Tobacco Tax Myths Exposed

Latuja is a fellow of Action for Economic Reforms.  This piece was published in the February 27, 2012 edition of the BusinessWorld, pages S1/4 to S1/5.

 

Time and again, anti-reformists rehash arguments, which are either false or exaggerated, to counter efforts to restructure the current excise tax system. Below I enumerate and debunk their top three favorite myths on tobacco and tax reforms.

Myth #1: Higher taxes = Lower tobacco consumption = Lower revenues

A common mistake of those against tobacco tax reforms is the application of elementary math on the impact of reduced consumption on revenues. That reduced tobacco consumption will generate revenue losses for the government is a hasty conclusion and ignores the empirical fact that demand for cigarettes is inelastic.

Inelasticity of cigarette demand is due to the highly addictive nature of smoking. It simply means that tobacco consumption is not proportionally responsive to changes in prices, i.e. a 10% price increase will lead to a less than 10% decrease in consumption. To illustrate more vividly, a P30 tax per pack will increase the price of the most popular brand by 50%, from P40 to P60, ceteris paribus, while consumption will be reduced by only 30-40%, with some (not all) smokers quitting and some, just cutting down on the number of sticks they smoke.

Because cigarette demand is inelastic, we can increase taxes and achieve both goals (though seemingly clashing) of raising additional revenues and reducing cigarette consumption. Our current low level of cigarette tax (44% of retail price vs. World Bank’s recommended 67-80%) gives us ample room for raising taxes even up to more than P30 per pack without incurring revenue losses.

Myth #2: Higher taxes will increase cigarette smuggling.

Related to the myth that increases in tobacco taxes will lead to revenue losses is the unfounded claim that higher taxes will increase illicit trade of cigarettes in the Philippines. More than price itself, other factors, such as weak administration and poor enforcement of rules, are largely responsible for the degree of smuggling in a country. Illicit trade is mainly a function of corruption and institutional strength.

That the Philippines has the cheapest cigarettes in the world is a good indicator that smuggling will not worsen with the implementation of tax reforms. Add to that the anti-smuggling measures that the BIR (Bureau of Internal Revenue) will be putting in place this year, the odds of a worsening illicit market for cigarettes will be close to nil.

Myth #3: Tax reforms are anti-tobacco farmers.

In the past three hearings in Congress of the Committee on Ways and Means on excise tax bills, legislators mostly from the North were hostile to the proposed reforms of the DOF (Department of Finance). Their main argument: tobacco tax reforms will hurt the tobacco farmers.

What these legislators do not recognize is that tobacco farming in the country has been on a downward trend for many years now. Over a span of only 20 years, land devoted to cultivating tobacco has been halved. Without much observed technological breakthroughs in tobacco farming, we can easily deduce that many farmers have already shifted to alternative crops or livelihoods.

The decline in tobacco farming is expected to continue, as more and more people are becoming aware of the ill effects of smoking. What better way to help the farmers than with tax reforms that will raise additional funding to support their ongoing movement to livelihoods other than tobacco farming?

The DOF proposes that 15% of the incremental revenues from cigarette excise tax reforms (estimated at P29 billion for the next five years) be dedicated for alternative livelihood programs for farmers in provinces producing Burley and Native tobacco. On top of that, Virginia tobacco-producing provinces will get an additional 15% of taxes on locally manufactured Virginia-type cigarettes.

Moreover, with 98% of the local cigarettes market captured by a single company, farmers are now facing a monopsonistic market for their produce. The dominant single buyer of raw tobacco is driving down the income of farmers. Avelino Dacanay, a farmer from the Ilocos Region, observes that just before the merger of Philip Morris and Fortune Tobacco in 2010, the price of raw tobacco was PhP97 per kilo. In the next crop season following the inception of Philip Morris Fortune Tobacco Corp., the price dropped by 23% to PhP73 per kilo.

The move to a unitary tax system will increase competition in the tobacco industry. More players in the market will translate to more buyers of raw tobacco, which will then improve the bargaining power of farmers in setting prices.

In summary, tax reforms are pro-tobacco farmers. The reforms will help farmers in their continuing movement to more lucrative income-generating activities, expand livelihood opportunities for farmers, and give them better prices for their produce.

Conclusion

It is comforting to know that the administration is grounded in truth, as it is committed to pushing for genuine reforms in the excise tax system. The Departments of Health, Finance, and Agriculture are already in agreement that tax reforms will bring about net gains for the country in terms of improved health of Filipinos, increased revenues for the government, and broadened opportunities for farmers. I do hope that our lawmakers will follow suit.

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