Published on The Morning
- Hiking the price of cigarettes to increase govt. revenue and reduce tobacco consumption
Reliefs and price decreases are generally expected from a budget in the Sri Lankan context; people almost never ask for taxes or price hikes. However, during the past few months, a number of groups have been demanding that the Government increase the taxes imposed on one consumer good: Cigarettes.
After the tax hike in 2019, Sri Lanka has not increased cigarette taxes thus far, even though taxes imposed on a large number of other goods have increased considerably. According to rough estimates, not increasing cigarette taxes after 2019 has cost Sri Lanka as high as Rs. 100 billion, and several groups, including public and private institutions, have pointed out the importance of taking prompt measures to do so through the upcoming Budget (Appropriation Bill) for 2022.
According to them, a scientific formula will help decrease cigarette consumption, reduce or control the economic and health-related costs resulting from cigarette consumption, and most importantly, increase cigarette tax based revenue significantly.
Interests, costs, and current taxing method
According to think tank Verité Research, the tobacco tax policy hinges on balancing three key interests, namely fiscal interest, social interest, and industrial interest, and it is crucial to understand the effects of each of these three key interests.
This was stated by Verité Research Executive Director Dr. Nishan de Mel during a webinar titled “A Rational Formula for Cigarette Taxes: An Alternative to Ad Hoc Taxation” held last Thursday (28 October), where the impacts of unsystematic and irregular cigarette taxing, and the economic costs of not having a pricing or taxing formula for cigarettes, were analysed extensively.
Speaking of the social interest, Dr. de Mel noted that tobacco is harmful to health, and that a large number of users have a high possibility of earlier mortality due to the consumption of the product. Also, there is global consensus about the benefits of curtailing smoking, and the World Health Organisation’s (WHO) Framework Convention on Tobacco Control (FCTC), to which Sri Lanka is a signatory, is based on the idea that there is a net benefit to any society from reducing the consumption of tobacco.
“According to the WHO, tobacco kills over eight million people a year. More than seven million of those deaths are the result of direct tobacco use, while around 1.2 million are the result of non-smokers being exposed to secondhand smoke,” he added.
With regard to industrial interests, he said that Sri Lanka currently has a monopoly concerning cigarette production, and that profit maximisation is a priority. Due to there being only one cigarette producer, the price is not based on a competitive market, Dr. de Mel said, adding that the market price is not determined by the Government, which only determines the taxes. He observed that it is generally not in the industry’s interest to keep the prices low, and that cigarette manufacturers increase prices aggressively when taxes are increased, mainly in order to keep the taxes low in relation to the price.
Explaining the fiscal interest aspect, he presented data from 2015 to 2020, according to which, the number of cigarettes consumed in Sri Lanka had decreased (3.96 billion in 2015, 3.79 billion in 2016, 3.15 billion in 2017, 3.15 in billion in 2018, 2.62 billion in 2019, and 2.28 billion in 2020). Taxes on cigarettes as a percentage of the recurrent expenditure too had also decreased since 2017 (4.77% in 2015, 5.03% in 2016, 5.57% in 2017, 5.33% in 2018, 4.35% in 2019, and 3.70% in 2020), which according to Dr. de Mel could be due to taxes or prices not being increased, even though there were inflation and nominal gross domestic product (GDP) increases with time.
He pointed out the priority areas relating to the three interests, generating higher tax revenue, the reduction of consumption, and having a reasonable policy and higher profits.
Dr. de Mel also said that the interests of the industry, society and the Government have a convergence, and that it can be described through the concept known as price elasticity of demand (PED), which, in this case, means the percentage change in the consumption of cigarettes in response to a percentage change in the price.
“When the price increases by 10% and consumption changes by 10%, we can say that the price elasticity of demand is at one. When the consumption response is a smaller percentage than the price change, then we can say that the price elasticity of demand is less than one. If we increase the price by 10%, the total revenue collected from cigarettes does not drop by 10% even if consumption is dropped, and instead, the total revenue increases. So, when the fall in consumption is smaller than the increase in price, for any price increase, the total revenue collected from cigarettes increases. When the price elasticity of demand is less than one, it means that we can simultaneously reduce consumption, which is in the social interest, have a higher tax revenue for the Government, which is in the fiscal interest, and depending on how that increased revenue is shared, we can also have a higher net tax revenue or profit to the industry.”
Excise taxes on cigarettes in Sri Lanka are based on the length of a cigarette, and at present, Sri Lanka has identified six length ranges, namely, 60 mm or less, 60-67 mm, 67-72 mm, 72-84 mm, and 84 mm or more. Taxes are not determined on the basis of the price of a cigarette.
According to the statistics presented by Dr. de Mel during the presentation, the frequency of tax changes shows an irregular and unpredictable manner.
While 2011 and 2012 saw three tax changes each year, two tax changes had been done every year from 2013 to 2016. No tax changes had been done in 2017. In 2018 and 2019, one change and six tax changes had been done, respectively. Again in 2020, no tax changes had been done.
Noting that the percentage of tax changes was also volatile, Dr. de Mel explained that according to the statistics, during the October 2014-December 2019 period, the percentage change of excise taxes with each tax change had increased from 0.05% to 92.82%, and had decreased from 12.23% to 32.42%, on different occasions.
Explaining how cigarette companies make profits by increasing prices by a higher percentage when the Government increases taxes, Dr. de Mel said that the net tax (the amount left after adjusting for the effects of taxes) price generated by tobacco companies grew faster than price tax (revenue collected by the Government as taxes).
Statistics showed that when the Government increased excise tax and/or value added tax (VAT), the cigarette prices increased by a larger percentage. From January 2005 to present, the amount the local cigarette company collected grew 10.7 times for the cheapest cigarette brand, while what the Government collected grew only 7.3 times. During the same period, for the most sold brand, what the Ceylon Tobacco Company (CTC) collected grew 8.7 times, while what the Government collected grew only 5.3 times.
“Economic and Social Costs of Tobacco and Alcohol in Sri Lanka” 2015 study researcher Prof. Amala de Silva noted that it is very important that the Government be conscious of the costs incurred owing to tobacco and alcohol in a context where Sri Lanka is not really working to reduce consumption.
The study, which was conducted by both local and foreign economists and health experts, estimated direct and indirect costs of the use of alcohol and tobacco in Sri Lanka. While the costs of illness were calculated by combining the human capital approach and prevalence-based estimates as proposed in the international guidelines for estimating the costs of substance abuse by the WHO, the direct costs estimated were the costs related to curative care for alcohol and tobacco-related disorders such as costs on inpatient and outpatient care and out of pocket expenditure by households.
The direct and indirect costs of alcohol and tobacco in Sri Lanka, according to the study, were estimated to be Rs. 209.03 billion ($ 1,548.37 million) for the year 2015, and the costs of tobacco use were estimated to be Rs. 89.37 billion ($ 662.0 million). According to the study, non-communicable diseases (NCD) were the major cost factor for both substances, and the costs for tobacco-related cancers was Rs. 16.3 billion ($ 121.1 million). When it comes to tobacco-related NCDs, the cost was Rs 73 billion ($ 540.7 million).
The study said in its conclusion: “The direct and indirect economic costs of alcohol and tobacco are substantial. These costs exceed the direct revenue obtained by the Government through the taxation of these substances alone. That is, without additional costs such as the psychosocial costs of impoverishment, diseases, and premature mortality. Therefore, health, social, and fiscal policies of the country should be adjusted taking into account these costs, with the objective of preventing, minimising, and eliminating harm to the society.”
Meanwhile, the Alcohol and Drug Information Centre (ADIC) Director – Human Development Sampath De Seram, speaking with The Morning, explained the benefits of increasing cigarette taxes methodically: “If taxes are increased properly, it will certainly decrease cigarette consumption. According to the WHO, a 10% price hike could decrease consumption by around 5% in countries like Sri Lanka. Therefore, a proper taxing method will lead to a win-win situation for the Government. Also, the more consumption declines, the more money the Government will be able to save through decreased expenditure on the health care sector because it can cut down on the money spent to treat those who fall ill owing to cigarette smoking. Due to this reason, even though tobacco prevention was earlier considered as social work, it is now seen by researchers as an investment.”
Increasing taxes through a tax formula
To address the aforementioned situation, and thereby make taxing cigarettes more methodical and advantageous to the country, several parties demanded that the Government introduce a scientific tax formula.
According to Dr. de Mel, the current cigarette taxing method is an ad hoc method, which does not include a methodical approach to determine by how much, and how frequently, cigarettes taxes should be increased. A tax formula, he said, should have several qualities, namely, regular adjustment in pricing free from the ad hoc nature of the current system, a logical and transparent policy free from political and bureaucratic discretion, and the capability to be adaptable based on Government policy.
Challenges in developing such a formula include developing the criteria on which cigarette prices should be updated through a formula or what should be indexed, what base years should be applied to an index, and how the index should be calibrated to the different types of cigarettes.
Elaborating on a formula methodology published by Verité Research, Dr. de Mel introduced the three aspects of its theoretical framework, namely, applying consumer theory to updating prices and taxes, benchmarking the most consumed cigarette, and figuring out a method to do price differentials between cigarettes.
With regard to the relationship between price and tax hikes and affordability, Dr. de Mel presented statistics that showed that between 1980 and 2000, cigarette prices have increased a little haphazardly as if it were keeping pace with the increase in per capita GDP; however, prices have failed to keep pace with such after that. The statistics showed that in 1981, cigarettes buyable with per capita GDP were 9,542, and that by 2012, it had increased to 17,815. However, it had declined to 12,124 by 2018.
He opined that had a price changing method been applied, the revenue the Government could have generated through cigarette taxes would have increased at least by Rs. 20 billion a year.
He added: “The substantial loss of revenue to the Government should be made up by taxation or by debt, because everything the Government does not turn into revenue today. It has to be met by future taxation, different taxation methods, or increased debts. Cigarette taxation can be done based on a formula on an annual basis in order to increase Government revenue. Also, this can help improve social benefits by not allowing consumption to go up too much, and even by helping to reduce consumption. As we have seen, it does not necessarily undermine the profit incentives of the industry either; it does not allow the industry to make more profits than the Government does. Currently, industry profits have been growing faster, and under this method, the Government can ensure that the revenue to the Government is maintained at an equal or higher level compared to industry profits and that this would be the goal of a sensible public policy concerning the same.”
Meanwhile, when queried about the nature of cigarette tax hikes that need to be done, De Seram said that, similar to the way the prices of daily consumer goods increase every year, the prices of cigarettes should also go up annually in accordance with a scientific formula. Adding that the Government should consider increasing cigarette taxes by at least by Rs. 20 through the upcoming Budget, he noted that the tax revenue generated through increased taxes on cigarettes could be used for many purposes, including reducing the prices of essential goods including food items.
He explained: “Taxes should be increased to a maximum possible level in line with inflation in order to make it difficult for people to purchase cigarettes. Once a formula comes into effect, it could be applied annually taking into consideration the changes in the overall economy such as inflation and purchasing power.”
De Seram, speaking of the concept of introducing a systematic tax formula for cigarettes, said that hiking taxes is possible, adding that it should, however, be done taking into account several economic factors such as inflation. According to him, such a measure has two main advantages, i.e. the Government will be able to rake in proper tax revenue through a systematic tax increase, and the consumption of cigarettes will decrease.
Even though suggestions for a proper taxing formula seem to be on the rise, the National Alcohol and Tobacco Authority (NATA) has already taken steps to propose a formula considering the necessity and urgency of such a method, and a Cabinet paper in this connection has already been presented to the Government.
NATA Chairman Dr. Samadhi Rajapaksa, speaking to The Morning, said that during the past few months, NATA, in collaboration with local and international experts, has developed the necessary plans to introduce a cigarette tax formula for Sri Lanka.
Describing the process, he said: “I appointed a sub-committee to formulate a suitable and transparent tax formula, taking into account the fact that so far in Sri Lanka, cigarette taxes were increased without adhering to any formula, and decisions relating to tax increases were taken by several persons as they saw fit. These decisions had no scientific basis. The NATA sub-committee conducted a great deal of research, and studied how cigarette taxes were increased so far. According to the WHO’s MPOWER project – which promotes several measures to combat the use of tobacco, including monitoring tobacco use, protecting people from tobacco smoke, quitting tobacco, warning about the dangers of tobacco, enforcing tobacco advertising, promotion, and sponsorship bans, and raising taxes on tobacco – raising taxes continuously is one of the most important measures that can help reduce tobacco consumption. The WHO also identifies raising taxes as the single most effective measure for the same goal. The said sub-committee was appointed because Sri Lanka has not succeeded in taking this measure thus far.
“The sub-committee conducted a number of discussions, and also researched how other countries have increased cigarette taxes. The conclusion was that Sri Lanka needs a proper formula, and we created a formula. The NATA also participated in a 10-day workshop with the WHO’s Knowledge Hub in Cape Town, South Africa, in this regard, and the tax formula was introduced taking into account other pertinent matters, such as the GDP and inflation, and a decision was also taken concerning how much said taxes should be increased.”
According to Dr. Rajapaksa, if the proposed tax formula was applied every year, the price of cigarettes will increase by some amount, and NATA predicts that the purchasing power as well as the consumption will decline as a result of tax increases.
As the news about the cigarette shortage and possible cigarette tax hike spread through social media platforms, some opined that with the increase of taxes, a black market – the sale of illegally imported or manufactured products – for cheaper cigarettes would be created, and that it will cause unprecedented impacts on the economy and the people.
When questioned about this belief, De Seram opined that the likelihood of such a thing taking place should not be relevant, and that the authorities should take steps to combat the increase in such illegal rackets regardless of the reasons behind them. He observed that if such a black market was to be created, it would mean that the Sri Lankan laws to handle such issues are not up to a satisfactory level.
“Necessary decisions should not be put on hold out of fear of such assumptions,” he emphasised, adding that the likelihood of the rise of such a black market for cheaper cigarettes after tax hikes is a false alarm spread by tobacco companies all over the world.
He added: “We can see signs of it in Sri Lanka as well. Sometimes, the seizure of illegally imported cigarettes increases as the announcement of the budget proposal approaches. Sometimes, that is an artificial situation created to compel the Government to take a step back, by way of creating fear that the illegal importation of cigarettes might increase as a result of tax hikes. The WHO points out that the illegal cigarette market has been created by the tobacco industry in order to make money, and to control tobacco-related policies adopted by countries. In fact, cigarette production cannot be conducted as a cottage industry.
“Another step, taken by tobacco companies in these types of situations, is introducing low-cost cigarette brands when prices and taxes have to be increased. Despite assumptions by some parties, those who smoke a certain type of cigarettes do not shift to cheaper cigarette brands such as beedi, which are vastly different from the cigarette brands that they are used to. Even though some smokers may consider shifting to other types of cigarettes, such a decision is limited to cigarette brands which are more or less similar to what they have been smoking. For example, despite tax or price hikes, there has been no notable increase in the consumption of beedi. On the contrary, there is generally a decline.”
According to a nationwide survey conducted by the ADIC regarding increasing the tobacco tax, a majority of Sri Lankans, i.e. 89.3% out of 3,958 respondents (981 females and 2977 males), had responded that they would support the Government increasing tobacco taxes through the upcoming Budget.
This survey was conducted in all 331 Divisional Secretariat areas in the 25 districts, from 15-25 September this year, and the sample was selected based on the adult population who were over the age of 20 in each district. The sample represented males, females, those holding different jobs, and various social strata, according to the ADIC. Of the sample, 21% (829 respondents) were between 20-25 years, 50% (1,999 respondents) were between 25-40 years, and 29% (1,130 respondents) were over the age of 40 years. Of the male respondents, 31% were tobacco smokers, 26% had quit smoking tobacco, and 43% had never smoked tobacco.
In response to the question: “If the Government had to increase taxes to raise revenue, which one of the following would you like to see taxes raised on: fuel, energy, tobacco, or food?” 91.5% had responded that tax on tobacco should be increased.
When the respondents who supported increasing tax on cigarettes were queried as to by how much they think the price of a cigarette should increase, 59.1% of them had said that the price of a cigarette should be increased by more than Rs. 25, while 23.7% of them had said that the price should be increased by Rs. 15-25. Overall, 82.8% of respondents had said that the price of a cigarette should be increased by Rs. 15 or above through the upcoming Budget.
When queried as to whether an increase in cigarette tax will discourage consumption, 76.3% of respondents had said that a tax increase would discourage consumption.
In conclusion, the ADIC said that the survey results demonstrate that the majority of Sri Lankans want taxes on cigarettes to be increased, and would support the Government for such an increase.
Cigarettes are one of the highest taxed consumer goods, and according to the statistics presented by Dr. de Mel, approximately 74% of the price of a cigarette is constituted of taxes. In this context, not having a proper tax formula for cigarettes is problematic, and has led to a massive loss of tax income, which could have been useful to support the struggling economy.
A controlled tax system for cigarettes is beneficial to the country’s tax income, health sector, and cigarette consumers, and time is right for the Government to put into action a more systematic taxing system.