Economics Commentary 1

Economics Commentary #1 [1st Draft] Title of Extract: Health tax on cigarette packs to rise on Thursday Source: Taipei Times 13/2/2006 11/12/2006 Date: Word Count: Date Commentary Written: Section: Name: Keith Chan Health tax on cigarette packs to rise on Thursday February 13, 2006 Taipei Times (Taiwan) Author: Jackie Lin Starting on Thursday, smokers will have to pay more for cigarettes, as tobacco firms pass the latest tax hike on to consumers. Retail prices are expected to increase by between NT$5 and NT$10 per pack to reflect the rising costs, depending on each firm's marketing strategies, officials said. Taiwan Tobacco and Liquor Corp (TTL, ), the nation's sole tobacco manufacturer, appeared cautious due to its state-owned status. "As a state-run enterprise, we cannot take the lead in hiking prices although price adjustment is inevitable in response to tax law revisions," TTL's president, Chen Wen-kai , said yesterday. TTL, which manufactures the leading cigarette brand "Long Life" , enjoys a 40 percent share of the tobacco market. The firm sold 1.7 million boxes of cigarettes last year, raking in over NT$26 billion (US$805 million) in revenues. Adopting a low-key attitude, TTL chairman Ray Dawn said last week that the firm might absorb costs and hike prices by only NT$5 per pack for some cigarette brands. Its other brands will still see prices rise by NT$10. Considering the fierce competition, TTL will take into consideration importers' pricing strategies before reaching a final decision, Dawn said. JT Tobacco International Taiwan Corp (JTI), which distributes one of the best-selling imported brands -- Mild Seven -- has been tight-lipped about the range of possible increases on its products. An executive of another importer who refused to be named, said pricing is a sensitive issue, and if JTI decides to wage a price war regardless of the tax hike, other importers will have no alternative but to follow suit. While pricing and the possible market reshuffle hinge on the market mechanism, the government should watch out for the possible surge of cigarette and tobacco smuggling to protect the interests of both consumers and manufacturers, the Tobacco Institute of the Republic of China said. Taiwan started to levy a special health tax on tobacco on Jan. 1, 2002. Statistics showed that cases of confiscated illegal tobacco products soared from 394 cases in 2001 to 1,834 cases in 2002. The value of the smuggled products jumped from NT$195 million in 2001 to NT$340 million in 2002, the institute said. "This proves that the increase in the health tax on tobacco will cause serious problems as tobacco smuggling will dramatically increase," said Nancy Yin , the institute's secretary-general. Citing an academic study, Yin said when tobacco prices rise by 1 percent, sales of smuggled cigarettes jump by 160 percent. "We call on the government to reinforce anti-smuggling activities to safeguard the government's tax revenues, manufacturers' interests and consumers' health," she said. According to the amendments to the Tobacco and Liquor Tax Law passed by the legislature early last month, the special health tax levied on a pack of cigarettes would double from NT$5 to NT$10. However, the actual cost of a pack would increase more than NT$5 as distribution and retail costs will increase and these will be reflected in the price tag as well. The tax hike is expected to generate NT$6 billion in additional tax revenue for the National Health Insurance program. Introduction The retail price for cigarettes in Taiwan is expect to increase per pack to reflect the rising costs as the Taiwan government has decided to raise the health tax placed on cigarettes from NT$5 to NT$10 per pack starting on 16 February, 20061, smuggling activities are expected to increase dramatically as a result2. Investigation Price Cigarettes in Taiwan MPC’’ starting from 16 Feb 06 MPC’ MPC = MSB MSB Social Private Optima MPB Quantity l Optimal Cigarettes are demerit good where there is an external cost when consuming, i.e. there is cost borne by the third party which is not part of the transaction. For instance, when smoking cigarettes, harmful smoke generated would affect surrounding non-smokers . The marginal private benefits (MPB)3 is therefore greater than the marginal social benefits (MSB)4. The private optimal is greater than the social optimal resulting in over-consumption. There is welfare loss in the society. Thus, market failure occurs where the market fails to allocate resources efficiently to maximize social welfare. To minimize the divergence between the MPB and MSB, the Taiwan government has chosen to increase the health tax on cigarettes from NT$5 to NT$10 per pack1. By doing so, the marginal private cost5 increases by NT$5 for every unit of quantity demanded. As price increases, the quantity demanded decreases. The government intervention equalizes the private optimal and the social optimal eliminating the 1 According to the amendments to the Tobacco and Liquor Tax Law passed by the legislature early last month, the special health tax levied on a pack of cigarettes would double from NT$5 to NT$10. 2 Citing an academic study, Yin said when tobacco prices rise by 1 percent, sales of smuggled cigarettes jump by 160 percent. 3 The additional benefits enjoyed by the consumer for the consumption of an additional unit of goods. 4 The additional benefits enjoyed by the society for the consumption of an additional unit of goods. 5 The additional cost incurred by the producer for the production of an additional unit of goods. welfare loss in society. The total tax revenue of the government is expected to increases NT$6 million more6. However, as stated in the article, the increase in price of cigarettes will lead to an increase in smuggling activities. As the prices of the traditional retail market goes up, smokers go to the black market where the price is not affected by the tax (i.e. the price remains the same). As a result, the demand in the black market increases. This leads to an increase in price in the black market and smokers stop going to smugglers when the price of the black market attends the same price as the traditional retail sales market. Evaluation The Taiwan government chose to minimize the differentiation between the MPB and MSB by increasing the health tax on cigarettes. But as the article as mentioned, the increase in tax will lead to an increase in illegal smuggling activities which implies that the total number of smokers might not reduce significantly. Therefore, apart from reinforcing anti-smuggling activities7 which will reduce the chances that consumers can buy cigarettes in a lower price and reducing consumption, there are other methods to actually reduce the total consumption of tobacco in Taiwan. 1. The government can subsidize substitute industries, e.g. chewing gum industry to reduce the consumption / demand for cigarettes. As the price of the substitutes goes down, the quantity demanded for chewing gums increases while the demand in cigarettes decreases. The MPC reduces and meets the social optimal. However, there is also limitations for this solution as most of the substitutes cannot compensate the satisfaction gain from smoking, e.g. the so-called sense of trendy and fashionable. Therefore, not all smokers will turn to substitutes. The government can set up more restrictions on smoking so to make smoking more inconvenient. For instance, it can expand the non-smoking areas (e.g. in all public places) or raise the legal age for purchasing tobacco so that less people are able to purchase cigarettes. Yet this also brings the same problem of law reinforcement. The government will have to set up laws and grant law enforcement authorities the power and resources to prosecute offenders. Only then will the smokers be encouraged to quit smoking which reduces the demand for cigarettes. The government can educate and advertise the harmful impacts brought by smoking and thus encourage smokers to quit smoking. It can also subsidize 2. 3. 6 The tax hike is expected to generate NT$6 billion in additional tax revenue for the National Health Insurance program. 7 "We call on the government to reinforce anti-smuggling activities to safeguard the government's tax revenues, manufacturers' interests and consumers' health," Nancy Yin said, the Tobacco Institute of the Republic of China 's secretary-general. organizations which helps people quit smoking. This also reduces the number of smoker and demand for cigarettes. And yet, there are also limitations to this solution as smokers will held the thought that the known diseases caused by smoking (e.g. lung cancer) does not apply to every smoker. For all cases the ultimate goal is to reduce the demand for cigarettes so that the private optimal equals to the social optimal. The society will then have no welfare loss and the market can allocate resources efficiently to maximize social welfare. In conclusion, I would suggest the Taiwan government to implement all the possible solutions to help reduce the number of smokers in the country to solve the problem of over comsumption thoroughly. Price Black Market S Price Traditional Retail Sale S D’ D Quantity Price D Quantity Price Chewing Gum S S’ Cigarettes D Quantity D’ D Quantity