Cigarette tax hike defies economic logic

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By Sam Oldfield, who is an economics student at Latrobe University and an Associate at Prosper Australia.

The Rudd government’s sudden increase in cigarette taxes completely disregards sound economic practice. Joe Hockey calls it “policy on the run” – he couldn’t be more correct. Making smokers the targets of Kevin Rudd’s war on anything bad for us is par for the course, but the obvious lack of thought here should shock the Australian public.

Of the recommendations of the Australian Medical Association report on tobacco use only one is considered – raising the price. Recommendations of restricting outlets, better support for people trying to quit and changing the culture of smoking are ignored in favour of easy money for a government pretending to manage its budget.

Chart: The Real Price of the most popular cigarettes in Australia, 1940–2011 (cents per stick)

The lack of a comprehensive, long term plan is only the beginning. Social and economic ramifications are conveniently disregarded. Cigarette taxes are regressive, and on a price-inelastic good to boot. A ten per cent price increase reduces consumption by a paltry four per cent. The Rudd government can tax cigarettes as hard as they like and smokers will keep paying.

The fact that the majority of smokers are from lower income brackets and the economic damage of taxing the poor for the benefit of the rich has evidently escaped the attention of Kevin Rudd and Chris Bowen. It seems nobody has considered how this will affect the wider economy, though the logic is plain: if a ten per cent increase in price leads to a mere four per cent decrease in smoking, then how is the rest of the price increase funded? The answer is obvious, smokers will fund their habit by cutting back elsewhere, and since average smokers are in the income brackets that consume most of their income, the effect of this tax hike on the wider economy will be immediately felt.

Retailers, regardless of how they feel about smoking, should be angered at $5.4 billion disappearing from the pockets of their customers over the next four years. The economic damage this slap-dash policy will have on investment, employment and household financial health should be at the forefront of the conversation.

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Chart: The Consumer Price Index, 1973–2011: Cigarettes and Tobacco Sub-group compared with overall index

Laughably, the Rudd government seems to think this economic chemo-therapy demonstrates its economic management credentials, when in truth it certifies them as economically incompetent.

Smokers can alternatively access the black market. Current market price is 26 cents a stick, so a white market price of $1 leaves plenty of room for both a black market price increase and volume growth. Even current prices offer a tempting $4.5 billion pie to criminals – it would be a tempting pie for anyone.

You may think this is no big deal but you’d be wrong. History has shown that it is through trafficking the high demand, socially acceptable drugs that distribution networks are formed, the contacts and supply lines set up by marijuana traffickers are the perfect conduit for the far less desirable methamphetamines and opiates. A supply chain conveying one type of small-bulk high-value good can easily carry any other small-bulk high-value good, indeed the temptation for otherwise civic minded “chop chop” dealers to increase profits by trading in dangerous drugs may prove too much to resist.

That smokers are expected to pay for the cost of their healthcare is widely accepted even by smokers. Most smokers would not have a problem with paying a bit beyond that, but when the government is making a profit (tax revenue minus healthcare cost due to smoking) of $1,771 per smoker already, which will rise to $2,902 with the tax hike, many will turn to the black market and thus no longer fund their own healthcare.

Money that should go towards treatment of smoking related illness will instead line the pockets of criminals. The free rider effect becomes apparent.

It is the lack of real economic thinking beyond some basic (and potentially spurious) statistics that most marks the failure of this policy. It is a dark condemnation of the current state of the economics profession and the competence of technocrats that this rubbish passes for economic policy. Instead of real reform (or even debate) of our economic policy and tax system, band-aid solutions like this are offered which should anger smokers and non-smokers alike.

You may not like smoking, but this policy shift of the Rudd government does little good and potentially does significant harm to Australia’s future.

Comments

  1. A bigger issue is where will the tax come from if it works too well and lots give up?

    At 17% of adults, we may be fast reaching the point that smoking cigarettes will seem as weird as snuff.

    I noticed amongst my smoking buddies that there was tipping point where suddenly the numbers plummeted after many had left the smoking flock.

    Going outside the pub on your own in the middle of winter loses its appeal quickly.

      • In due course. But that will be no comfort to the govt.

        If all the smokers gave up, the booze hounds stopped drinking and gamblers stopped punting there would be a great shortage of easy revenue.

        I should declare that I once was a severe nicotine addict and had enormous difficulty giving up but finally succeeded about 9 years ago. The high cost of tobacco back then kept the pressure up to quit and the smoking bans in just about every public place have made it a lot easier to stay off.

        I don’t buy the line that the existence of a market for chop chop or the possible encouragement of that market is a reason not to tax tobacco heavily.

        Nicotine is certainly addictive but a much smaller number of kids are likely to get themselves hooked on chop chop compared to those who get themselves hooked on tailor made brands.

        Nothing sexy about a jiffy bag of dodgy tobacco and the nausea from nicotine (until you are hooked) is hardly a selling point.

        The chop chop market is largely for the hard core existing smokers who are unable to quit.

        A declining market that hardly requires fear and loathing or high handed law enforcement. It will fade away. No one is making home made snuff or chewing tobacco.

  2. “Most smokers would not have a problem with paying a bit beyond that, but when the government is making a profit (tax revenue minus healthcare cost due to smoking) of $1,771 per smoker already, which will rise to $2,902 with the tax hike, many will turn to the black market and thus no longer fund their own healthcare.”

    I’d like to see a reference for that very precise calculation.

    • Phil the engineer

      +1. I call BS. What is the cost of treating 1 lung cancer patient through to death?

      • but you would also need to minus the cost of nursing non smokers to death – we all die at some point right? Smokers just might be a bit earlier than otherwise, which might also mean we should subtract the reduced pension costs due to smokers dying earlier etc.

    • Agreed. I have seen figures going the other way: that smokers cost more to the health system than they raise in excise.

      I’d say the calculations each way are very rubbery due to the difficulty of working out the real economic cost.

    • The Costs of Tobacco, Alcohol and Illicit Drug Abuse to Australian Society in 2004/05; Collins and Lapsley

      Table 44
      __________________________________
      Receipts $m

      Excise tax 5,220.0
      Customs duties 518.0
      GST 937.4

      Total tobacco revenue
      6,675.4

      Less

      Revenue forgone
      Income tax 1,025.0
      Indirect taxes 1,848.9
      Total revenue forgone 2,873.9

      Total net revenue
      3,801.5
      ___________________________________
      Outlays $m

      Health

      Hospitals 178.5
      Medical 124.8
      Nursing homes (139.6)
      Pharmaceuticals 64.6
      Ambulances 21.0

      Total health
      249.3
      Fires n.e.i.
      10.2

      Total outlays
      259.5

      Net revenue minus outlays
      3,542.0

  3. Those charts from the civic-minded Tobacco Institute are 2011, so Rudd’s $5.4 billion extra taxes are an exponential leg up from there. Prepare for a ciggie black market to dwarf the marijuana, heroin, amphetamines cash sub-culture. The feds just guaranteed it.

  4. i think its appalling that the govt relies on people’s addiction to increase revenue and then justifies it on the grounds that “they should not be smoking anyway”. These are often people who can least afford it.

    as for costs to smokers, a packet a day smoker pays around $60 bucks a week in tax. That would more than cover the insurance weighting for smokers on an insurance policy so CLEARLY the govt is making money out of this relative to health costs AND if smokers drop off the earth earlier then we have major retirement savings right there.

    • GunnamattaMEMBER

      ‘as for costs to smokers, a packet a day smoker pays around $60 bucks a week in tax. That would more than cover the insurance weighting for smokers on an insurance policy so CLEARLY the govt is making money out of this relative to health costs AND if smokers drop off the earth earlier then we have major retirement savings right there.’

      and when you think about the economic environment we are moving into there could easily be a case for promoting ‘a couple of smokes a day for your country, mate.’

  5. General Disarray

    Some of the figures in this piece are questionable but I agree as the regressive nature of this tax increase.

    I used to do some volunteer work for a group that was involved with helping the homeless and disabled. The amount of homeless – often people with profound mental illness or brain injury – who are smokers would be well into the 90% plus range. You’ve probably seen these people pulling cigarette butts out of public bins – this goes beyond addiction.

    For many of the most vulnerable cigarettes have become trusted companions.

    • Yep, nicotine is helpful with a number of psychological conditions (including working in certain environments).

      It is better to give them access to nicotine delivery systems that are less likely to destroy their health.