and substantial tax increases to The experiences of Ukraine and Moldova multiply public health impact. Such a bold are also noteworthy. Continuing the 13 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements Figure 2. Results of Tobacco Excise Policy Reform in Ukraine, 2008-2018 50 140 125 43.6 45 112 39.9 120 40 95 33.2 100 35 88 30 82 75 73 74 76 80 25 67 22.2 56 60 20 17.9 18.1 16.6 15.3 15.5 15 13.1 12 40 9.1 8.62 10 8.7 8.6 8.35 8.1 7.7 10.1 6.7 6.5 20 5 3.6 9.2 2.74 3.48 4.04 1.62 6.08 6.9 0.58 4.76 4.96 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Tobacco excise revenue, bln UAH Average excise per 20 cigarettes pack, UAH Number of daily smokers, mln Cigarette sales, bln sticks (RHS) Source: World Bank Group staff based on national data collected by Konstantin Krasovsky and Tatiana Andreeva, 2019. tobacco tax increase pathway adopted tobacco as a percentage of retail price) will since 2016 with support of the World Bank increase from 62 percent in 2015 to 77 per- Group Global Tobacco Control Program, cent in 2019. Figure 2 shows how national the Ukrainian Parliament approved a new tobacco excise revenue in Ukraine increased increase as part of the 2019 budget: from from 22 billion UAH in 2015 (1.12% of GDP) to January 1, 2019, all specific excise rates were 40 billion UAH (1.34% of GDP). increased by 20 percent, and an additional 9 Tax increases are helping to reduce percent excise increase will be effective July tobacco consumption, generating public 1, 2019.4 Building upon tobacco tax increases health benefits in Ukraine. Results from in previous years, the average excise tax the Ukraine Global Adult Tobacco Survey burden (excise tax as a percentage of retail (GATS) show that daily smoking prevalence price) after the 2019 increase will rise from has dropped by nearly 20 percent during the 45 percent in 2015 to 60 percent in 2019. last seven years, from 25% in 2010 to 20% The total tax burden (including excise taxes, in 2017 (GATS Ukraine 2017). This is largely value-added tax [VAT], and other duties on due to a reduction in smoking among men, with no significant reductions observed 4  The increases adopted in 2016 included a 40 percent specific excise tax increase on tobacco products over the 2015 level and in the share of women who smoke (GATS the increase of effective ad valorem excise rate from 10 to 12 Ukraine, 2017). Additional World Bank percent. In 2017 and 2018, the specific excise rates were further increased by 40 percent and 29.8 percent, respectively. In 2015, Group-supported microsimulation model- Ukraine introduced an additional 5 percent ad valorem excise tax paid to local budgets. ling in Ukraine estimated the public-health 14 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity Figure 3. Results/Projections of Tobacco Excise Policy Reform in Moldova, 2007-2025 9,000.0 € 100 Total cigarette excise tax revenue (MDL mln) Average cigarette excise tax (EUR)/1,000 pieces € 91.25 8,000.0 € 90 7,000.0 6,808.0 8,008.6 € 80 5,726.9 € 73.08 € 70 6,000.0 5,550.5 5,064.0 4,890.1 4,819.7 € 60 5,000.0 4,752.7 € 58.57 4,520.8 4,112.0 € 50 4,000.0 4,064.2 3,917.5 3,690.7 3,311.5 4,312.5 € 47.00 € 40 3,000.0 2,866.0 2,449.8 € 39.05 € 30 2,051.0 € 31.23 2,170.0 2,000.0 € 27.21 1,737.8 € 20 € 22.54 1,117.6 1,392.7 € 17.73 696.8 899.0 1,000.0 369.5 483.8 586.1 € 10 - €- 2017 2018 2019 2020 2021 2022 2023 2024 2025 Year Total cigarettes taxed (million pieces) [1] Total cigarettes excise tax revenue (million MDL) [2] Average cigarette excise tax (MDL per 1000 pieces) Average cigarette excise tax (EUR per 1000 pieces) Source: World Bank Group staff estimates; excise tax revenue and total cigarettes taxed data from MoF & Customs, 2018. impacts of tobacco taxation measures, sure (Marquez and Guban 2018; Marquez along with other tobacco control policies. et al 2018). The government has increased The health impacts were modeled for 2025 tobacco taxes every year since 2016, with the and 2035, including coronary heart disease goal of achieving the European Union (EU) (CHD), stroke, chronic obstructive pulmonary tobacco tax directive minimum rate of 90 disease (COPD), and lung cancer. Relative EUR/1,000 cigarettes by early next decade, to a status quo scenario with no change in per its Associate Agreement with the EU. tobacco taxes, the model estimated that, by This has translated into public health gains 2035, Ukraine’s tobacco tax hike will avoid: for the country, with a reduction in the 126,730 new cases of smoking-related disease; volume of cigarettes sales taxed (used as a 29,172 premature deaths; and 267,098 poten- proxy for consumption) by about 10 percent, tial years of life lost. Reductions in disease and to 5.55 billion pieces in 2017 compared to death will save UAH 1.5 billion (about US$ 6.19 billion pieces in 2016. While reducing 57 million) in healthcare costs and UAH 16.5 tobacco use, and the related risk of develop- billion (about US$ 631 million) in premature ing tobacco-attributable diseases, Moldova mortality costs (Webber et al. 2017). has been able to collect additional tax rev- enue, partly because of still high levels of Moldova’s positive experience with taxing tobacco use and the low cost of cigarette tobacco in recent years provides some production relative to the average retail lessons, and possible encouragement, price. As shown in Figure 3, cigarette excise for other countries considering this mea- tax revenue in the country increased from 15 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements Figure 4. Tax and Price Increases in Colombia, 2017-2018 180 Dec 2018 SPECIFIC PRICE 170 167.49 TAX (SUPERMARKET) 2016: 0,54 2,51 Mar 2018: 162.19 160 2017: 1,08 3,10 150 2018: 1,62 4,38 Jul 2017: 142 Dec 2017: Real price % 140 143 change 42.5 2019: 1,74 4,65 130 (International dollars of 2019 per 20 stick pack) 120 Dec/2016:117 110 100 90 Dec–08 Apr–09 Aug–09 Dec–09 Apr–10 Aug–10 Dec–10 Apr–11 Aug–11 Dec–11 Apr–12 Aug–12 Dec–12 Apr–13 Aug–13 Dec–13 Apr–14 Aug–14 Dec–14 Apr–15 Aug–15 Dec–15 Apr–16 Aug–16 Dec–16 Apr–17 Aug–17 Dec–17 Apr–18 Aug–18 Dec–18 Source: Llorente, B. and Maldonado, N. 2019 MDL 1.73 billion (US$ 87 million) in 2016 to percentage of retail price of a pack of 20 MDL 2.05 billion (US$ 110.6 million) in 2017, cigarettes) increased from 50 percent in 2016 or about 1.16 percent of Moldova’s GDP. The to 68 percent in 2018. The average price of tobacco tax increases adopted by Moldova’s a pack of 20 cigarettes increased by 42.5 Parliament for 2018-2020 are projected to percent over 2017-2018, as shown in Figure further increase excise tax revenue, hitting 4. The expected fiscal and health impacts of 3.31 billion MDL (US$194 million) or 1.45 per- this measure are noteworthy. It is estimated cent of GDP in 2020. that COP 1 trillion (about US$ 347 million) in additional revenue will be generated through The recent experience of Colombia is 2022, along with a reduction of approximately another good international example. 20 percent in the mortality associated with As part of a broad fiscal reform package tobacco consumption. In addition, the approved by Colombia’s Congress on fiscal reform law mandates the earmarking December 23, 2016, the specific excise tax on of tobacco tax revenues to finance health a pack of 20 cigarettes was increased from insurance coverage at the departmental level COP 700 (US$ 0.25) in 2016 to COP 1,400 (US$ (World Bank Group 2016).5 0.50) in 2017, and COP 2,100 (US$ 0.75) in 2018, with annual adjustments of Consumer Price The recent experience of Australia, Index (CPI) + 4 points in subsequent years. United States, United Kingdom (UK), and The ad valorem excise tax component was Russia also clearly illustrates the public maintained at 10 percent of the total sale price of a 20-cigarette pack, and the general The fiscal reform program adopted by the Colombian 5  government, including tobacco and alcohol tax increases, is VAT rate was raised from 16 percent to 19 supported under the World Bank Group’s US$ 600 million fiscal percent. As a result, the total tax burden (as Development Policy Operation, approved on March 9, 2017. The tax reforms are accompanied by stronger anti-contraband measures to prevent illicit tobacco trade. 16 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity health and fiscal gains that result from the The UK Government uses excise duty (& imposition of high tobacco taxes. VAT) as part of a unified approach to reduc- ing smoking, in addition to generating rev- In Australia, population use of tobacco enue. In the UK, tax accounts for 77 percent has been falling steadily since the 1980s. of the price of a pack of cigarettes and has This has resulted from the combined impact increased significantly more than the rate of of increased costliness, awareness about inflation. As a result, of high taxes and prices, health risks, declining social acceptability of smoking rates has continued to decline smoking, campaigns encouraging quitting, over the past decade. Statistical information improved treatments for tobacco depen- indicates that the number of adult cigarette dence, and greatly reduced opportunities smokers dropped nearly 20 per cent from an for smoking (Scollo and Bayly 2016). Indeed, estimated 10.2 million in 2007 to 7.4 million or the annual increases in tobacco excise taxes 15.1 percent of the population in 2017 (Cancer in the past decade have led Australia to Research UK’s site 2019; Kay 2019). Tobacco have one of the highest prices of cigarettes taxes also contributed the UK government in the world--a 20-pack of Marlboro costs an estimated £10 billion in tax revenue over approximately a high US$19, while the same 2016/17 (HM Revenue and Custom). pack costs only US$12 in the UK, US$7 in the United States and US$3.88 in South Assessments done by the World Bank Africa. The high tobacco tax level has also Group in Russia show that that life expec- contributed massive yearly tax revenue to tancy in the country for men increased the Government. to 65.4 years in 2016, up from 58 years in 2003, and among women, to 76.2 In the United States, the federal cigarette years in 2016, up from 72 years in 2003. tax for cigarettes was increased signifi- A big factor for this change has been the cantly in 2009 from US$0.39 per pack effective measures adopted to control the to approximately US$1.01 per pack to consumption of tobacco and alcohol over fund the expansion of children’s health this period, including the enactment of a insurance coverage. Besides revenue law on tobacco control in 2013 and regular mobilization, estimates suggest that this tax increases in tobacco excise taxes since 2010. increase could have reduced the number Because of tax and price increases, along of smokers in a cohort of 18 year-olds by with other tobacco control interventions, between 45,000 and 220,000 people, roughly tobacco sales fell by almost 30 percent over 3 to 15 percent (CBO 2012), and contribute to this decade. Not surprisingly, the number the reduction of the number of premature of smokers also decreased, by 21 percent deaths due to smoking by between 15,000 between 2009 and 2016, while higher and 70,000 for two young population cohorts tobacco taxes increased tax revenue for the (12-17 and 18-25) (Furman 2016). country. (Marquez and Salakhutdinova 2018, Marquez et al 2005). 17 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements Table 2. Trends in Prices and Taxes on Tobacco Products, Selected Countries in Europe and Central Asia OF AVERAGE PRICE REVENUE, MILLION REVENUE, BILLION GDP, MILLION USD EXCISE PER PACK, GDP, BILLION LCU TOBACCO EXCISE TOBACCO EXCISE TOBACCO EXCISE OF 20 CIGARETTE EXCHANGE RATE (EXCISE + VAT), % AVERAGE PRICE REVENUE, % OF TAX BURDEN PACK, LCU COUNTRY TO USD GDP USD LCU LCU ARMENIA 2015 350 100.0 45.3 23.5 470 50.0 5,044 10,732 0.47 2016 362 110.0 47.1 30.4 480 63.3 5,067 10,556 0.60 2017 386 126.4 49.4 44.3 480 92.3 5,569 11,602 0.80 2018 417 145.5 51.6 480 6,003 12,506 AZERBAIJAN 2015 1.55 0.1 20.4 1.03 54 52,997 2016 2.20 0.1 18.9 1.60 60 37,863 2017 1.56 0.1 20.4 0.0 1.72 28.8 70 40,868 0.07 2018 0.2 1.70 80 46,940 BELARUS** 2015 0.93 0.3 47.5 1.59 90 56,541 2016 1.09 0.3 44.6 0.8 1.99 395.5 95 47,688 0.83 2017 1.29 0.3 42.0 0.9 1.93 467.9 106 54,767 0.85 2018 1.39 0.4 43.8 1.2 2.04 603.9 GEORGIA 2015 2.40 1.0 52.4 0.4 1.77 213.0 32 17,944 1.19 2016 2.95 1.4 56.4 0.5 2.27 241.9 34 14,991 1.61 2017 4.03 2.0 60.3 0.7 2.37 283.5 38 15,970 1.78 2018 4.36 2.1 58.9 2.51 41 16,367 KAZAKHSTAN 2015 296 78.0 37.1 96.1 222 433.4 40,884 184,387 0.24 2016 324 100.0 41.6 121.4 342 354.8 46,971 137,278 0.26 2017 358 124.0 45.4 137.8 326 422.7 53,101 162,887 0.26 2018 397 150.0 48.5 165* 345 445.9 58,786 170,537 0.28 MOLDOVA 2015 16 6.0 54.2 1.4 19 71.9 146 7,674 0.94 2016 22 8.0 53.0 1.7 20 86.7 161 8,040 1.08 2017 24 9.2 55.0 1.8 18 101.5 179 9,939 1.02 2018 26 10.8 58.2 17 190 11,176 UKRAINE 2015 16 6.1 59.6 22.2 21.85 1,016.0 1,989 91,007 1.12 2016 17 8.5 71.7 33.2 25.55 1,299.4 2,385 93,362 1.39 2017 23 11.9 73.4 39.9 26.6 1,500.0 2,984 112,177 1.34 2018 29 15.5 74.9 43.6 27.2 1,602.9 3,559 130,846 1.23 Source: World Bank Group team based on national and international data collected by Konstantin Krasovsky and Tatiana Andreeva, 2019. Notes: LCU = Local currency units. * Preliminary. ** Revenue includes excise and other taxes. 18 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity In the European Union (EU) member states, cent that year, and by 2.5 percent in 2016. the consumption of cigarettes has been Smoking prevalence among youth in Korea declining over the years, as reflected in also declined from 9.2 percent in 2014 to 7.8 the number of cigarettes released for con- percent in 2015, and to 6.3 percent in 2016. sumption between 2002 and 2015, from At the same time, total tax revenue signifi- almost 800 billion pieces in 2002 to just cantly increased by 20 percent (0.9 trillion below 500 billion pieces in 2015 (Bouw won) – a figure that continued to rise in 2016. 2017). Also, in the EU, the total revenue of In addition, as shown by a recent study, excise duties on cigarettes has been stable reduced tobacco use and related health between 2008 and 2015, despite declining risks are estimated to lower national health consumption. The latter is explained by the expenditure by 1.02 billion won and by 14.08 increase in tax rates—since 1992, the EU billion won over 10 years (KIPF 2015). tobacco excise duty directive requires mem- Table 2 above summarizes trends in tobacco ber states to levy a minimum overall excise prices and tax systems in Eastern Europe and duty on cigarettes consisting of at least €90 Central Asia. Data for countries like Armenia, per 1000 cigarettes and least 60 percent of Azerbaijan, Belarus, and Uzbekistan, show the weighted average retail selling price. the potential of tobacco tax and price hikes And in the Republic of Korea, the 2015 to increase government revenues, as a tobacco tax reform introduced a series of secondary effect to reducing health risks extensive tax increases for all tobacco prod- associated with tobacco use. Since 2018, ucts, including cigarettes, e-cigarettes, pipe other countries across the world—including tobacco, cigars, waterpipes, roll-your own China, Gabon, Indonesia, Lesotho, and Nige- tobacco, chewing tobacco, snus, and snuff ria—have undertaken reforms on tobacco (Eun Choi, S. 2018). There are several taxes tax structures and increased tax rates, and and charges imposed on tobacco products Kazakhstan will start taxing e-cigarettes to reduce consumption but also to mobi- beginning in 2020. lize revenue (Local Education Tax, National Overall, as clearly observed on a Interna- Health Promotion Charge, Waste Charge, tional Monetary Fund (IMF) how-to note Public Fund, Tobacco Production Stabiliza- (Petit and Nagy 2016), “in many countries, rais- tion Charge, Special Consumption Tax, and ing tobacco taxes can offer a “win–win”: higher General VAT). As a result of the 2015 reform, revenue and positive health outcomes. Coun- the price of a pack of cigarettes rose by 80 tries’ circumstances and governments 'weight- percent (from 2,500 won per pack to 4,500 ing of revenue, health, and other objectives won). Tax as a percentage of cigarette retail vary, and hence so too will the desirable level prices increased from 62 percent to 74 per- of tobacco tax rates. In many cases, however, cent. The 2015 tobacco tax reform prompted current tax rates are evidently far below what is male smoking prevalence to fall by 3.8 per- feasible in terms of revenue potential. Thus, tax 19 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements increases could serve revenue purposes as well Countries reporting significant progress as health and other objectives. Of course, coun- in the control of illicit tobacco trade tries putting more weight on health objectives adopted some key policy and institu- could raise taxes even further.” tional measures which contributed to their success. A good example is Ireland, Empirical Findings Contradict where a high rate of tobacco excise, and the Traditional Arguments of consequent high price of tobacco products, Illicit Trade, Employment and makes the country attractive to those Regressive Effects involved in the illicit tobacco trade. However, Illicit trade undermines global tobacco Ireland’s comprehensive and effective prevention and control interventions. system of customs and tax enforcement, However, a recent global report by the alongside strong regulatory control of the World Bank (2019) also shows that, contrary tobacco market, has contained the illicit flow to tobacco industry arguments, tobacco of tobacco products onto the Irish market. taxes and prices have only a limited impact Box 1 summarizes these measures, which are on the illicit market share at country fully consistent with the provisions of the level. From a public health perspective, WHO FCTC Protocol to Eliminate Illicit Trade illicit trade weakens the effect of tobacco in Tobacco Products, which entered into excise taxes on tobacco consumption—and force in September 2018, and needs to be consequently on preventable morbidity and ratified and adhered by all FCTC Parties. mortality—by increasing the affordability, Policymakers considering tobacco tax attractiveness, and/or availability of tobacco hikes are often concerned about impacts products. Furthermore, tobacco illicit trade on employment. However, increase in often depends on and can contribute to tobacco taxes does not negatively affect weakened governance. However, evidence employment, as evidence from Indonesia presented in the report from over 30 coun- shows. Recent assessments done by the tries across the income and development World Bank Group (Araujo et al 2018), with spectrum, shows that raising tobacco taxes the participation of the American Cancer is not the primary cause of illicit trade. The Society, indicate that share to industry-wide evidence indicates that the illicit cigarette employment is about 5 percent, or .60 per- market is relatively larger in countries with cent of total employment in Indonesia. This low taxes and prices, while relatively smaller share is smaller in comparison to employ- in countries with higher cigarette taxes and ment in the food (27 percent), garment (11 prices. Non-price factors such as governance percent), and textile (8 percent) sectors in status, weak regulatory framework, and the Indonesia. The core-sector employment availability of informal distribution networks includes about 2.5 million manufacturing appear to be far more important factors. workers: 693 thousand farmers, 1.04 million 20 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity Box 1. Policies and Institutional Measures to Confront Illicit Tobacco Trade Findings from the country case studies and and they should be destroyed when the assessments included in the World Bank pack is opened (also to prevent reuse). Group report “Confronting Illicit Tobacco The absence of secure excise marking Trade: A Global Review of Country Experi- in Southern African Customs Union ences” (2019), suggest the following spe- countries, Chile, and Mexico weakens cific actions: the ability of the tax authorities to collect taxes, as noted in the case studies. • Require licensing for the full tobacco • Establish effective track-and-trace supply chain. At present there is licensing systems to follow tobacco products at least for all manufacturers, importers, through the supply chain from produc- exporters, and distributors in almost all tion or import to sale to consumers. country cases. What is needed is for each Secure excise stamps are crucial but country to assess its capacity to require not sufficient to prevent tax evasion if licensing the rest of the supply chain, there is no downstream verification that particularly retail. As noted in the Canada cigarettes have tax stamps and that they case study, the best example of using are authentic. A track-and-trace system licensing to control the supply chain is would help address, for example, the in the province of Quebec, where the challenge posed by under-declared entire supply chain is licensed including domestic cigarette production or pro- tobacco growers, transporters, manufac- duction declared for export but then sold turers, those who store raw tobacco and/ on the domestic market. The Mexico, or final products, importers, wholesalers, Chile, and Southern African Customs retailers, as well as those in possession Union case studies identify the absence of manufacturing equipment. Tobacco of a track-and-trace system as the major importers are licensed in Malaysia and obstacle to controlling illicit trade in the Philippines requires suppliers of raw tobacco products. Notably, as detailed in materials to the production process, the case studies, Ecuador’s tax track-and- including those providing tobacco papers trace system for domestically produced and filter components, to be licensed. cigarettes, alcoholic beverages, and beer • Require use of secure excise tax stamps was implemented by its Internal Reve- and other product markings to facili- nue Service in 2017 and is the first track- tate enforcement and tax collection. and-trace to comply with the Protocol to These markings should possess multiple Eliminate Illicit Trade in Tobacco Products. layers of security (as implemented in • Establish effective enforcement teams Kenya, Georgia, and the Philippines, for equipped with automated reporting example); they should not be removable; devices, to reduce human discretion 21 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements in tobacco tax administration. This tobacco products. In contrast, Colombia feature played a major role in improving and Malaysia both established a strict the level of enforcement in Kenya and regulatory framework for free trade Georgia. However, the Kenya case also zones to prevent this challenge. underlines the importance of enforce- • Set and enforce significant financial ment agents with the power to carry out penalties and penal provisions for illicit inspections at any time and at any point trade in tobacco products. Seizures, in the supply chain, to seize illicit prod- financial penalties, and other punish- ucts on the spot, and to bring immediate ment severe enough to be a deterrent charges against offenders. (unlike some of those reported in the • Obtain detection equipment and use it Kenya case study) are important. Crimi- effectively at customs posts. Most coun- nal prosecutions are particularly import- tries already have access to detection ant as deterrents, as indicated in both equipment, although not necessarily in the UK and the Colombia case studies. adequate quantity. Potential governance • Provide for secure and environmentally challenges, with respect to the use of friendly destruction of seized cigarettes, this equipment, can be further reduced carried out by the regulatory authorities by separating the roles of generating and not by the tobacco industry. In Mex- and interpreting scans (as noted in the ico, customs officials destroy seized cig- Kenya case study). arettes, while in the Philippines approval • Develop a risk profile to target inspec- and presence of a Bureau of Internal tions. The Chile case highlights the use of Revenue representative is required. In a risk analysis tool for targeting suspicious contrast to this guidance, in South Africa cargos and to generate customs alerts. an industry-representative body is respon- • Set relatively low duty-free allowances sible for the destruction of illicit goods. for tobacco product purchases, both in • Educate the public on the impact of terms of amounts (e.g. only two packs, tobacco illicit trade. Getting the public as in Australia) and frequency (e.g. only involved supports enforcement and once every 30 days as in Georgia). Chile reduces the demand for illegal products. shows how the lack of restrictions on As noted in the case studies, the Phil- frequency led to substantial but legal ippines and Kenya introduced apps for small-scale tax avoidance. the public to verify the authenticity of • Regulate or ban trade in tobacco cigarette packs, while the UK ran a public products in free trade and other special awareness campaign explaining how economic zones. The Chile case study purchasing illegal cigarettes harms the illustrates how the relative freedom from country and local communities. regulation in these zones can make them Source: World Bank 2019 gateways for domestic sale of untaxed 22 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity clove farmers, and 750 thousand tobacco inclusive analytic model reverses the initial farmers. Most tobacco sector workers are appearance of tobacco tax regressivity. Far females and unskilled (66 percent manufac- from unfairly burdening the poor, tobacco turing workers and 92 percent production taxes deliver the greatest share of their workers). About 43 percent of households potent long-term benefits to people with with tobacco workers are poor; they contrib- low incomes. It is smoking that is regressive ute, on average, to 60 percent of household and tobacco tax increases that are progres- income. There is also a male-female wage sive (Marquez and Moreno-Dodson 2017). gap: female production workers earn 25 per- The next sections discuss the main theoreti- cent less than males. The assessments also cal elements of this approach, as well as the estimated that raising cigarette taxes by an main findings of the country studies. average of 47 percent and simplifying the cigarette tax structure to 6 tiers in Indonesia The Price Elasticity of would reduce cigarette demand by 2 per- Tobacco Consumption cent, increase government revenue by 6.4 The distributional impact of raising taxes percent, and reduce gross employment in on tobacco—whether the poor are more tobacco manufacturing sector by only heavily burdened or see the greatest ben- 0.43 percent. efits—depends on the responsiveness of Another often-cited concern among pol- low- and high-income consumers to the icy makers is that tobacco taxes are regres- price changes in tobacco (WHO 2011a). sive, as they disproportionately burden The responsiveness of consumers to price poorer smokers, who spend a larger por- changes can be expressed by the price elas- tion of their incomes on tobacco products, ticity of demand.6 Because of their highly relative to wealthier consumers. To assess addictive nature, tobacco products may be this argument, empirical analyses by the expected to be more price-inelastic—have World Bank in several countries over 2016–19 lower price elasticities in absolute value, provide an in-depth picture of the sociode- or less responsiveness among consumers mographic distribution of tobacco use. They to price changes—than other non-addictive use the ECBA framework, described below, products. This intuition may be used to to incorporate a wider view of longer-term advocate against raising tobacco taxes. health and economic costs and benefits However, the magnitude and distribution of by income group. This approach allows the elasticities remain an empirical question to adjustment behaviors to be compared if be determined in each country context and tobacco taxes rise for poorer and wealthier population group. Understanding the price smokers. It also allows health benefits and elasticities of tobacco across the population productivity gains because of taxes to be incorporated that are neglected in tradi- 6  This parameter—often used in economics—captures the change in the quantity of cigarettes demanded by consumers in tional fiscal incidence analyses. This more reaction to a 1 percent rise in the price of cigarettes. 23 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements Figure 5. Effect of Increasing Tobacco Prices, Extended Cost-Benefit Analysis Change in Change in med- Change in years Net Income = tobacco expen- + ical expenses + of productive Effect diture (A) (B) life list (C) Source: World Bank Group elaboration. is therefore crucial in calibrating the correct China, Indonesia, the United Kingdom, and policy actions and estimating the welfare and the United States, suggests that the sensitiv- distributional effects of tobacco tax systems. ity of smoking prevalence to changes in cig- arette pricing is greater among lower socio- An extensive body of evidence attempts to economic strata. However, the evidence is estimate the relationship between tobacco still mixed in other cases, including Egypt, prices and consumption. Meta-analyses Bulgaria, and Turkey (IARC 2011). of the relationship between tobacco prices and use suggest that the overall elasticity of Tobacco elasticities can be expected to demand among adults lies between -0.3 and increase in the future as more-responsive -0.8, signifying that a 10 percent increase in young generations become the largest cigarette prices will lead to a 0.3 percent to consumer group (Fuchs and Del Carmen 0.8 percent decline in consumption (CBO 2018). It is often argued that younger indi- 2012; Chaloupka and Warner 2000; Gallet viduals and low-income groups are more and List 2003; IARC 2011). responsive to price changes relative to their peers. Lower dependence on nicotine, larger Such relationships, however, are not peer effects, and limited disposable income homogeneous across countries and may cause younger people to be more income groups. In high-income countries, responsive to tobacco price shocks (Jha and raising the price of cigarettes by 10 percent Peto 2014). Chaloupka and Grossman (1996) leads to an estimated reduction of 4 percent and Lewit and Coate (1982) find that, in the in the demand for cigarettes (World Bank United States, individuals ages under 18 1999). An equivalent price change in low- and exhibit much larger tobacco price elastici- middle-income countries would likely result in ties (between −1.44 and −1.31) than adults a 6 percent average fall in demand (IARC 2011). (between −0.27 and −0.42). Lower-income households tend to show higher price elasticity of demand relative to The Extended Cost Benefit medium- and higher-income groups (World Analysis Methodology Bank 1999). Empirical research in a variety ECBA can be used as a theoretical frame- of countries, including Bangladesh, Canada, work to understand the mechanisms 24 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity through which taxes on tobacco affect which tend to allocate a larger proportion of household welfare and equity outcomes. their budgets to tobacco. While the ECBA methodology can vary, However, consumers respond to price two main features allow the distributional increases by adjusting their consumption impact of increasing taxes on tobacco to be behavior. This response depends on the assessed. First, incorporating decile-specific sensitivity of consumers to price changes, price elasticities of tobacco products allows captured by price elasticities of demand. While the stylized fact that different income groups the effect may still inflict a short-run welfare can have different behavioral responses loss on some households, its magnitude to price changes to be taken into account. and distribution depend on the initial distri- Second, accounting for both the costs and bution of consumption across households, the benefits of increasing prices provides a household elasticities of demand, and the more comprehensive understanding of the magnitude of the price shock. net effects, as well as likely short-, medium-, and long-term policy outcomes. Benefits of Tobacco Taxes: Figure 5 summarizes the mechanisms that Reduced Medical Costs (B) have thus far been incorporated in empir- and Additional Years of ical applications of the ECBA by the World Working Life (C) Bank. And the next two sections describe By discouraging consumption, taxes on the main cost and benefit components. (For tobacco products reduce the adverse further methodological details, see Fuchs health effects of tobacco, as well as the and Meneses, various years; Pichón-Riviere large associated medical and human et al. 2014; Verguet et al. 2015.) capital costs to households and societies. Medical treatment of the numerous chronic Costs of Tobacco Taxes: Short- diseases caused or exacerbated by tobacco Term Direct Price Effect (A) swells annual health care costs in public All else being equal, increasing prices of health care systems and households (World tobacco necessarily translate to a welfare Bank 2017). Smoking reduces household loss among consumers, who must spend earning potential and labor productivity, higher shares of their budgets to continue negatively affecting human capital accu- to purchase the same quantities of tobacco. mulation and development (WHO 2015). Such a mechanism is generally behind Hence, reducing tobacco use translates to the claims of regressive effects. A naïve lower smoking-related medical expenses, complete pass-through scenario whereby increases in life expectancy at birth, and households continue to purchase the same reductions in disability. quantity of tobacco at higher prices dispro- portionally affects lower-income households, 25 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements Figure 6. Benefits of Increasing Tobacco Taxes: Channels of Transmission Averted premature mortality Fewer cases of impoverishment Reduced Lower Lower out-of- as a result of consumption of incidence pocket health out-of-pocket tobacco products of tobacco- spending on expenditures [higher reduction related tobacco-related among the poorer diseases diseases wealth quintiles] Fewer cases of Lower government catastrophic Higher Higher health spending health excise taxes price on tobacco- expenditures related diseases Incremental Additional government financing for revenues health and other sectors Source: Postolovska et al. 2017. Public and private health care accounts The indirect costs of smoking on house- for the major share of the costs of tobacco hold welfare may include losses in labor use, beyond the price of household con- incomes because of lower productivity or sumption. Tobacco-related health care costs working days forgone because of illness, can be either direct or indirect. Direct costs as well as the value of lives prematurely include the monetary value of the consump- lost because of tobacco (WHO 2011b). tion of goods and services that is motivated Hence, raising the prices of tobacco may or compelled because of tobacco use. These expand the years of productive life. Verguet include health care costs (hospitalization, et al. (2015) analyze the health effects of a pharmaceuticals and supplies, medical price increase in China and conclude that a equipment, and so on) and non–health care 50 percent rise in prices would result in 231 costs (insurance, job replacements for sick million life years gained over 50 years and smokers, cleaning up cigarette residues and would have a significant impact among the packaging, and so on). For example, in the poor. In contrast, Pichón-Riviere et al. (2014) United States, tobacco-related diseases are estimate that tobacco use in Chile would associated with direct health care costs of reduce life expectancy by nearly 4.0 years 1.1 percent of GDP or 8.7 percent of annual among women and 4.3 years among men. health care spending (Xu et al. 2015). Ahsan et al. (2013) estimate that, if taxes were raised to 57 percent of the retail price of tobacco products, 1.96 million tobacco-re- 26 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity lated deaths would be averted in Indonesia. Similarly, if taxes were raised even more, to 70 percent, more than 5 million deaths would be averted. Other indirect and second-round effects may also be significant. Raising taxes on cigarettes may reduce exposure to second- hand smoke, with significant health and economic benefits. Households may likewise benefit from increased public expenditure because governments have typically ear- marked tax revenues from tobacco sales for health care and social programs. Figure 6 summarizes the channels of trans- mission from taxes to health and economic benefits. It is assumed that the excise tax is directly passed on to the consumer in the form of higher prices. This results in reduced consumption of tobacco products, leading to a decline in the incidence of tobac- co-related diseases, such as stroke, lung cancer, cardiovascular disease, and chronic obstructive pulmonary disease. In turn, this reduces premature deaths associated with tobacco use. In addition, it leads to lower out-of-pocket spending for the treatment of tobacco-related diseases, resulting in fewer cases of impoverishment and catastrophic health spending. Given that a large share of health services is financed by governments, this would also result in government savings on tobacco-related health expenses. Com- bined with the revenues from tobacco taxes, the additional resources could be used to finance health care and other sectors. 27 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN 4 EMPIRICAL RESULTS: LESSONS FROM COUNTRY CASE STUDIES A growing body of evidence has success- income groups; accounting for benefits fully applied the ECBA methodology facilitates a more comprehensive long- to different countries and consistently term picture of the effects of tobacco tax found evidence of medium- to long-term policy. Fuchs and Meneses (2017b) simulate progressive distributional effects. This the effect of increasing taxes on cigarettes in section summarizes the lessons learned Chile. As expected, a naive assumption that through eight country studies carried out smokers do not adjust their consumption to by the World Bank. Most studies highlight the price changes would appear to confirm that lower-income households are more the concerns about regressive policy effects. likely to reduce consumption of tobacco To keep on purchasing the same quantity when facing higher prices. They also find of tobacco, the poorest 20 percent of the that the medium- and long-term benefits of population would have to reduce their con- reduced consumption can often outweigh sumption of other goods more than three the short-term costs, resulting in net income times the equivalent reduction among the gains, particularly among lower-income wealthiest decile (as a percentage of income). groups. In addition to the eight cases pre- However, accounting for behavioral changes sented below, the World Bank Group also by incorporating price elasticities reduces produced assessments following a similar the negative shock across all deciles because methodology in Armenia (Postolovska et smokers react by switching consumption al 2017), Colombia (James et al 2017), and away from tobacco products and toward Kyrgyz Republic (Postolovska et al 2018). other goods. This price effect remains neg- (For full methodological details, results, and ative before taking into account of health further information, the reader should refer and earnings benefits, but simulations to the individual country studies that can be suggest that, in the long term (under accessed at the World Bank Group Global an upper-bound elasticity scenario), the Tobacco Control Program site). price effect on household budgets would approach zero, as tobacco consumption is Chile further abandoned. Findings from Chile illustrate the rele- The net effect of increasing taxes on vance of the price responsiveness across tobacco is calculated by incorporating the 29 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements benefits of reducing the medical costs and budget in some middle-income groups years of life lost to the direct price effect. (deciles 3–6). The ECBA allows the relevant Medical costs because of tobacco-related benefits of reducing tobacco consumption diseases are estimated at US$496 million in in Indonesia to be incorporated that would Chile by Pichón-Riviere et al. (2014). Almost be underestimated under a traditional 30,000 people are estimated to die prema- naive estimation. Approximately 153,108 turely from tobacco-related diseases annually. people (mostly men) died prematurely from Simulations under a lower-bound elasticity tobacco-related diseases in Indonesia in 2016, scenario, show that the net effect of increas- which translated to more than 4 million years ing the price of cigarettes by 25 percent is of life lost. Additionally, in 2015, annual direct negative and regressive, affecting the low- health care costs attributable to tobacco use er-income groups of the population more amounted to US$2.2 billion (equivalent to 2.5 severely. However, as elasticities increase, the percent of GDP). effects become more progressive. Assuming The case of Indonesia raises a variety of a long-term (or high-elasticity) scenario, the complexities in applying ECBA, and it price increase has a progressive distributional sheds light on many questions that may effect, has a positive effect on all income be applicable to countries with local groups, and shows a progressive pattern, substitutes for cigarettes. White and that is, greater benefits among lower-in- clove cigarettes are widely consumed in come groups. Indonesia. Hence, price elasticities and cost Indonesia benefits were estimated separately. Clove cigarettes are cheaper and, on average, have The ECBA in Indonesia highlights the lower price elasticities than white cigarettes need to account for different tobacco (−0.52 vs. −0.63). However, in both cases, the products that raise further complexities distribution of elasticities is consistent with in understanding the effects of tobacco the literature; lower-income households are tax increases. Using data from the 2015–16 more responsive to price changes. Assuming Indonesia National Socioeconomic Surveys, a 25 percent price shock, the benefits of Fuchs and Del Carmen (2018) estimate that reducing tobacco-related medical bills and the net distributional effect of increasing years of life lost contributed to offsetting prices on white and clove cigarettes in the direct price shock of increasing taxes. In Indonesia will likely be progressive. Smoking the case of white cigarettes, the net effect is prevalence in Indonesia is among the highest always positive, but regressive; irrespective in the world, with two households in every of the elasticity assumption, poorer deciles three-reporting positive expenditure on benefit less than richer ones. In contrast, tobacco products. The amount spent on clove cigarettes show heterogenous effects, tobacco among these households is large, depending on the elasticity assumptions. reaching almost 10 percent of the household Under lower-bound elasticities, the results 30 // Empirical Results: Lessons from Country Case Studies show that the net effect of clove tax policy percent of households have elasticities above is negative and regressive. In the case of unit (in absolute value). Because of their high the medium-bound elasticity, the tax is sensitivity to prices, households at the lower progressive, with positive gains among end of the income distribution change their the poorest 20 percent of the population. consumption not only to reduce the quantity For upper-bound elasticity, the tax would of cigarettes, but also to allocate less money to have a positive effect on most income cigarette purchases than before the increase. groups and a progressive pattern. Further Similar to the findings in other countries, research into the heterogeneity of results in considering the two additional effects and possible substitution effects is needed derived from the decrease in tobacco to formulate appropriate policy responses consumption, households would see their that curtail tobacco consumption altogether, welfare eventually increase. For example, avoiding substitution to cheaper (and often households could save resources with lower-quality) tobacco products. a reduction in health expenditures on a lower incidence of tobacco-related illnesses. Bosnia and Herzegovina Moreover, additional income brought about The case of Bosnia and Herzegovina by an increase in life expectancy means that provides some evidence to question the the bottom 60 percent of the income dis- traditional view of tobacco as a highly tribution could end up with more resources price inelastic product, particularly among than before the price increase. lower-income groups. Based on data from the 2015 Household Budget Survey, Fuchs, Ukraine Cancho, and Orlic (2019) simulate the impact Reducing medical expenses is the main of increasing cigarettes prices by 25 percent, mechanism driving the progressive effects a similar increase to the one registered on the of raising taxes on cigarettes in most case average 20-pack of cigarettes between 2015 studies on middle-income countries. In and 2018, according to the Indirect Taxation line with patterns in other country cases, Authority. When faced with increases in Fuchs and Meneses (2017) find that the tobacco prices, households with the least results in Ukraine are mixed and highly financial resources reduce consumption dependent on the assumptions of price considerably more than those with more elasticities. Under a lower-bound elasticity resources. After an increase of 10 percent in scenario whereby the population has low price, people at the lowest income curtail responsiveness to the price changes, the consumption by up to 10 percent, while net effect is negative across all households people at the highest income reduce though the incidence is progressive, with consumption by only 3 percent. In fact, the a smaller shock on lower-income groups. In distribution of elasticities found in Bosnia and the case of a medium-bound elasticity, the Herzegovina suggests that the poorest 10 31 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements tax has a progressive impact, with net income particularly among men and lower-in- gains among lower-income groups and a come households (Fuchs, Matytsin, and negative effect on higher-income groups. In Obukhova 2018). Tobacco-related medical the case of the upper-bound elasticity, inci- expenses are likely to be a considerable dence is progressive, and the income effects burden on Russian households. Medical are mostly positive. Only the highest income expenses for tobacco-related diseases groups face long-term income losses. are estimated at Rub 418 billion in 2017. Averting these medical expenses has a The progressive effect is mostly driven by much larger effect on average household the offsetting effect of reduced medical welfare than the short-term negative costs. The same mechanism is found in the impact of increasing tobacco prices. If ECBAs on most countries, except Bangladesh. reduced tobacco consumption translates Reducing medical bills is highly progressive directly into improved health outcomes, the because treating a tobacco disease would poorest 10 percent of households in Russia represent a much higher share of the budget could increase their available household among lower-income households. In addition, budgets by over 1 percent when facing a lower-income individuals may have less 25 percent price increase in cigarettes. The access to risk management instruments, and, equivalent elasticity-adjusted price shock thus, should catastrophe occur, this group on these households would be less than a will suffer even more than the rest. On the 10th of the benefits from reduced medical other hand, available data still present limita- bills (a 0.01 percent income loss). Hence, tions on capturing the exact smoking-related Fuchs, Matytsin, and Obukhova (2018) find medical expenses across income groups. that taxing tobacco in Russia exerts a net Finding ways to estimate the distribution of positive and progressive long-term effect medical expenses more accurately across the on household incomes. However, as theory population is key to improving the knowledge and empirical applications suggest, the on the equity effects of tobacco tax policy, as magnitude depends on the structure of well as interventions in the health system to price elasticities. If the population is more tackle possible catastrophic expenses associ- responsive to tobacco price changes, it will ated with tobacco-related diseases. experience greater gains from the medical and extended work-life benefits. Russian Federation In Russia, the reduction in medical Moldova expenses is also the most relevant chan- In Moldova, simulations show a poten- nel of transition to improve household tially progressive impact, despite data welfare by increasing taxes on tobacco. limitations and only a partial view of the Despite gradual reductions in recent ECBA. Tobacco-related diseases are the years, smoking is still common in Russia, leading cause of premature adult deaths. 32 // Empirical Results: Lessons from Country Case Studies Consistent with other country cases, Fuchs households to respond firmly to the and Meneses (2018) find that the net effect price changes. First, increasing the price of increasing taxes on tobacco in Moldova of cigarettes in Bangladesh has only small would be progressive, ultimately benefiting consumption impacts. The effect on poverty low-income households most. The gains and inequality would be negligible. Relative in reduced medical expenses seem to be to other country studies, the lack of pro- sufficiently large to offset the negative price gressive effects seems to stem from a more effect on household budgets, with a pro-eq- uniform distribution of elasticities among uity result. The ECBA is estimated in Moldova less and more well-off households. Second, to account for the direct price shock, as well in contrast to other countries, reducing as reductions in tobacco-related out-of- medical bills seems to be less significant in pocket medical expenses. Bangladesh. However, this finding may be driven by an underestimation of tobacco-re- Information on the years of life lost lated medical expenses. Even if medical because of tobacco-related premature expenses are correctly calculated, given the deaths is not incorporated because of low household incomes in Bangladesh, they limitations in the mortality data. Despite are likely to increase in the future as incomes this, under the long-term (high elasticity) rise and the epidemiological transition scenario, the bottom 40 percent of the toward NCDs kicks in. population would capture net positive gains in income. The progressive effect is driven There are relevant policy implications. by two factors that are common in most While elasticities are taken as exogenous country studies. First, lower-income house- parameters in the ECBA methodology, holds capture higher benefits because they policy may still aim to influence respon- are most likely to reduce smoking given their siveness to tobacco price changes. For higher elasticities of demand. Second, reduc- example, complementing tax reforms with ing the high costs of treatment represents a other programs to support quitting among large share of the lower income base among smokers may increase the overall magnitude the poorer households. While the progres- of the effects. Reaching lower-income sive findings are impressive, accounting for households through these efforts would the change in medical expenses as well as likely improve equity and poverty reduction. other channels is fundamental to acquiring a full picture. South Africa Efforts to reduce tobacco consumption Bangladesh can feed back into future consumer The results in Bangladesh highlight the behavior and become increasingly diffi- need to improve the estimation and pre- cult, highlighting the need to complement diction of medical expenses and underline tobacco taxes and other policy inter- that the progressivity of tobacco taxes ventions to maximize impact. The price may depend on allowing lower-income responsiveness of smokers seems less in 33 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements South Africa than in other countries. Fuchs, likelihood of smoking initiation among Del Carmen, and Mukong (2018) calculate younger individuals. A uniform increase in elasticities of tobacco demand in South tobacco taxes should not be the only policy Africa, using longitudinal data with repeated in place to reduce tobacco consumption observations on the cigarette purchases of in South Africa. Along with price increases, individuals over time, allowing an improve- complementary policies to induce quitting ment on earlier calculations based on more will likely be required. aggregated time series data. They find that the poorest decile has a medium-bound New Comparative Evidence elasticity of −0.36, whereas the richest Fuchs et al. (2019) have conducted a has an elasticity of −0.22. Such estimates comparative study to simulate tax policy are below the range of −0.4 and −0.8 changes in the eight low- and middle-in- usually estimated for developing countries come countries in (circa) 2016. Using (Chaloupka et al. 2000). Despite low elasticity updated and comparable data sources estimates, Fuchs, Del Carmen, and Mukong across countries, they confirm previous (2018) continue to find a progressive net findings of a progressive net distributional effect of increasing taxes on tobacco. And effect of raising taxes on cigarettes. Similar aggregate welfare gains are positive among to the previous country studies, they find the bottom five deciles (under the medi- that elasticities help mediate the direct price um-bound elasticity scenario). shock among lower-income households. Possible explanations for the more Incorporating the reductions in medical inelastic tobacco consumption in South expenditures and the additional years of Africa are the country’s past in substantial working life because of lower premature antitobacco policies and the changing mortality help offset the negative price structure of the tobacco market in recent effects in all countries. However, this years. Following profound changes in depends on the initial distribution of smok- tobacco legislation, smoking prevalence ers and price elasticities. Figure 7 shows decreased by over 10 percentage points. the net effects under 25 percent and 50 Today, smoking prevalence is lower in South percent price shock scenarios, assuming a Africa than in other developing countries. medium-bound price elasticity scenario. While these are highly desirable policy In sufficiently high price shocks and outcomes, they seem also to indicate that elasticity scenarios, incidence is pro- impactful policy interventions will become gressive, and net welfare changes are increasingly more difficult to achieve. It is positive among a large proportion of the likely that people who continue to smoke population. Half the population in these are more addicted and possibly less sensitive countries could potentially benefit in the to price changes. Despite this, it is essential medium term from net household income that policies be focused on reducing the 34 // Empirical Results: Lessons from Country Case Studies Figure 7. Comparative Net Income Effects of Increasing Tobacco Prices a. 25% price increase, medium-bound elasticity 1.2 Income Gains (%) 1.0 0.8 0.6 Bosnia and Herzegovina 0.4 Indonesia 0.2 South Africa Russian Federation 0.0 Ukraine -0.2 Moldova Bangladesh -0.4 Chile -0.6 -0.8 1 2 3 4 5 6 7 8 9 10 Deciles b. 50% price increase, medium-bound elasticity 2.5 Income Gains (%) 2.0 1.5 Bosnia and Herzegovina 1.0 Indonesia 0.5 South Africa Russian Federation 0.0 Ukraine -0.5 Moldova Bangladesh -1.0 Chile 1 2 3 4 5 6 7 8 9 10 Deciles Source: Fuchs et al 2019 Note: Deciles calculated from household per capita consumption (excluding identifiable rent and lumpy expenses). Years of life lost calculated form death events related to the risk of smoking tobacco. gains—in addition to health and quality of Limitations of the life improvements and the potential benefits Empirical Findings from increased revenues—if cigarette prices The main theoretical limitation of rose by 50 percent. The updated evidence the ECBA methodology is the partial collected on the eight countries supports equilibrium approach, while data lim- the view that resolute tax policy, combined itations continue to constrain empirical with actions to induce behavioral changes applications in many countries. The sec- among smokers, can generate progressive, ond-round effects and general equilibrium pro-poor and welfare-improving outcomes changes of increasing taxes on tobacco in the long term. are excluded from the model and may be 35 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements significant. For example, the ECBA does not cover additional behavioral changes among economic agents that could unleash econo- my-wide reactions that are difficult to predict. Other effects, such as labor productivity gains, reductions in secondhand smoking, or time allocation to care for sick family members, can be potentially incorporated in the ECBA at higher complexity and data requirements. The incorporation of nonlinearities in elasticities could also be complex. Data lim- itations and higher theoretical and estimation complexities have prevented such efforts thus far. Moreover, lack of data continues to be a constraint on the application of empirical estimations of the ECBA to other develop- ment settings. 36 // Empirical Results: Lessons from Country Case Studies 37 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN 5 KEY TAKEAWAYS A growing body of evidence in different of the ECBA to eight low- and middle-in- countries finds no support for the claims come countries. To simulate the distribu- that the impacts are regressive and tional impact of increasing taxes on ciga- highlights the relevance of the long-term rettes, the methodology allows for different benefits of increasing taxes on tobacco. consumer responses across income groups, Increasing taxes on tobacco can generate and it incorporates both the negative bud- health and equity improvements and help get shock and the benefits derived from mobilize additional domestic resources to improved health and productivity. The results expand the fiscal space for priority invest- on these countries contradict the regressivity ments and programs that benefit the entire claim. Increasing taxes of tobacco is in general population, particularly the poor. The results pro-poor even without taking into account of in eight countries show that, for large price all important benefits for the poor—therefore shocks, the aggregate benefits of tobacco a progressive policy. taxes can exceed increased tax liabilities, To assess the net welfare gains of this with progressive effects that particularly policy, one must consider the behavioral improve the welfare of lower-income responses of consumers facing a price households. The net income and distribu- change, look beyond the direct impact tional effects of increasing taxes on tobacco on household budgets, and assess other depend on the distribution of smoking prev- benefits derived from lower tobacco use alence and the magnitude and distribution of and consumption. Considered by itself, a price elasticities across income groups. price increase in tobacco through higher Tobacco taxes are recognized as an effec- taxes generates negative income variations tive policy tool to reduce tobacco con- across all groups in the population. However, sumption and improve health outcomes; if price elasticities are incorporated, these however, policy makers often hesitate results no longer hold because the poorest to use them because of their perceived individuals tend to have higher price elastic- regressive effects, that is, poorer house- ities than their richest peers. As individuals holds are disproportionally more affected reduce tobacco consumption, reductions than richer households when faced with in medical expenses and gains in potential increased prices due to higher taxes. This working years also work to offset the direct policy note summarizes the findings on the negative income changes. effects of tobacco taxes on distributional Several channels translate the increase in and fiscal outcomes across several coun- tobacco taxes into health and economic tries. It presents results from the application 39 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements improvements among households, methodological problems. There is a clear particularly households at lower income. need to refine the methods used to estimate It is well established that reducing tobacco the medical costs of tobacco (Lightwood consumption improves health outcomes et al. 2000). Improving the estimation of and the quality of life among smokers and these costs and understanding their burden their family members. Moreover, by increas- across population groups will be key in the ing prices and discouraging consumption, research agenda. Implementing policies taxes on tobacco also affect household to shield the poor from these catastrophic economic welfare through several channels. expenses will be necessary during a transi- Lower smoking prevalence reduces the tion period. tobacco-related burden of disease, freeing Policies should aim to induce and leverage households from medical bills and averting the behavioral responses among consum- premature deaths. In addition to the intrinsic ers by complementing tax increases and value of human lives (conservatively not other policy interventions to reduce smok- taking into account of here), averting the ing. Higher elasticities increase the potential premature deaths also increases the poten- gains from reducing health expenses and tial earnings of workers, both by increasing years of working life lost (Fuchs and Del their productivity (not covered here), as Carmen 2018). Hence, long-term positive well as extending their working lifetimes. gains from tobacco taxes require inducing The ECBA allows for the incorporation of relevant behavioral changes in consumers these mechanisms—averted medical bills that allow health-related benefits to kick in. and additional working —to estimate the After a few decades, it is expected that the changes in household welfare. To the extent impact of the tax policy would resemble the that lower-income households face higher upper-bound elasticity scenario. High price relative burdens of tobacco, the benefits will shocks and targeted tobacco control policies be progressive. Other transmission chan- (on groups with higher smoking rates) may nels—for example, increases in productivity be justified to reach welfare-improving and because of reduced days of sickness or the progressive policy outcomes. Taxes will be effects of curtailing secondhand smoking most effective if they are complemented by among children—can generate additional policies such as smoking cessation programs welfare benefits. or media campaigns. A population that Tobacco consumption affects household is not sensitive to tobacco price changes welfare and equity in societies negatively will not reduce consumption sufficiently mostly through medical expenses. to allow health and work benefits to offset The reduction in medical expenses is cost increases. the main driver of the increase in net Short- and long-term policy outcomes will incomes. However, current estimates of likely differ. While it is possible that tobacco medical expenses are associated with taxes will remain regressive in the short run 40 // Key Takeaways because health effects take time to kick in, grassroots support for proposed tobacco the results of this report are helpful as lower- tax hikes, as well as enhance the progres- and upper-bound estimates of the benefits sivity of tobacco taxation (Furman 2016; of tobacco taxation. Adult smokers tend Marquez and Moreno-Dodson 2017). to exhibit small changes in their behavior Improved data availability and further if price increases, while younger groups research should build on the quality and show more elastic demand. After a few specification of the model. While an exten- decades, the impact of the tax policy would sive research on the health and economic be expected to resemble the upper-bound effects of tobacco has accumulated, knowl- elasticity scenario. edge on the distributional effects of tobacco Tobacco control policy should target the is still nascent in many developing settings. most vulnerable groups. The heterogeneity Collecting relevant data to understand the in price responsiveness that has been found distribution of tobacco consumption and across a variety of country cases highlights elasticities across population groups is fun- the opportunity to maximize policy impact damental to implementing policy reforms by targeting specific population groups. and to help smokers and poor households For example, governments may consider to overcome the burden of tobacco. complementing tax policies with tailored Exploring other mechanisms through which interventions to leverage higher price tobacco affects equity will be fundamental. responsiveness among youth or women to prevent smoking initiation. And tax systems must be well designed to ensure that afford- ability is reduced across all tobacco products, with attention to potentially cheaper substi- tutes to cigarettes that may disproportionally affect the most vulnerable groups. Smart policy design and implementation can also help to maximize health impacts and to raise support for tobacco tax policies. As shown by the experience in countries such as Botswana, Colombia, Ecuador, Republic of Korea, Philippines, and the United States, “soft” earmarking of public funds—for example, linking increased taxes to increased health spending or other priority programs and investments that benefit low-income populations—helps generate 41 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACC CONSUMPTION AND IMPROVE HEALTH OUTCOM HOWEVER, POLIC MAKERS OFTEN 6 CONCLUSION The key take-away message to convey in averted treatment costs, the bottom to policy makers and other actors is income group would avert 4.6 times more that higher prices of cigarettes provide costs than the top income group (US$46 more health and financial gains to the billion v US$10 billion). About 15.5 million poorest than to the richest groups of the men would avoid catastrophic health population. As such, higher excise taxes expenditures in a subset of seven countries that lead to higher prices and reduced without universal health coverage. As consumption and health risks associated result, 8.8 million men, half of them in with tobacco-attributable diseases support the bottom income group, would avoid the targets of the sustainable development falling below the World Bank definition of goals on non-communicable diseases and extreme poverty. These 8.8 million men poverty, and provides financial protection constitute 2.4 percent of people living against illness. in extreme poverty in these countries. In contrast, the top income group would Indeed, as shown by the results of a recent pay twice as much as the bottom income study on which we collaborated, a 50 per- group of the US$122 billion additional cent increase in cigarette prices would lead tax collected. Overall, the bottom income to about 450 million years of life gained group would get 31 percent of the life years across 13 diverse middle income countries saved and 29 percent each of the averted (lower middle income, India, Indonesia, disease costs and averted catastrophic Bangladesh, the Philippines, Vietnam, and health expenditures, while paying only Armenia, and upper middle income, China, 10 percent of the additional taxes (Global Mexico, Turkey, Brazil, Colombia, Thailand, Tobacco Economics Consortium 2018). and Chile) from smoking cessation. Half of these are estimated in China. Across all countries, men in the bottom income group (poorest 20 poorest of the population) would gain 6.7 times more life years than men in the top income group (richest 20 percent of the population; 155 v 23 million). The average life years gained from cessa- tion for each smoker in the bottom income group was 5.1 times that of the top group (1.46 v 0.23 years). 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Model Annex A. A Model The Thisfocus Annex A is describes section on the impact of a equilibrium rise in the price the partial of cigarettes, approach a common used to simulate target the impact onof tobacco consumption A. Model of an increase A. in Model the price of cigarettes. This approach is used to evaluate the first-order effects of tax reform. This section A. describes This section Model the partial describes the equilibrium approach partial equilibrium simulate used toused approach the impact to simulate on consumption the impact on consumption a change in prices. It relies mainly on household expenditure patterns. The focus is on the impact of h used to simulate the impact on consumption of an A.increaseModel of an price increase in the price in the of cigarettes. price of cigarettes. This approach This approach is usedis to usedevaluate the first-order to evaluate the first-order effects effects of of a rise in the This This section sectionof cigarettes, describes describes athe thecommon partial partial target equilibrium equilibrium of tobacco approach approach tax reform.used used to to simulate simulate the the impact impact on on consumption consumption Toa h is used to evaluate the first-order effects ofchange assess a in the changeprices. This It distributional section in relies prices. mainly describes It impact relies on the mainly household of partial an on increase equilibrium household expenditure in the approach expenditure patterns. price of used The cigarettes, patterns.to focus simulateThe is on the focus thesimulation impact is impact on the on of consumption impact of of of an an increase increase in in the the price price of of cigarettes. This approach is used to evaluate the first-order effects of nditure patterns. The focus is on the impact a rise This allows To section assessof in a the for rise the price of in an differences the describes of increase distributional cigarettes, price in of the partial the in the cigarettes, impact a responses common price equilibrium an of mainly ofcigarettes. a commontarget cigarettes. across increase approach of in This tobacco targetThis consumption the used approach of price tax approach tobacco toofsimulate deciles isis reform. cigarettes, used tax used to reform. tothe to reflect the evaluate evaluate impact the simulation onfact the thefirst-order consumption first-order that allows poor for effectsof effects of aaa change change in in prices. prices. It It relies relies mainly on on household household expenditure expenditure patterns. patterns. The The focus focus is is on on the the impact impact of of bacco tax reform. of an differences increase in change in the the in price responses prices. of It relies cigarettes. across mainly consumptionThis on approach household deciles is used to expenditure to reflect evaluate the patterns. factthe that The first-order focus poorresources. effects households is on the of impact of households To assess aaa the rise likely rise in in the have distributionalthe price pricedifferent of of impact cigarettes, price cigarettes, a anelasticities of household aa increasecommon common thetarget inrelative target price of to ofof tobacco households tobacco cigarettes, tax tax reform. with reform. the more simulation a change likely Toin have assess rise prices. different in the Itthedistributional relies price price mainlyof elasticities cigarettes, onimpact of relative common an increase toexpenditure target households in the of tobacco price patterns. with of more tax cigarettes, The reform. focus resources. isthe the allows on simulation The impact different for allows of for differences The e price of cigarettes, the simulation allowsa rise different for in the in differences price the elasticities, ofresponses in the cigarettes, combined responses across a common consumption acrosswith the consumption target deciles initial of tobacco to consumption reflect deciles tax to reform. the reflect fact patterns the that fact poor across that households deciles, poor households elasticities, To Tocombined assess assess the the with the initial consumption distributional distributional impact impact of of an an patternsin increase increase across in the the price pricedeciles, of of explain whether cigarettes, cigarettes, the the a price allows simulation simulation allows for for likely have different To assess price the elasticities distributional relative impact of to an households increase in with the more price of resources. cigarettes, The the different simulation allows for reformlikely ciles to reflect the fact that poor households explain will whether be havemore differences differences a different regressive, price in in reform the the price responses responsesmore will elasticities be neutral, more across across relative or more regressive, consumption consumption to households progressive. more deciles deciles neutral, to to with or reflect reflect more more the the resources. progressive. fact fact that that The different poor poor households households useholds with more resources. The different elasticities, To assess elasticities, the combined differences combined distributional with in thethe impact initial responses with the of consumption aninitial across increase consumption consumptionin patterns the price across patterns of deciles cigarettes, deciles, to across deciles, explain reflect the the simulation whether fact explainallows that a whether price poor for households a price likely likely have have different different price price elasticities elasticities relative relative to to households with more resources. The different tterns across deciles, explain whetherThe areform price differences will reform be likely in willmore the have be regressive, more responses different regressive, across moreprice neutral, elasticities more consumption or more neutral, relative or deciles more totohouseholds progressive. households progressive. reflect the with factwith that more more poor resources. resources. households TheThedifferent different loss ofelasticities, real consumption elasticities, combined combined arising with with from the the the initial initial price increases consumption consumption in a product patterns patterns across across i is obtained deciles, deciles, explain explain as follows: whether whether a aa price price e progressive. likely have elasticities, different price combined elasticities with the relative initial to consumption households patterns with across deciles, more resources. The different explain whether price The loss ofreform real reform reform will consumption will will be be be more more more arisingregressive, regressive, regressive, from more the more more price neutral, increases neutral, neutral, or oror morein more more a progressive. product progressive. progressive. i is obtained as follows: elasticities, combined with the initial consumption patterns across deciles, explain whether a price The reform loss of real will The be more loss consumption of real regressive, consumption arising more fromneutral, arising the ∆+ from price , more or the increases price progressive. in a product increases in a product (A.1) i is obtained i is obtained as follows: as follows: !#$,& + ∆ #$ ) ∗ +, creases in a product i is obtained as follows: ∆+ where #$ The The loss loss of of real real consumption consumption #$,& + ∆ arising arising∗ ,from from ∗ +thethe price price increases increases (A.1) a inin a aa product product is inii decile isis obtained obtained j; ∆# as as follows: follows: ∆+ isThethe share loss of of real ! product consumption i!in total #$,& #$ ) household + ∆ arising +,#$ ) from ,expenditure the price increases for in (A.1) household product i obtained is as follows: , (A.1) the The price loss of increase; real consumptionand ∆ is arising the change from the in price consumption increases∆+ ∆+ in of a the product good i isthat obtained depends as on follows: price where where ω_ where is #$share is the the is theof share of shareproduct product #$ of product i in i intotal !!total household in i #$,& + + household total∆ ∆ household #$) ∗∗ ,,expenditure expenditure ∆+ expenditure for a for household for a(A.1) a household (A.1) household in decile ininjdecile ; ∆# isj; ∆ is decile , , (A.1) #$ #$,& #$ )) elasticity. the price 8 increase; and ∆ is the ! change #$,& + in ∆ #$ consumption ∗ ++, + of the good that depends on price # expenditure for a household in decile j; ∆ ∆p# the is the price price increase; increase; and and #$ ∆ ∆ω + is is ∆ the the ∗ change ∆+ change , in consumption , consumption (A.1) of of the the good good that that depends depends on price 8where #$ isis the the share #$,& of of product #$ ) i+ i in total household expenditure for a household in decile jj;; ∆ ## is #$ #$ elasticity. where where 8 share ! product in total household expenditure for aa household in decile ∆ is umption of the good that depends on price elasticity. #$ is the share of product , i in total household expenditure for household in decile j; ∆ # is on pricein Change tobacco the elasticity. the price price 7expenditures increase; increase; and and ∆ ∆ is is the the change change in in consumption consumption of of the the good good that that depends depends on on price price where #$ is thetheprice share increase; of product and i in∆ #$ total #$ #$ is the change household in consumption expenditure for a household of the good in decile thatj;depends ∆# is on price Change elasticity. elasticity. tobacco in increase; 88 expenditures the price Change elasticity. in To estimate the variation in cigarette tobaccoand8 expenditures ∆ #$ is the change in consumption consumption after the price increase, the model considers of the good that depends on price the elasticity. Change change in 8 in Tobacco prices Change ( in∆ ),Expenditures tobacco the tobacco expenditures price elasticity ( ) for decile j , and the share of cigarette To estimate Change the variation Change To estimate in in the tobacco tobacco in cigarette expenditures expenditures consumption after the $ price increase, the model considers the the expenditure change in in period prices ( ∆ 0variation ), (the #$,& ). The tobacco in cigarettechange price inconsumption the expenditure elasticity ( ) after for of the decile price increase, household j , and ithe in decile share the j model is of presentedconsiders cigarette er the price increase, the model considersTo the Change estimate change in To tobacco the in prices expenditures variation (∆ in ), the tobacco cigarette consumption price elasticity $ after for decile ($ ) price the increase, j, and the the model share con-of cigarette as a share expenditure of To total inestimate estimate period expenditure 0 the the ( variation variation ).( and The averaged in in change cigarette cigarette in bythe decile consumption consumption expenditure to quantify after after of the the the household overall price price impact, increase, iincrease, in decile as the the isfollows: model model considers considers the the ($ ) for decile j, and the share of cigarette To expenditure estimate in period #$,& the variation 0 #$,& ).in Thecigarette change consumption in the expenditure after the price of household increase, i injdecilethe presented model considers j is presented the siders as a share the change change change of total in in in prices prices prices expenditure ((∆ ∆ ), and), ), the thethe averaged tobacco tobacco tobacco by price price price decile elasticity elasticity elasticity to quantify ( (( )) the for for for decile decile decile overall jj ,j, , impact,andand and the as the the share share share follows: of ofof cigarette cigarette enditure of household i in decile j is presented To estimate as a change the share variation of in total prices in expenditure ( cigarette ∆ ), the and tobacco consumption averaged price after by elasticity the decile price to ($ $ increase, quantify $ ) for decile the the model overall j , and impact, the considers share as the follows: of cigarette expenditure expenditure in in period period 000 (( ). ).).The The change change in in the the expenditure expenditure of of household household ii in in decile decile j is presented i in j j isis presented @AB, change in cigarette e to quantify the overall impact, as follows: expenditure ∆ prices expenditure Expenditure (∆), in in the period period :,; = ((1 tobacco + ( #$,& price #$,& ∆p )!). #$,& 1 The ;change elasticity + ε ∗ ∆p)( change -1)in $) in the ∗ for theexpenditure decile expenditure j, and of household the share (A.2) of household ofi in decile cigarette presented as as aa share share of of total total expenditure expenditure and and averaged averaged by by decile CDEFG HIJHKL:EMNH decile to to quantify quantify AB, the the overall overall impact, impact, asas follows: follows: expenditure as a shareas of( total expenditure and averaged byaveraged decile to quantify the overall impact, as follows: ∆in period 0 ). The change 1 in the expenditure of household i in decile j is presented @ decile j is presented Expenditure ∆ Expenditure a :,; = ((1 share #$,& of+ total ∆p)! expenditure + ε; ∗ 1∆p ε-1)and ∗ CDEFG HIJHKL:EMNH AB, by @ decile AB, to quantify (A.2) the :,; = ((1 + ∆p )!decile +) ; ∗ ∆p )-1) ∗ CDEFG HIJHKL:EMNH (A.2) @AB, as a share of total expenditure and averaged by to quantify the overall AB, impact, as follows: AB, -1) ∗ CDEFG HIJHKL:EMNH (A.2)overall impact, as follows: @ @AB, Medical expenditures∆ Expenditure :,; == ((( (11+ + ∆p 1 1+ +ε ε;; ∗∗ ∆p )-1) ∗ (A.2) AB, ∆∆ Expenditure ∆p) )! ∆p) -1) ∗ @ AB, (A.2) :,; = ((1 + ∆p! -1) (A.2) Expenditure :,; )!1 + ε ; ∗ ∆p ∗ AB, CDEFG HIJHKL:EMNH ) @ CDEFG HIJHKL:EMNH CDEFG HIJHKL:EMNH AB, AB, AB, AB, Medical ∆ Expenditure expenditures Medical expenditures :,; = ( ( 1 + ∆p )! 1 + ε ; ∗ ∆p ) -1) ∗ (A.2) CDEFG HIJHKL:EMNHAB, The change in medical expenditures associated with tobacco-related diseases is estimated using equation A.3, Medical Medical for which expenditures expenditures the cost of treatment of tobacco-related diseases for income decile is The change The in medical Medical change in expenditures medical expenditures expenditures associated associated with tobacco-related with tobacco-related diseases is estimated diseases using using obtained from administrative data. The cost of tobacco-related medical expenditures isis estimated distributed equation Medical using equation A.3, expenditures for which A.3, for the which the cost of treatment cost of tobacco-related diseases for income decile is tobacco-related diseases is estimated across incomeThe The decile change change in in according medical medical to theof expenditures expenditures treatment share of households associated associated of tobacco-related with with that consume tobacco-related tobacco-related diseases tobacco for income diseases diseases in decile is isis decile estimated estimated . is using using bacco-related diseases for income decile obtained from obtained The administrative change from in administrative medical data. The expenditures data. is A.3 shows the income gains associated with the reduction in medical expenditures because cost The of tobacco-related cost associated of tobacco-related with medical tobacco-relatedexpenditures medical is diseases expenditures distributed is estimated distributed using Equation equation equation A.3, A.3, for for which which the the cost cost of of treatment treatment of of tobacco-related tobacco-related diseases diseases for for income income decile decile is isis across o-related medical expenditures is distributed The change income across equation decile income in medical A.3,decile according for which according to thethe share cost to the of of sharehouseholds treatment of of that tobacco-related households consume that consumetobacco diseases in tobacco for decile income in . decile decile . 7  of Forreduced a detailed tobacco obtained discussion of the expenditures consumption from administrative methodology, oversee associated the Coadydata. long et al. The with term.cost (2006); Kpodartobacco-related of tobacco-related (2006). diseases medical is expenditures estimated using is distributed Equation A.3obtained shows obtained from the from administrative income administrative gains associateddata. data. The with The cost the cost of tobacco-related reduction of tobacco-related in medical medical inmedicalexpenditures expenditures expenditures because isis distributed distributed ouseholds that consume tobacco in decile equation . Equation A.3, for A.3 whichshows the the cost income of gains treatment associated with of tobacco-related the reduction diseases medical for income expenditures decile isbecause across across income income decile decile according to the share of households that consume tobacco in decile . he reduction in medical expenditures becauseof reduced obtained of from reduced tobacco across consumption income tobacco administrative decile consumption data. according over the according The over cost longof toto the the term. the long share tobacco-relatedshare term. ofofhouseholds households medical thatconsume that expenditures consume is tobaccoin tobacco distributed decile . . indecile Equation Equation A.3 A.3 shows shows the the income income gains gains associated associated with with the the reduction reduction in in medical medical expenditures expenditures because because across income Equation decileA.3 shows theto according income the share gains of associated households withthat the reductionconsume in medical tobacco in expenditures decile 55 . because of of reduced reduced tobacco consumption tobacco consumption over over the the long long term. term. Equation A.3 of reduced shows thetobacco income gains consumption associated over with the the long term. in medical expenditures because reduction 8 For a detailed discussion of the methodology, see Coady et al. (2006); Kpodar (2006). of reduced tobacco consumption over the long term. 8 For a detailed discussion 8 For a detailed of the methodology, discussion see Coady of the methodology, etCoady see al. (2006); et al.Kpodar (2006);(2006). Kpodar (2006). Page 40 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements Medical Expenditures The change in medical expenditures associated with tobacco-related diseases is estimated using equation A.3, for which the cost of treatment of tobacco-related diseases for income decile i is obtained from administrative data. The cost of tobacco-related medical expen- ditures is distributed across income decile i according to the share of households that consume tobacco in decile i. Equation A.3 shows the income gains associated with the reduction in medical expenditures because of reduced tobacco consumption over the long term. UDVE CNHFE.CDXFYYDZ[HGFEHL \:VHFVHVA ∆ Medical expenditure:,; = (!1 + ε; ∗ ∆P)-1)∗ (A.3) CDEFG HIJHKL:EMNHB, A reduction A reduction in tobacco consumption in tobacco consumptioninin the long the run long would run be be would strongly related strongly to a related toreduction a in tobacco-related diseases. The model assumes that the health effects of tobacco-related diseases reduction in tobacco-related will immediately diminish with diseases. model Thein the reduction assumes tobacco that the consumption. health Even effects though of tobac- this assumption is implausible co-related in the short diseases with changes term because will diminish in the effects the reduction of tobacco-related in tobacco consumption. diseases take time Even though to materialize, ∆ it provides an =upper-bound estimate of the effects of tax increases. UDVE CNHFE.CDXFYYDZ[HGFEHL \:VHFVHVA this Medical expenditure assumption :,; (! is implausible in1+ ε; short the ∗ ∆P)-1) ∗ because term (A.3) changes in the effects of tobac- CDEFG HIJHKL:EMNHB, co-related diseases The increase time takelife in working to materialize, it provides an upper-bound estimate of the years of taxin A reduction effects tobacco consumption ∆ Medical expenditure increases. in the long run would be strongly :,; = (!1 + ε; ∗ ∆P)-1)∗ relatedA to a reduction (A.3) in UDVE CNHFE.CDXFYYDZ[HGFEHL \:VHFVHV UDVE CNHFE.CDXFYYDZ[HGFEHL \:VHFVHV tobacco-related diseases. ∆ Medical expenditure CDEFG HIJHKL:EMNH The model assumes :,; = (that A !1 +the ε; ∗health ∆P)-1)effects ∗ (A.3) the increase of B, tobacco-related diseases The model estimates the impact on income arising from in working yearsB, CDEFG HIJHKL:EMNH (equation will immediately A.4). To estimate diminish the increase with the reduction in working in tobacco years, the years consumption. of life lost, Even YLLthough this assumption , from tobacco-related Ais reduction implausible inin tobacco the short consumption term because in changesthe longin runthe would effects beof strongly tobacco-related related diseases to a reduction in The Increase diseases in A Working are distributed reduction across Life Years tobacco in deciles consumption proportionallyin to thethelong number run would of households that take be strongly time related consume to a reduction in tobacco-related to materialize, diseases. provides ittobacco-related The model an upper-bound assumes estimate that the of the health effects of tobacco-related diseases tobacco (equation A.5). Subsequently, diseases. the The income model assumes lost iseffects that estimated of the tax as increases. health effects of the average tobacco-related income per diseases will immediately The model in estimates diminish with the reduction in tobacco consumption. Even in though this assumption household decile . the will immediately Overall, impact the on diminish model income with anticipates arising the reduction from that the increase in tobacco income will consumption. increase working as the years Even though number of this assumption is implausible The increase in in the working shortlife term because changes in the effects of tobacco-related diseases take time years years (equationlost because A.4). is implausible of premature in the short deaths fromterm because tobacco changes consumption thein thedeclines. effects of tobacco-related YLL, from diseases take time to materialize, itTo provides estimate an the increase upper-bound in working estimate of years, the effects years of taxof life lost, increases. to materialize, it provides an upper-bound estimate of the effects of tax increases. tobacco-related The model estimates diseases the impact are distributed on income acrossarising deciles from itheproportionally increase in to the number of `DNa:Kb cHFNV A ∗CDEFG dIJHKL:EMNH A working years (equation The increase ∆inIncomeworking : = ( life ! 1+ ε; ∗ ∆P)-1)∗ years (A.4) A.4). To estimate households that The the consume increaseincrease tobaccoin working in working (equation lifeyears, years A.5).theSubsequently, years of life CDEFG HIJHKL:EMNH A lost, theYLL income , from lost tobacco-related is estimated diseases are distributed across deciles proportionally to the number of households that consume as The the average model estimates income theper impact household on income in decile arising i. from Overall, the the model increase anticipates that income tobacco (equation The A.5). model Subsequently, estimates ∗ the # = (# the income impact on lost income is estimated ℎ # )/ arising from in as working the the # average years (equation (A.5)income increase in workingperyears (equation A.4). will To estimate increase household inas decilethe the number .increase Overall, ofinthe working years model years, the lost anticipates because of yearspremature that of life lost, income deaths will YLLfrom increase , from tobacco-related tobacco as the con- of number A.4). To estimate the increase in working years, the years of life lost, YLL, from tobacco-related diseases years are lost distributed because of premature across deciles deaths proportionally from tobacco to the number consumption of households that consume declines. The total sumption income declines. gains diseases inare each income distributed group across are estimated deciles by adding proportionally theto the results of the number ofincrease householdsin that consume tobacco (equation A.5). Subsequently, the income lost is estimated as the average income per tobacco expenditures, tobacco the reduction (equation in medical A.5). Subsequently, expenditures, the income and the lost gain isin working years. estimated as the average income per household in decile . Overall, the model `DNa:Kb cHFNV anticipates that income will increase A ∗CDEFG dIJHKL:EMNH as the number of ∆ Income household : = (!1in + decile ε; ∗ ∆P) .-1) Overall, ∗ the model anticipates that A income(A.4) will increase as the number of years lost because of premature deaths from tobacco consumption CDEFG HIJHKL:EMNH A declines. B. Tobacco Pricelost years Elasticity, because byofDecile premature deaths from tobacco consumption declines. Let #{ be ∆ as : = (!1average = ( ∗∗ `DNa:Kb cHFNVA ∗CDEFG dIJHKL:EMNH ℎ per # )/ A (A.5)A in income Income defined the + # ε ; ∗ ∆P ∆ Income )#-1) quantity = ( of cigarettes ∆P)-1)∗ smoked `DNa:Kb cHFNV day by # individual A ∗CDEFG dIJHKL:EMNH (A.4) (A.4) : !1 + ε; ∗ CDEFG HIJHKL:EMNH A decile d; the average price per cigarette (unit value of tobacco use); # the consumption CDEFG HIJHKL:EMNH A decile of The total income individual ; and gains the inindividual each income group are estimated characteristics. Then, the by adding the smoking intensity results of the increase equation is writtenin The totalexpenditures, tobacco income #{ gains the # = ( in reduction each income in # ℎ ∗ medical group are estimated expenditures, # )/ and by the gain adding #inthe (A.5) results working years.of the as follows: # = (# ∗ ℎ # )/# (A.5) increase in tobacco expenditures, the reduction in medical expenditures, and the gain in The total Price in income gains B. Tobacco each income Elasticity, group are estimated by adding the results of the increase in by Decile working years. Theln #{ income total  = & + gains # +income in∗each Ä #{ + #{ are estimated group (A.6) by adding the results of the increase in tobacco expenditures, the reduction in medical expenditures, and the gain in working years. tobacco expenditures, the reduction in medical expenditures, and the gain in working years. Let The #{ be defined empirical analysis as the average (A.6) of equation quantity assumes a log-logsmoked of cigarettes per day relationship among by individual in income smoking intensity, B. dTobacco Price Elasticity, per by Decile (unit value of tobacco use); the consumption decile of B. Tobacco decile price, ; income. and Price the average B. #{ Elasticity, price is observed Tobacco cigarette Price ifby andDecile Elasticity, only if by the individual in a given Decile # decile is a current individual ; and #{ the individual characteristics. Then, the smoking intensity equation is written smoker. Let defined as be defined #{ be the average quantity ofofcigarettes smoked perper day by individual in income i individual in income as follows: Let as #{ the beaverage defined as quantity the average cigarettes quantitysmoked of cigarettes day by individual smoked per day by decile Several d; modelsthe average have price per cigarette (unit value of tobacco use); the consumption decile of in income decile d; Pbeen decile the tested d; average the average toprice determine priceperper the cigarette cigarette best (unit forvalue fit(unit each value country. of of # tobaccouse); tobacco Di# the consumption decile of use); individual ; and #{ln the individual = + characteristics. ∗ + Then, + the smoking intensity equation (A.6) is written individual #{ ; and &  the individual #{ # Ä characteristics. #{ #{ Then, the smoking intensity equation is written as follows: as follows: The empirical analysis of equation (A.6) assumes a log-log relationship among smoking intensity, 56 // Annex price, and income.A ln #{ = & +  #{ is observed lnif and ∗ # + if only Ä #{ + the #{ individual in a given (A.6) decile is a current (A.6) #{ = & +  ∗ # + Ä #{ + #{ smoker. The empirical analysis of equation (A.6) assumes a log-log relationship among smoking intensity, The empirical analysis of equation (A.6) assumes a log-log relationship among smoking intensity, price, Several and income. models #{ is tested have observed if and only the if the individual given decile is a current in a country. price,been and income. to determine best fit for each #{ is observed if and only if the individual in a given decile is a current smoker. `DNa:Kb cHFNVA ∗CDEFG dIJHKL:EMNHA ∆ Income: = (!1 + ε; ∗ ∆P)-1)∗ (A.4) CDEFG HIJHKL:EMNHA `DNa:Kb cHFNV `DNa:Kb cHFNVA ∗CDEFG dIJHKL:EMNH A ∗CDEFG dIJHKL:EMNHA ∆ Income: = (!1 + ε; ∗ ∆ -1) ∆P Income ∗ : = (!1 + ε; ∗ ∆P)-1)∗ A (A.4) A (A.4) ) CDEFG HIJHKL:EMNHA CDEFG HIJHKL:EMNH # = (# ∗ ℎ # )/# (A.5) # = ( # = ( # ∗ ℎ # ∗ ℎ # )/# (A.5) # )/# (A.5) The total income gains in each income group are estimated by adding the results of the increase in tobacco expenditures, the reduction in medical expenditures, and the gainby working in adding years. The total income gains inThe each total income income group gains are in each income estimated group the by adding are estimated results of the increase the in results of the incre tobacco expenditures, tobacco expenditures, the reduction in medical expenditures, and the gain in working years. the reduction in medical expenditures, and the gain in working years. B. Tobacco Price Elasticity, by Decile B. Tobacco Price Elasticity, by DecilePrice Elasticity, by Decile B. Tobacco Let #{ be defined as the average quantity of cigarettes smoked per day by individual in income decile d; theLetaverage #{ be price per cigarette defined as cigarettes the average (unit value quantityof tobacco # the use); smoked consumption day bydecile of in in Let #{ be defined as the average quantity of smoked perof day cigarettes by individual inper income individual individual ; and decile the #{ d; individual the average characteristics. price of per cigaretteThen, the (unit smoking intensity equation is written decile d; the average price per cigarette (unit value tobacco use); # value of tobacco use); the consumption the consumption de #of decile as follows: individual icharacteristics. and X_ ;; and individual the individual consumption decile individual ; and of individual #{ the #{ the Then, thecharacteristics. characteristics. smoking intensity Then, Then, the equation thesmoking smoking intensity equation is w is written as follows: intensity equation is written as follows: as follows: ln #{ = & +  ∗ # + Ä #{ + #{ (A.6) #{ = ln of & +  ∗assumes # + #{ Ä #{ + & #{  # ln Ä(A.6) #{ #{ = + ∗ + + (A.6) Theanalysis The empirical empirical equation analysis (A.6) of equation (A.6) a log-log assumes relationship a log-log among relationship smoking among smoking intensity, intensity, price, price, andincome. and income. #{ is observed lnQ_ observed ifif and and only if only the individual if the ain individual given ain decile a given is among decile adcurrent The empirical analysis of The empirical equation (A.6) analysis assumes of aequation log-log (A.6) assumes relationship amonglog-log relationship smoking intensity, smoking inten smoker. price, is and income. a current smoker.#{ price, and income. is observed #{ if and only is observed if the in a only if and individual given the individual ifdecile in a given decile is a curren is a current smoker. smoker. Several models have been tested to determine the best fit for each country. Several models have been tested to determine the best fit for each country. testedmodels Several Several models have been have been to determine tested the best fit to fordetermine the best fit for each country. each country. Page 41 Page 41 57