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Taxes on tobacco: What works and what doesn’t work

Just come across an interesting article published this week entitled “Tobacco excise tax structure: Implications for public health” by Chaloupka, et al. and published by voxeu.org.

It doesn’t sound wildly amusing on the surface but contains some interesting EU-wide research which is very relevant to microeconomics in terms of the effects of specific and ad valorem excise taxes.

In February 2005, 171 countries representing more than 80% of the world’s population signed up to the World Health Organisation’s Framework Convention on Tobacco Control. A central part of this treaty was for member countries to increase tobacco excise taxes.

Interestingly, in historical terms, governments have been primarily interested in taxing tobacco solely for revenue-gathering reasons. However, in the modern climate governments are now using such taxation to discourage the use of tobacco. Excise taxes can either be specific (per unit) taxes or ad valorem (value-based) taxes.

The authors point out that the real value of specific taxes will erode over time and need to be regularly adjusted for inflation. On the other hand ad valorem takes will rise with prices. However, ad valorem taxes may lead to a substitution in favour of cheaper tobacco products which will hit tax revenue and may not cause a sufficient reduction in demand.

The authors found that average cigarette prices are higher in countries where the specific tax accounts for a greater share of the total tax on cigarettes, and that therefore cigarette consumption is lower in such countries. They also found that for the same total overall excise tax, the greater reliance on the specific tax resulted in higher tax revenues and less variation in those revenues over time.

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