Fiscal policy has a key role in reducing tobacco use. According to the WHO FCTC, raising taxes has been one of the most effective measures by far. This is because an increase in taxes, directly affects the price, which in turn makes tobacco products less affordable. Pricier tobacco products have the positive effect of reducing tobacco initiation, prevalence, and consumption. Ample evidence has shown that on average, a 10% price increase will reduce consumption by 5% in low- and middle-income countries, and by about 4% in high-income countries. Furthermore, implementing tobacco taxation only costs low- and middle-income countries about US$0.05 per capita each year to administer, making it a very inexpensive measure to reduce tobacco use.
Tobacco use generates externalities of various kinds. The decision of consumers to smoke tobacco does not internalize the possibility of affecting the health of other individuals through passive consumption. Nor does it internalize the cost generated by smoking in the health system, which must be borne by the rest of the taxpayers with higher taxes (public health) or risk premiums (private coverage). Also, because the demand for tobacco is inelastic, the deadweight loss is minimized, and the benefits of better health are maximized. In the case of goods that generate negative externalities such as tobacco (e.g., less healthy population), the tax can be used to correct pre-existing distortions. These taxes are known in the economic literature as the Pigouvian taxes.
The globally accepted framework to tax tobacco consists of excise taxes, which can be ad valorem, specific, or a combination of both. Out of the final sale price of the most sold brand, on average 60.8% is explained by taxes on tobacco. This percentage has grown over the last few years capturing a larger global effort to restrict tobacco use, although there are differences among regions and countries. For instance, 70% of the final selling price is due to taxes in European countries, while in Africa, this percentage amounts to 37% (Figure 1).
In Latin America, the average fiscal burden is close to 51%. Nevertheless, this figure also hides heterogeneities among countries. In Paraguay and Bolivia, the final selling price is explained by taxes of 17% and 37% respectively, while in countries like Chile or Brazil, it goes up to more than 80% (Figure 2).
Tobacco Taxation in Latin America
As these figures show, there has been progress adopting tobacco taxation policies in the region, but more still needs to be done. In Latin America, smoking is one of the five leading risk factors for death and disability. About one million people die annually from smoking-related causes in the region and nearly 70 million smokers in Latin America are at risk of tobacco-related death and disease. Given this evidence, are countries in the region amenable to further increase tobacco taxes to save lives?
To answer this question, the Fiscal Division of the IDB has conducted a cross-country analysis of the recent efforts to curb tobacco consumption through fiscal policy in five Latin American countries that will be published in a forthcoming technical note. The study investigated tax changes on prices, price-elasticities, and effects on smoking prevalence, and the fiscal impacts associated with tobacco taxation. Moreover, it investigated the impact of illicit trade, the use of cigarette substitutes, and the importance of monitoring the effectiveness of taxation in young smokers or on lower income families.
The main conclusion is that taxation of tobacco products is indeed an effective measure to curb consumption in the region. Cigarettes should increasingly become less affordable and tax policies should be improved to include emerging tobacco products and to increase their effectiveness in collecting tax revenue. Higher tobacco taxes can generate income, enhance well-being, and improve living conditions over the long term. More specifically, the study offers four practical recommendations for policymakers to make tobacco taxation more effective that we will detail in this blog.
Strategy #1. Keep your tax simple
Tax policy should adhere to the following principles: simplicity, revenue, and efficiency. Tobacco tax policies in Brazil and Argentina, for instance, are complex, which if combined with a weak control and monitoring state capacity can open the door to diverse forms of manipulation and lead to lower revenue. In the case of Brazil, for example, cigarette prices differ among states, in great part because states can apply different rates for a state tax on the circulation of goods and services, called Imposto sobre Operações relativas à Circulação de Mercadorias e sobre Prestações de Serviços de Transporte Interestadual e Intermunicipal e de Comunicação (ICMS).
The application of the different rates provides an opportunity for tobacco companies to price tobacco products less in states with high taxes and compensate that loss by charging more in states with higher tax rates. The result is that in this case, on average, tobacco prices will increase less than expected, making taxes a less effective tool to reduce consumption.
Besides, designing a simpler tax policy, governments should facilitate tax collection. In Colombia, the tobacco taxes administration is the responsibility of multiple actors, so complexity becomes a rule. The Ministry of Finance has been trying to standardize the process through a 2016 Resolution that establishes the official forms for tobacco taxes declaration. To streamline the administration of these taxes, the country issued a decree in 2019 establishing a system called Integrated Support System for the Control of Consumer Taxes (SIANCO), to simplify the process and procedures regarding the administration of excise tobacco taxes, among other taxes on consumption. The system seeks to facilitate, standardize, and unify the ﬁscal administration of such taxes, providing that standardization and digitalization of tax collection forms for subnational governments.
A rule that adds to simplicity and efficiency is that all tobacco products should be taxed in a comparable way as appropriate, more relevantly when the risk of substitution exists. According to WHO, governments should “ensure that tax systems are designed in a way that minimizes the incentive for users to shift to cheaper products in the same product category or to cheaper tobacco product categories as a response to tax or retail price increases or other related market effects. In particular, the tax burden on all tobacco products should be regularly reviewed and, if necessary, increased and, where appropriate, be similar.” Risk of substitution also exists with new and emerging products such as vapes, vaporizers, vape pens, hookah pens, electronic cigarettes (e-cigarettes or e-cigs), e-cigars, and e-pipes which are some of the many tobacco product terms used to describe electronic nicotine delivery systems (ENDS).
Strategy #2. Regulate new and emerging products
The use of cigarettes substitutes should be monitored and regulated. Public health advances in tobacco control are under constant threat of being undermined by challenges both new and old. New products appearing in the market are becoming fashionable, particularly among the younger population.
The WHO report on the global tobacco epidemic 2021: addressing new and emerging products highlight that ENDS are not a safe alternative to conventional cigarettes, but rather addictive and not without harm. Some ENDS contain either nicotine, which is highly addictive, or liquids that when inhaled may contain long-term health impacts. ENDS appeal to children and young people because they often have enhanced flavors. Studies in the United States have shown that flavors play a major role in using ENDS.
For instance, the use of e-cigarettes amongst high school students increased from 1.5% in 2011 to 19.6% in 2021; and 70% of current e-cigarette users aged 12 to 17 say they use e-cigarettes “because they come in flavors I like”. The prevalence of young use of any tobacco product varies widely among countries. Figure 3 shows the prevalence for five countries analyzed in the forthcoming technical note.
Cigarette substitutes should be treated, when possible, like traditional cigarettes, not only when it comes to taxation, but also regarding other policies such as advertising or smoke-free areas. Policymakers should also monitor these new products to dimension the size and pervasiveness of this market, and to understand if it is a passing fad or if these new products are there to stay.
Strategy #3. Collect data to understand the tobacco market in your country
Tobacco consumption for different population groups, consumption of cigarette substitutes, and illegal market should be systematically and continually monitored to effectively control tobacco. Tools such as census could be useful for this purpose. Countries could add questions on tobacco use when conduct censuses as has been done in Austria, Germany, and Tonga.
Specific tobacco surveys such as The Global Adult Tobacco Survey (GATS) and the Global Youth Tobacco Survey (GYTS) can provide a guide on how to gather comparable information both on an international and time-series approach through specific protocols of questionnaires, sampling, field procedures and data gathering and treatment. Surveys should also include information that might help to better characterize the illicit market and to include information on all types of smoked and smokeless tobacco products.
For example, Mexico included information on electronic cigarette consumption for the first time in the 2017 Mexican National Survey on Drug, Alcohol and Tobacco Consumption, Brazil specifically asked for other tobacco product consumption in its 2012 and 2015 National Scholar Health, and Argentina included it in its 2018 National Survey for Risk factors.
Surveys should also include information that might help to better characterize the illicit market. In parallel, it is important for tobacco surveillance systems to include information on all types of smoked and smokeless tobacco products. This will enable identification of changes in consumption patterns so that existing policies can be adjusted accordingly.
Administrative records could also be exploited and seized to add new information sources. Authorities require more knowledge about composition of tobacco products (with special attention to flavors), their production costs, and marketing costs by brand. This information is crucial to assess the market power, market share and markup behavior of tobacco industry agents. It can also inform discussions on elasticities, including consumers’ choices between brands.
Strategy #4. Illicit trade should not halt taxation increases
Concerns about illicit trade should not deter countries from raising taxes. Tax avoidance and evasion undermine tobacco control policies effectiveness, particularly tax rises. The growth of the illicit market in countries like Brazil and Ecuador during the last few years implied a fall in revenue and a larger risk for the population.
In the literature, illicit trade is usually measured by estimating the percentage of illicit cigarettes in the market, or by estimating the percentage of illicit smokers with several methods. The different estimations of this issue are subject to bias; therefore, countries need to update independent measures of illicit trade on a regular basis, using two methodological approaches already applied in the scientific literature on this topic: (a) smoker surveys, that can identify the types of cigarettes circulating in the market, their prices, and the magnitude of illicit cigarette consumption; and (b) from the supply side, retailer surveys or littered pack collection.
Some countries have been adopting a comprehensive strategy to control production, imports, commercialization, and distribution of cigarettes, but further efforts need to be done on this matter: increasing budget and tax administration capacity to fight illegal cigarettes, subscribing to the WHO’s Protocol to Eliminate Illicit Trade in Tobacco Products and adopting international action to have neighbor countries joining the Protocol. National revenue administrations should share information with their state counterparts and vice versa, in a more integrated way to tackle smuggling and illicit production more efficiently.
A more integrated work could also be propelled among national revenue administrations, customs offices, and ministries of health. Reducing uncertainties about illicit trade activities, although quite complex, represents a valuable step in characterizing the dynamics of the tobacco market.
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 WHO report on the global tobacco epidemic 2021: addressing new and emerging products. Geneva: World Health Organization; 2021. License: CC BY-NC-SA 3.0 IGO.