Overview to tobacco taxation [631040]
9Chapter 2
Overview to tobacco taxation
Introduction
Taxes are usually raised to
provide revenues for government
expenditure. These taxes take many
forms—for example, income taxes,
payroll taxes, customs duties, excise
taxes, sales taxes or value-added
taxes (VAT). Indirect taxes are
taxes levied on the consumption of
specific goods (for example, excise
taxes on tobacco or alcohol) or on
practically all goods (VAT). The
interest in raising taxes on products
such as tobacco is based on their
potential to raise large amounts of
revenues relatively easily, but also
because they enable correcting for
the negative externalities tobacco
use generates (negative health
impact of both tobacco consumption
and exposure to tobacco smoke)
and discourage its use because of
its destructive impact. The rationale
behind raising taxes on products
such as tobacco lies in the particular
aspects of the product: i) production
is dominated by a few companies,
which makes supervision and
tax collection by the government
relatively easy;; ii) the demand for
this product is relatively inelastic –
tobacco users are addicted to the
products and therefore have little
sensitivity towards a price change;;
iii) the product is not considered a
basic necessity;; and iv) the product produces negative externalities
(McCarten and Stotsky 1995;; World
Health Organization, 2010).
This chapter provides an
introduction to the different types of
taxes applied on tobacco products,
with a special focus on excise taxes.
The reasons behind levying such
taxes are then discussed, including
the political, social and economic
arguments often used against
tobacco tax increases when the
issue is discussed by policymakers.
The different approaches to excise
taxation are then reviewed, with a
description of the structures applied
on tobacco products and the pros and
cons of each one of them. The impact
of taxes on the price of tobacco
products is also considered briefly.
An overview is made of the levels
of taxation globally (with a focus on
cigarettes because of better availability
of data). The issue of earmarking
or dedicating tobacco taxes for
specific programmes, particularly
health-related programmes, is also
discussed. Finally, the last section
highlights the main issues covered in
the chapter.
Description of taxes
Taxes on tobacco products can
be classified into two general categories: consumption taxes and
customs duties.
Consumption taxes
Consumption taxes are taxes on
spending on goods and services.
The term refers to a tax system with
a taxable base of consumption. The
main consumption taxes are value
added tax (VAT) or retail sales taxes
and excise duties. These are indirect
taxes, meaning that they are not
levied directly on the income of the
consumer or earner. These taxes are
due to the revenue authorities by the
supplier of the goods or services;;
however they are ultimately borne by
the final consumer. They are called
regressive because they are not
based on the ability-to-pay principle.
Consumption taxes apply to all
supplies or releases for consumption
on the territory of a jurisdiction and,
normally, also to imports of tobacco
products. Tobacco products that are
exported are normally not subject to
consumption taxes.
VAT, retail sales taxes and excise
duties have different characteristics:
Value added tax is a general
consumption tax that applies,
in principle, to all commercial
activities involving the production
and distribution of goods and the
IARC Handbooks of Cancer Prevention
10provision of services. It is charged as
a percentage of price, which means
that the actual tax burden is visible
at each stage in the production and
distribution chain. It is collected
fractionally, via a system of partial
payments whereby taxable persons
(i.e. VAT-registered businesses)
deduct from the VAT they have
collected the amount of tax they
have paid to other taxable persons
on purchases for their business
activities. This mechanism ensures
that the amount of tax will be the
same, independent of the number of
intermediate transactions before the
final supply to the consumer. VAT
is due to the revenue authorities by
the seller of the goods, who is the
“taxable person,” but it is actually
paid by the buyer to the seller as part
of the price.
VAT is a multistage sales tax
that applies at several stages of the
production/distribution chain for a
product or service. However, a few
countries have single-stage sales
taxes that apply only at one stage.
The most common single-stage tax is
the retail sales tax which is charged
only on the sale of an item to its final
end user (e.g. the United States).
Multistage taxes ease the
enforcement of higher tax levels
(rates), as the taxes are collected
fractionally. Norway, Denmark,
Sweden and Hungary have the
highest VAT rate at 25% (http://
ec.europa.eu/taxation_customs/
taxation/vat/how_vat_works/rates/
index_en.htm). More and more,
conventional sales taxes are being
replaced by more broadly-based
value added taxes.
Most countries around the
world levy a VAT or another broad-
based consumption tax on tobacco
products. Only a few countries do not
apply such a tax on tobacco products
(e.g. Yemen, Egypt, Maldives,
Fiji, the Comoros, and Grenada) (World Health Organization, 2010).
In contrast to VAT, excise duties
are usually levied at the stage of
production or importation—and not
distribution—and they target the
consumption or the use of specific
products. The most commonly applied
excise duties are those on alcoholic
beverages, manufactured tobacco
products and energy products (motor
fuels and heating fuels, such as petrol
and gasoline, electricity, natural gas,
coal and coke).
Excisable goods have the
following common characteristics:
demand is price inelastic;; production,
distribution and sales can be closely
supervised by the government;;
and they are associated with
negative externalities (e.g. health or
environmental) or are considered
luxury goods.
There are two types of excise
duties on tobacco products: specific
and ad valorem . A specific excise
duty is a fixed monetary amount of
tax per quantity, volume, or weight
of tobacco products (e.g. per piece,
pack, carton, kilogram). An ad
valorem excise duty, on the other
hand, is levied as a percentage of
some measure of value of the tobacco
products (e.g. the manufacturer’s
price or the retail selling price).
Excises on tobacco are levied
in most countries around the world.
Only a few countries do not levy an
excise on tobacco products (e.g.
Benin, Cook Islands, Maldives, Saudi
Arabia, Grenada) (World Health
Organization, 2009). However, the
type (specific versus ad valorem ),
rates and base of the tax vary
considerably across countries.
Other, supplementary taxes
on tobacco products are named
differently in different countries;;
however they may act as excise
duties despite their names (e.g. the
stamp duty in Brazil). Some countries
levy several additional taxes on tobacco products. Often they aim to
finance various programmes through
earmarking but nonetheless act
as excises (e.g. the health tax on
tobacco products in Romania).
Customs duties
Customs duties (also called tariffs)
are taxes levied on imports of goods
(and, sometimes, on exports) by the
customs authorities of a country,
mainly to raise state revenue, and/
or to protect domestic industries
from more efficient or predatory
competitors from abroad. Again, the
duty may be specific or ad valorem .
Specific customs duties are based
upon the weight, dimensions, or
some other criteria of the item
(such as the size of the engine in
the case of automobiles). The ad
valorem customs duties are levied
on importer’s CIF (cost, insurance
and freight) value, as opposed to
ad valorem excise duties which are
levied on the manufacturer’s price or
the retail selling price. Consequently
the impact of a customs duty on the
final consumers’ price will be less
than that of an excise duty, because
the CIF value at importation can be
considerably lower than the e.g. the
final retail selling price. For example,
total tax as percentage of retail price
is 50% in Saudi Arabia, Bahrain, and
Qatar despite 100% import duties
(World Health Organization, 2010).
Almost all countries levy – usually
an ad valorem – tariff on imported
tobacco products. Again, the practice
varies greatly among countries, with
rates for example of 100% in Guyana
and 83% in Egypt (World Health
Organization, 2010).
Customs duties aim to raise
state revenue, and/or to protect
domestic industries and not to
influence the consumers’ price/
behaviour. Moreover, relying on
higher import duties as a way of
11Overview of tobacco taxationgenerating revenues or increasing
the price of tobacco products may
not be an appropriate policy given
the trade liberalization and the
bilateral, multilateral or global trade
agreements which provide for a
phasing out of such duties.
Description of taxed products
In principle, excise duties are levies
on manufactured tobacco and not on
raw tobacco leaves. Manufactured
tobacco includes products which are
entirely or partly made of tobacco
for the purpose of smoking, sniffing,
sucking or chewing. It includes rolls
of tobacco such as cigarettes;; bidis,
kreteks, cigars and cigarillos;; loose
smoking tobacco such as fine-cut
tobacco, pipe and water pipe tobacco,
as well as smokeless tobacco such
as snus (for sucking), nasal snuff (for
sniffing) and chewing tobacco.
In most countries, the various
categories of manufactured tobacco
carry different levels of taxation,
reflecting differences in the fiscal
policy objectives as well as in the
perceived tax-bearing capacity of
the different product categories.
In particular, hand-made or
more labour intensive products,
products made mainly by small-
and medium-sized enterprises, as
well as products predominantly
consumed by consumers in the lower
income groups, often benefit from
preferential tax treatment (World
Health Organization, 2010).
Rolls of smoking tobacco
Cigarettes are basically rolls of
tobacco wrapped in paper tubes
capable of being smoked as they are.
Manufacturing cigarettes is a capital-
intensive, fast-paced and highly
automated process. Machines may
produce between 8000 and 20 000
cigarettes every minute.Cigarettes are the most
consumed tobacco product.
Worldwide cigarette consumption
accounts for approximately 80%
or more of the total production of
tobacco leaves (http://www.fao.org/
docrep/006/Y4956e/y4956e04.htm).
In the European Union, cigarettes
account for approximately 92% of
the total sales of tobacco products
(European Commission, 2010a).
However, in some areas such as
southeastern Asia, substitutes
like bidis and kreteks have a more
important market share.
Bidis are the Indian-southeastern
Asian version of cigarettes. They are
made by rolling a dried, rectangular
piece of tendu or temburni leaf
(plants native to Asia) with sun-
dried, flaked tobacco (approximately
0.2–0.3 g) into a conical shape and
tied with a piece of thread. The bidi
industry has a large number of small-
scale industries, with a significant
share of bidis being handmade.
Bidis account for around 85% of total
smoking tobacco consumption in
India, with the remainder consisting
of cigarette consumption (John et al. ,
2010). Historically, excises on bidis
have been close to zero. A lobbying
argument of the bidis industry is that
a tax increase will affect employment
and tobacco-related trade (Ray and
Gupta, 2009).
Kreteks, sometimes referred to as
clove cigarettes, are the Indonesian
version of cigarettes and by far the
most widely-smoked form of tobacco
in Indonesia. They typically contain
a mixture of approximately 60–80%
tobacco, 20–40% ground cloves,
clove oil and other additives.
Cigars and cigarillos are rolls
of tobacco with an outer wrapper
of natural tobacco or rolls with a
threshed, non-cut, blend filler and
with an outer wrapper of the normal
colour of a cigar, of reconstituted
tobacco, covering the product in full. Cigars are handmade or machine
made but at lower speed and higher
cost compared to cigarettes. This
is reflected in the taxation regime,
whereby cigars or cigarillos are
often taxed at a considerably lower
level than cigarettes. However,
new products have appeared over
the last years (e.g. “eco cigarillos”
in the EU, “small cigars” in the US)
which are manufactured at low cost
and marketed as alternatives for
cigarettes but taxed at a sometimes
considerably, lower rate.
Loose smoking tobacco
Fine-cut tobacco is loose tobacco
which consumers primarily use to
make cigarettes, either by rolling it by
hand into cigarette paper (roll-your-
own, RYO) or using fabricated filter
tubes and a making device (make-
your-own, MYO).
Although worldwide fine-cut
tobacco (together with pipe tobacco)
is estimated to be only around
1% to 2% of the tobacco market,
in some regions it has a more
important market share (Euromonitor
International, 2009). Fine-cut
tobacco comprises approximately 8%
of the total sales of tobacco products
in the European Union (European
Commission, 2010a). The core
markets in the EU are Germany, the
Netherlands, Belgium, Luxembourg,
France and the United Kingdom,
covering in volume 80% of the EU
fine-cut market. In Luxembourg
and the Netherlands, fine-cut even
accounts for more than 50% of total
consumption of tobacco (European
Commission, 2010a).
The fine-cut tobacco
manufacturing process is relatively
labour-intensive as compared to
cigarettes. There are many small-
and medium-sized, often family-
owned, enterprises producing fine-
cut tobacco. In addition, fine-cut
IARC Handbooks of Cancer Prevention
12tobacco is predominantly consumed
by consumers in the lower income
groups. Historically, it has been
taxed at a significantly lower level
than cigarettes.
Pipe tobacco is loose tobacco
processed in a different way to
make it capable of being burned
in a pipe. In many countries, it is a
niche market product with low and
steadily declining volumes. Because
of its generally more traditional and
more labour intensive manufacturing
processes, inter alia, it often has an
even lower tax level than fine-cut
tobacco. Pipe tobacco is taxed as
«other smoking tobacco» (European
Commission, 2010a). As a result,
also in this market, new products
have appeared which are taxed as
pipe tobacco, but are marketed as,
and in direct competition to, fine-cut
tobacco.
Water pipe tobacco is another
form of smoking tobacco widely used
in southwestern Asia and the eastern
Mediterranean area. However, its
consumption is increasing in other
regions, such as the EU (Unpublished
data from Internal Reports from
Member States to the EC;; Knishkowy
and Amitai, 2005). Recent data
published by the Eurobarometer
indicate that 9% of smokers use
water pipes occasionally (European
Commission, 2010b). Little
information is available with regards
to excises on tobacco products for
water pipes. The tax rates seem to
vary widely, from 2% of the producer
price in Libyan Arab Jamahirya, to
15% in Syrian Arab Republic, to 58%
of retail price in Turkey and 108% in
Lebanon (World Health Organization,
2010). In the EU, water pipe tobacco
is taxed like pipe tobacco (European
legislation Directive 2010/12;;
see «other smoking tobacco» in
European Commission, 2010a).Smokeless tobacco products
Taxation of smokeless tobacco
products has received comparatively
little attention in most countries.
Smokeless tobacco is a major
consumer’s choice in some markets
such as Sweden, Norway and India,
and is widespread in countries such
as the USA (IARC, 2007). Basically,
there are three major forms of oral
smokeless tobacco products:
Tobacco alone with aroma and
flavouring includes products that
are sucked, chewed or both. For
example, snuff, which is chopped into
particles like large coffee grounds
and moistened, is used by holding
between gum and cheek. Swedish
snus, which is a variant of snuff
processed differently and typically
moister, is sucked. Snus exists in
two packaging formats, loose snus
and portion-packed snus. Chewed
products, shredded like short cut
grass, generally mildly acidic, are
intended to be chewed throughout
the day as desired, for example
loose-leaf.
Tobacco with other components
includes products that contain lime,
sodium bicarbonate, ash or other
additives and which can be either
chewed or sucked, for example chimó
and shammah.
Betel quid with tobacco includes
areca nut, slaked lime, catechu, and
tobacco, and comprises products
that can be chewed or/and sucked,
such as gutka.
The tax treatment of smokeless
tobacco differs widely among
countries;; often it is not taxed, while
some countries apply differential rates
for, e.g., snuff and chewing tobacco
(World Health Organization, 2010).
Smokeless tobacco is becoming
a more important policy issue
because of the appearance of new
smokeless tobacco products. These
new smokeless products include a variety of dissolvable tobacco
products and snus, in addition to
the more traditional moist snuff and
chewing tobacco products. The
issue of how to tax all these products
remains an open question for further
study.
Finally, to avoid loopholes,
countries may also tax other
manufactured tobacco, such as
tobacco refuse put up for retail sale
or all other tobacco which has been
cut, split, twisted or pressed and is
capable of being smoked without
further industrial processing.
Objectives of tobacco taxation
In many countries tobacco is taxed
more heavily than other goods. There
are at least three reasons for this.
Revenue objectives
Historically, revenue generation
has been the primary aim of
tobacco taxation of most, if not all
governments. Taxes on tobacco
products are a very efficient revenue
raiser given the large sales volumes,
the relatively inelastic demand
(consumers are not price-sensitive
due to addiction) and the lack of
close substitutes. They satisfy
the so-called “Ramsey Rule” for
economically efficient consumption
taxes—because of the relative
inelasticity of demand, they can
generate considerable revenues
while creating fewer distortions in the
market than would result from taxes
on goods and services with more
elastic demand. Moreover, given the
small number of producers and the
large sales volumes, tobacco taxes
are relatively easy to collect, at low
administration and enforcement cost,
in particular as compared to general
consumption taxes and income
taxes. Table 2.1 shows the share of
excises on tobacco as a percentage
13Overview of tobacco taxationof total tax revenues in countries in
the EU.
Given the size of total revenues
in some countries, even a share of
1–2% represents a significant source
of revenue in absolute monetary
amounts. However, to date, and
in particular in more developed
economies, VAT and other general
sales taxes have the capacity to raise
much larger revenues from a more
widely spread tax base. Therefore
the retention and the increase of
excise duties on tobacco products
are also justified by reasons other
than budgetary.
Health objectives
To discourage consumption
of the product
Tobacco use is the leading cause of
preventable death, and is estimated
to kill more than 5 million people
each year worldwide. If current
trends persist, tobacco will kill more
than 8 million people worldwide by
the year 2030, with 80% of these
premature deaths in low- and middle-
income countries (World Health
Organization, 2008). It is the biggest
single form of avoidable death and
one of the leading causes of illness
and mortality.
Taxation forms part of an overall
strategy of tobacco use prevention
and dissuasion that also includes
other measures intended to reduce
demand, such as protection from
exposure to tobacco smoke,
advertising bans, regulation of the
contents, etc. Price increases of
tobacco are considered to be the
most effective and cost-effective
single measure to prevent and
reduce tobacco use. Over one
hundred studies have examined the
impact of tobacco taxes and prices
on overall tobacco use. While these
studies have produced a wide range Country Share of tobacco excise
Sweden 0.7%
Slovenia 0.8%
Denmark 0.9%
Finland 1.2%
Netherlands 1.5%
Belgium 1.8%
Lithuania 1.8%
Ukraine 1.8%
Austria 2.0%
France 2.1%
United Kingdom 2.2%
Italy 2.3%
Latvia 2.3%
Ireland 2.6%
Germany 2.8%
Spain 2.9%
Hungary 3.2%
Estonia 3.4%
Cyprus 3.6%
Portugal 3.7%
Slovakia 4.0%
Czech Republic 4.0%
Poland 4.8%
Malta 4.9%
Greece 5.6%
Romania 5.8%
Bulgaria 6.8%
Luxembourg 7.3%
Indonesia (2007) 8.4%Table 2.1. The share of excises on tobacco as a percentage of total tax
revenues in the EU Member States and two other selected countries in 2005
Source: European Commission (2008a) (SEC/2008/2266) ;; see tobacco products legislation;; impact assessment
of estimates of the magnitude of the
effects of price on overall tobacco
consumption, it is clear that a price
increase will lead to a reduction
in consumption (see Chapter 4 for
the value of these estimates). More
importantly, the impact of higher
prices is likely to be greatest on young
people, who are more responsive
to price rises than older people.
In addition, price increases are an
effective policy tool to prevent people from taking up smoking (especially
among young people), encourage
smoking cessation, reduce the
number of ex-smokers who resume
the habit, and reduce in the long run
the average cigarette consumption
among continuing smokers.
Article 6 of the World Health
Organization’s Framework Convention
on Tobacco Control (WHO FCTC)
recommends tax policies so as to
contribute to health objectives aimed
IARC Handbooks of Cancer Prevention
14at reducing tobacco consumption
(World Health Organization,
2005). More and more countries or
jurisdictions are using tobacco taxes
as a way to promote public health by
reducing tobacco use and the death
and disease it causes (e.g. the EU,
Norway, New York and California in
the United States, Pakistan, etc.). A
health-driven taxation policy aims
to increase the overall tax and price
levels of tobacco products, increase
in particular the tax and price levels
of the cheaper brands, and reduce
the price gap between low-priced
and premium brands to discourage
down-trading (smokers switching to
cheaper brands as a result of tax and
price increases).
To recoup what economists call
“negative externalities.”
Negative externalities are the costs
borne by society collectively, or by
individuals other than the individual
tobacco consumer. Theories
suggest that these external costs
associated with the consumption of
tobacco, such as the costs to treat
smoking-related diseases, warrant
supplementary taxes on tobacco.
Generally, these costs are not
reflected in the price of the tobacco
products. The purpose of externality
taxation is to confront the individual
decision-maker with the external
costs of their decision, on the same
basis as if these costs were private
costs (so-called “internalisation”).
Because the consumer pays for
the societal cost, he is assumed to
make a more economically efficient
decision on whether and how much
tobacco to consume.
Negative externalities fall into
three broad categories. The first
consists of direct externalities
experienced by other individuals,
including the adverse health effects
experienced by those exposed to environmental tobacco smoke
(passive smoking). The second
comprises collectively-borne costs,
such as the cost of publicly-funded
medical treatment for smoking-
related conditions, and other
public expenditure costs. The third
category of externalities is, in effect,
a tax revenue externality, namely
the loss of income and consumption
taxes as a result of reduction in the
consumer’s income and expenditure,
especially through premature
death and a higher rate of sickness
absence. The consequences or the
costs for the individual consumer’s
own health, income, and so on, are
no externalities.
Most estimates distinguish
between the gross costs of smoking
(higher costs of medical treatment,
etc., as a result of conditions caused
by smoking), and the net costs,
which offset against the gross costs
a range of cost savings (mainly
public expenditure effects, such as
savings on retirement pensions)
arising because of the premature
death of smokers. Some literature
suggests that in high taxing countries
smokers pay their way—in other
words, that the supplementary taxes
on tobacco overcompensate the
net external cost (Cnossen, 2006;;
Manning et al. , 1989). However,
this is a controversial area, inter
alia, because of the treatment of
costs borne by family members.
Family members of a smoker may
experience considerable costs,
including ill health, and pain and
distress as a result of the illness and
premature death of the smoker. This
harm inflicted on family members—
which is hardly quantifiable—is often
not considered as an external cost
(Smith, 2007), as family members
are assumed to care for each other’s
welfare to the extent that the welfare
of the household can be considered
as a single entity.Political, social and economic
considerations
In principle, the three aforementioned
objectives are complementary.
Increases in tobacco taxes aiming to
raise additional revenue will contribute
to a reduction in consumption and
in the external cost of smoking. Vice
versa, given the inelastic demand and
the high share of the tax in the retail
price, tax policies aimed at reducing
tobacco consumption or at recouping
externalities will, all other things being
unchanged, entail revenue increase .
Nonetheless, when determining
their taxation policy governments
will take into account other, at
times competing, considerations.
This section does not aim to list
exhaustively all political, social or
economic considerations that may be
taken into account in determining a
taxation policy, but focuses briefly on
the most frequently used arguments
against tax increases.
Poverty
Concerns about the affordability of
cigarettes, in particular for the poor,
are arguments for those who oppose
tobacco tax increases. Consumption
taxes are regressive because
they are not based on the ability-
to-pay principle. Assuming equal
consumption patterns, tobacco taxes
will account for a greater share of
income for the poor than for the rich
(see Chapter 7). This regressivity will
be more pronounced in countries
where the tobacco consumption is
greater among lower than among
higher incomes. A “pro-poor policy”
can keep taxes on tobacco low in
general, but can also keep taxes low
on the products/brands most widely
used by the poor while more heavily
taxing more expensive products or
brands (e.g. fine-cut tobacco versus
cigarettes).
15Overview of tobacco taxationHowever, a policy aimed at
keeping tobacco affordable for lower
incomes is likely to end up with a
disproportionate share of the health
and economic burden of tobacco
consumption on the poor. On the
other hand, although the initial tax
is regressive, tax increases can be
progressive (Chaloupka et al. , 2000).
To the extent that lower incomes are
more sensitive to price increases
than higher incomes, tax increases
will entail a higher reduction in
consumption among this population
while having less of an impact
on higher-income populations.
Consequently, the burden of the
actual supplementary taxes paid as a
result of a tax increase will be greater
on those with higher incomes. In the
long run the poor benefit from an
increase in the quality of their health
and economic welfare.
Inflation
Consumption taxes may have an
inflationary effect. At times the
inflationary impact of increases
of tobacco taxes is raised as an
argument to oppose increase of
tobacco taxes, in particular where
government policy is to keep inflation
low. However, as opposed to broad-
based consumption taxes, the relative
weight of expenditure on cigarettes
in the consumer price index should
not be overestimated, and in general
the impact on inflation of an increase
of tobacco taxes will be relatively
small (see Chapter 9). To the extent
that concerns about the impact on
inflation are a barrier to tax increases,
excluding tobacco products from the
baskets of goods used in developing
key price indices used for the
indexation of wages and pension
payments, such as for instance in
France, Belgium and Luxembourg,
would greatly reduce these concerns
(World Health Organization, 2010).Employment
In general, only jobs in tobacco
farming, leaf processing, warehousing
and manufacturing are fully
dependent on tobacco. Other sectors,
such as retailers who sell tobacco
among many other products are only
partly and indirectly involved. To date,
tobacco manufacturing is a capital-
intensive sector and is relatively
small in terms of numbers of people
employed, e.g. 60 000 in the EU-25
in 2003 (Commission Staff Working
Document Impact Assessment
Accompanying the Proposal for a
Council Directive amending Council
Directive 95/59/EC, 92/79/EEC and
92/80/EEC on the structure and rates
of excise duty applied to manufactured
tobacco (SEC/2008/2266)).
In general, any tobacco-
dependent job lost in response to
the reduced demand for tobacco
products will be offset by new jobs
in other sectors because the money
spent on tobacco will be shifted to
more labour-intensive goods and
services (see Chapter 9). To address
employment concerns in tobacco-
dependent sectors, programs have
been adopted to ease the transition to
another economic activity, e.g. crop
diversification for tobacco farmers or
product diversification for retailers. At
times, the employment argument has
been used to justify reduced rates on
products other than cigarettes, which
are perceived as being more labour
intensive (e.g. handmade kreteks;;
bidi rolling, fine cut tobacco).
Protection of domestic tobacco
growers and manufacturers
Some countries levy a lower tax on
local tobacco products to protect
domestic tobacco growers and
tobacco manufacturers from outside
competitors. This can be done by
directly applying different excise rates to tobacco products depending
on the source or type of tobacco
contained in the product or on other
product characteristics, or indirectly
by applying an ad valorem excise
duty where foreign brands are more
expensive than local. This can be
an infringement of Article III (2) of
the General Agreement on Tariffs
and Trade legal text referred to as
GATT, 1947 (http://www.wto.org/
english/docs_e/legal_e/gatt47_01_e.
htm#articleIII), now embedded in the
World Trade Organization, according
to which internal taxes shall not
be applied to protect domestic
production, or of similar provisions
laid down in regional free trade
arrangements.
Other constraints for tax and price
increases
As aforementioned, the health and
budgetary objectives are to a large
extent complementary. Decision-
makers will also take into account other
considerations, such as the impact on
inflation, employment, affordability
and the interests of the domestic
tobacco growers and manufacturers.
However, the ability to increase
prices and revenues by means of tax
increases has certain constraints,
as any tax increase may entail a
change in other variables affecting
the expected revenue increase or
reduction in consumption. The most
pertinent ones are the manufacturers’
pricing policy, the consumers’
behaviour and the share of the non-
domestic duty paid consumption in
total domestic consumption.
The share of the non-domestic duty
paid consumption (NDDP):
tax evasion and tax avoidance
A part of the tobacco market will
escape domestic taxation because
IARC Handbooks of Cancer Prevention
16of illicit trade and cross-border
shopping. Cross-border shopping in
neighbouring low-taxing countries
or jurisdictions is legal as long as
the quantitative restrictions laid
down in the traveller allowances are
respected. Illicit trade covers mainly
smuggling, illicit manufacturing
and counterfeit. Smuggling refers
to products illegally traded across
borders. Large-scale organized
smuggling involves the illegal
transportation, distribution and sale
of large consignments of cigarettes
and other tobacco products. Small-
scale smuggling involves the
purchase, by individuals or small
groups, of tobacco products in low-tax
jurisdictions in amounts that exceed
the limits set by customs regulations,
for resale or just use in high-tax
jurisdictions. Illicit manufacturing
refers to the production of tobacco
products contrary to taxation laws
or other laws (such as licensing or
monopoly-related laws) that restrict
the manufacture of tobacco products.
Counterfeit tobacco production is a
form of illegal manufacturing in which
the manufactured products bear a
trademark without the consent of the
owner of the trademark. Counterfeit
and illegally manufactured products
can be sold on the domestic market
or smuggled into another jurisdiction
(see Chapter 8).
Significant differences in taxes
and prices of tobacco products
between countries and jurisdictions
have created an environment for
tax-induced cross-border shopping
and illicit trade. Worldwide illicit trade
is estimated at 11.6% of the global
cigarette market in 2007 (Joossens
et al. , 2009).
Manufacturers’ pricing policy
Manufacturers may absorb the
tax increase, partly or completely,
by reducing their profit margin. Consequently, the tax increase
will not result in the expected price
increase and related reduction of
consumption. Moreover, in the case
of ad valorem duties, this may even
affect the expected revenue increase
(see further and Chapter 3).
Consumer behaviour
As cigarettes may be sold at different
price points (low, medium-priced,
premium), consumers may switch
to cheaper cigarettes or to other
tobacco products (e.g. fine-cut
instead of cigarettes) as a result
of a tax increase. For example, a
Klynveld Peat Marwick Goerdeler
(KPMG, 2005) study commissioned
by the European Commission
concluded that the market share of
cheap cigarettes has soared in most
EU Member States as a result of tax
hikes triggering less tax revenue and/
or mitigating the downward the effect
on the consumption of cigarettes.
Again, an ad valorem structure will
make price and tax policies more
vulnerable to changes in consumer
behaviour (see further).
Structure of the taxes
There are two types of excise taxes:
specific and ad valorem . A specific
excise tax is a fixed monetary amount
of tax per quantity, volume, or weight
of tobacco products. An ad valorem
excise tax is levied as a percentage
of the price of the tobacco products.
Countries may have either an ad
valorem or a specific structure.
Specific and ad valorem taxes have
different effects on prices, profits
and competitive positions of tobacco
producers, tax revenues, quality and
variety of products, administration
and distribution of income. They will
contribute in a different way to the
achievement of health objectives.
The relative merits depend on the objective that a country wants to
achieve with the tobacco tax, and in
part on whose perspective is being
used to evaluate their effects (revenue,
health, manufacturers, consumers).
To have the best elements of both, it
is possible to combine an ad valorem
with a specific tax. A so-called mixed
structure applies an ad valorem and
specific duty to all tobacco products.
Mixed systems can give preference to
more ad valorem or to more specific
duties depending on the desired
effects.
Ad valorem excise duties can also
be combined with a minimum tax floor.
Minimum excise duties are similar to
specific excise duties, and are a fixed
monetary amount per quantity or
volume that applies if the ad valorem
excise falls below a minimum floor. In
other words the ad valorem cannot
be less than the minimum tax floor;;
lower-priced products will be taxed at
the specific minimum rate, and higher-
priced products will be taxed at the ad
valorem rate. The effects of a minimum
tax floor are similar to those of specific
duties. Finally, more complex taxation
systems may even combine a mixed
structure with a minimum duty.
In summary, this leads to five
structures:
1) Purely specific;; with a tax base
per unit, e.g. per 1000 cigarettes;; per
1 kg tobacco.
2) Purely ad valorem ;; the tax
base is the value of the products (e.g.
ex factory price;; retail price).
3) Mixed;; a combination of both
ad valorem and specific duty.
4) A combination of an ad valorem
duty for medium-priced and/or
premium brands and a specific duty
for cheaper brands. The ad valorem
excise applies on the value of the
products;; however, if the ad valorem
excise falls below a minimum floor, a
specific tax applies.
5) A combination of a mixed
duty for medium priced and/or
17Overview of tobacco taxationpremium brands and a specific duty
for cheaper brands. A mixed excise
applies;; however if the mixed excise
falls below a minimum floor, a specific
tax applies.
Only 55 countries rely on
specific duties only;; most (108)
apply at least to some extent an
ad valorem duty (see Table 2.2)
(World Health Organization, 2009).
No complete data are available as
concerns the number of countries
applying a minimum tax. Twenty-
four EU Member States (European
Commission, 2010a) as well as
the Russian Federation and the
Ukraine combine a mixed structure
with a minimum tax. Turkey applies
an ad valorem system combined
with a minimum tax (World Health
Organization, 2010).
The preference of countries for a
particular structure shows similarities
by income groups. Most low-income
countries rely on ad valorem taxes.
Conversely, almost all high-income
countries apply purely specific or
mixed systems. Within the high-
income countries, the European
Region (except Norway) relies on
a mixed system, and almost all
other countries on a purely specific system (inter alia, the United States
of America, Canada, Australia, New
Zealand, Japan, Singapore).
There are also similarities by
region. Most countries in Latin
America and the Caribbean region
as well as in Africa apply purely ad
valorem systems. North America
and a large number of countries in
the East Asian and Pacific region
rely on purely specific systems.
Mixed systems are mainly applied
in Europe, and in China, Indonesia,
Pakistan, Malaysia and Thailand
(World Health Organization, 2009).
Countries applying a mixed
structure may rely mainly on ad
valorem or mainly on specific duties.
In the EU, Member States must
apply a mixed structure (Fig. 2.1). The specific component may not be
less than 5% or more than 55% of
the amount of the total tax burden
(proportional and specific excise
duty plus VAT). As from 1 January
2011, the specific component of the
excise duty on cigarettes may not
be more than 76.5% of the amount
of the total tax burden and as
from 1 January 2014, the specific
component of the excise duty on
cigarettes may not be less than 7.5%
(Council Directive 2010/12/EU of 16
February 2010 amending Directives
92/79/EEC, 92/80/EEC and 95/59/
EC on the structure and rates of
excise duty applied on manufactured
tobacco and Directive 2008/118/EC).
The upper limit has been increased,
allowing Member States relying more
on specific duties in the context Table 2.2. Excise structure for cigarettes in 2008
Structure Number of countries (total 182)
Purely specific system 55
Purely ad valorem system 60
Mixture of both excises 48
No excise 19
Source: World Health Organization (2009). WHO report on the Global Tobacco Epidemic 2009: implementing smoke-
free environments. Geneva, World Health Organization
Figure 2.1. Share of ad valorem and specific taxes in total excise duties: EU27
Figure generated by the Working Group based on data published in the excise duty tables in European Commission (2010a). Excise duty tables 2010, Part III- Manufactured Tobacco.
Brussels, European Commission. http://ec.europa.eu/taxation_customs/taxation/excise_duties/tobacco_products/rates/index_en.htm) . Abbreviations: AT, Austria;; BE, Belgium;; BG,
Bulgaria;; CY, Cyprus;; CZ, Czech Republic;; DE, Germany;; DK, Denmark;; EE, Estonia;; EL, Greece;; ES, Spain;; FI, Finland;; FR, France;; HU, Hungary;; IE, Ireland;; IT, Italy;; LT, Lithuania;;
LU, Luxembourg;; LV, Latvia;; MT, Malta;; NL, Netherlands;; PL, Poland;; PT, Portugal;; RO, Romania;; SE, Sweden;; SI, Slovenia;; SK, Slovakia;; UK, United Kingdom.
IARC Handbooks of Cancer Prevention
18of a health-driven taxation policy.
To maintain a minimum level of
harmonization of the tax structure,
the lower limit should, in theory, have
been increased to the same extent.
However, due to strong opposition
of several countries applying high
ad valorem duties, a compromise
was reached at only 7.5%. As a
consequence, there is flexibility
resulting in widely differing practices,
reflecting the differing objectives
that the countries want to achieve by
means of tobacco taxation.
Within these systems different tax
rates may apply for different products
(e.g. filtered and unfiltered cigarettes,
cigarettes versus fine-cut tobacco)
which render the tax structures very
complex.
There are many factors that can
influence the choice of one structure
over another. Regulators will consider
the effects on tax revenues, prices,
profits and competitive positions
of tobacco producers, quality and
variety of products as well as the
ability to administer the tax.
Because specific duties are the
same for all cigarettes, independent
of the price, they will reduce the
relative price differentials between
high- and low-taxed cigarettes. This
may lead consumers to switch to
higher-priced cigarettes, assuming
that more expensive cigarettes are
considered to be of a higher quality
(and thus more appealing). They
have an upgrading effect that favours
high quality, which may lead to a
higher average price.
Ad valorem duties are a
percentage of the price of cigarettes
and will maintain the relative (pre-tax)
price differentials between high- and
low-taxed cigarettes. Consequently
there will be more price competition
under an ad valorem system, which
may entail a lower average price.
They have a multiplier effect that
favours low quality.Specific duties may have several
merits as concerns their impact on
prices, consumption and revenues.
Changing an ad valorem structure
to a more specific structure
Objectives may change over time.
Where an ad valorem structure was
preferred in the past, specific duties
may now fit better to achieve revenue
and health objectives. However, a
change from an ad valorem structure
into a specific will have a certain cost:
the tax burden on the lower-priced
cigarettes would be increased, but
the change to specific taxation would
result in a reduction of the tax burden
on higher priced brands. This might
have undesired effects on consumer
prices of premium brands and on the
profits and competitive positions of
tobacco manufacturers. Producers
of premium brands would get a tax
subsidy, while their competitors
would potentially face a significant
increase of the tax burden on their
products. To avoid these effects, a
switch to a more specific tax structure
could be done in the context of tax
increases, i.e. by increasing the
specific element while leaving the ad
valorem unchanged. Another option
is the introduction of a minimum tax
floor that does not affect the tax
burden on higher priced brands.
Tax rates
Overview
Tax rates vary greatly across
countries, ranging from countries
with no excise imposed on tobacco
products (e.g. Benin, Cook Islands,
Grenada, Maldives, Saudi Arabia) to
an excise tax representing more than
75% of the retail price of a pack of the
most sold brand of cigarettes (e.g.
Cuba, Fiji, Poland and Seychelles)
(World Health Organization, 2010). However, rates do cluster by income
groups, and some common features
can be seen on an average level
when moving from one income
group to another. Figure 2.2 shows
the average levels of the price, tax
amount and tax share of the price of
the most-sold brands of cigarettes
by income groups based on World
Bank classification in 2008 (http://
data.worldbank.org/about/country-
classifications/country-and-lending-
groups). There is a clear downward
trend in the tax and price level as
the level of income of countries goes
down. At the extremes the total tax
rate for low-income groups is almost
40% lower than the tax rate of high-
income groups.
Figures 2.3 and 2.4 show details
of tax levels by countries and by WHO
region. The rates shown in Figure 2.3
apply to the most-sold brand;; those
rates of course vary within a country
when price differentials are large
among brands and particularly when
differential excise tax rates are applied
on different brands and products. For
example, in Bangladesh, the total tax
share of the retail price is 47% for the
cheapest brand pack of 20 cigarettes
and 87% for a pack of Marlboro
cigarettes. In the Philippines the total
tax share of the cheapest brand pack
of cigarettes is 54%, and goes up to
76% for the Marlboro brand (World
Health Organization, 2010).
Differential taxation between
tobacco products
Most countries apply different rates
on tobacco products, either to protect
their domestic industry (e.g. India
where much lower taxes are applied
on bidis compared with cigarettes),
or because of the perception that
the products are of a different nature
(e.g. cigars, water pipe tobacco,
chewing tobacco versus cigarettes).
19Overview of tobacco taxation
Figure 2.2. Price and tax average for a pack of the most-sold brand of cigarettes by income groups, 2008§
Source: Adapted from World Health Organization (2009). WHO report on the Global Tobacco Epidemic 2009: implementing smoke-free environments. Geneva, World Health Organization.
§July 2008 World Bank classification of countries by income
Figure 2.3. Cigarette price, excises, and other taxes as in 2008, by region
WHO African Region (AFRO)
IARC Handbooks of Cancer Prevention
20
WHO Region of the Americas (AMRO)
WHO Eastern Mediterranean Region (EMRO)
WHO South-East Asia Region (SEARO)
21Overview of tobacco taxation
Source: World Health Organization (2009). WHO report on the Global Tobacco Epidemic 2009: implementing smoke-free environments. Geneva, World Health Organization.
Notes: Price of the most sold brand in the country converted into US dollars using official (principal or market) exchange rates at end of time period;; total tax share includes specific
excise, ad valorem excise, value added tax (VAT), imported tax duty (if the most popular brand in the country is imported), and others (if applicable);; un-weighted arithmetic average.WHO Western Pacific Region (WPRO)
WHO European Region (EURO)
IARC Handbooks of Cancer Prevention
22Little data is collected on the tax
rates applied on products other than
cigarettes on a global scale. Data
collected by the WHO Reports on the
Global Tobacco Epidemic can provide
some examples of tax rates for some
countries and some tobacco products
(World Health Organization, 2009).
Table 2.3 provides tax rates of roll-
your-own (RYO) tobacco and chewing
tobacco as well as cigarettes for
selected countries (where data was
available). For comparison purposes,
the tax rate was applied for the price
of 20 g of RYO and chewing tobacco,
assuming that a pack of 20 cigarettes
would weigh 20 g (1 g of tobacco per
cigarette). For RYO, tax rates seem to
be similar to those for cigarettes but
can also vary widely, with the rates on
cigarettes being higher (e.g. Georgia,
Mongolia, Thailand and the United
Kingdom). In the EU, the minimum
rates for fine-cut are around 50% of
the minimum rates for cigarettes. The
gap between the level of taxation of
cigarettes and fine-cut tobacco gives
Figure generated by the Working Group based on data published in the excise duty tables in European Commission (2010a). Excise duty tables 2010, Part III- Manufactured Tobacco.
Brussels, European Commission (data from 2010 used to produce the graph available upon request);;
http://ec.europa.eu/taxation_customs/taxation/excise_duties/tobacco_products/rates/index_en.htm).
Abbreviations: AT, Austria;; BE, Belgium;; BG, Bulgaria;; CY, Cyprus;; CZ, Czech Republic;; DE, Germany;; DK, Denmark;; EE, Estonia;; EL, Greece;; ES, Spain;; FI, Finland;; FR, France;;
HU, Hungary;; IE, Ireland;; IT, Italy;; LT, Lithuania;; LU, Luxembourg;; LV, Latvia;; MT, Malta;; NL, Netherlands;; PL, Poland;; PT, Portugal;; RO, Romania;; SE, Sweden;; SI, Slovenia;; SK,
Slovakia;; UK, United Kingdom.Figure 2.4. Taxes on cigarettes in the European Union - 1 January 2010
rise to product substitution. Mainly
as a result of increased taxation, the
quantities of cigarettes released in
the EU-251 decreased by around 14%
between 2002 and 2008. Conversely,
the quantities of fine-cut tobacco
increased in the same period by
around 18% (European Commission,
2010a).
Moreover, in contrast to ready-
made cigarettes, which are taxed
on a per-stick basis, specific duties
on fine-cut tobacco are levied on a
per-kilogram basis. The conversion
rate between kilogram and sticks is
a controversial issue. Traditionally, 1
kg is supposed to correspond to 1000
sticks. However, the average weight of
a cigarette is estimated to be around
0.75 gr. Moreover, new products
called “volume tobacco” have gained
a significant market share. Each kilo
of “volume tobacco”2 used can yield a
savings of at least a half-kilo of cut filler.
Consequently, the real tax burden as
well as the increase in volumes of fine-
cut tobacco may be underestimated.On the other hand, chewing
tobacco is almost always taxed at a
significantly lower rate than cigarettes
(e.g. Algeria, Bangladesh, Guatemala,
Nigeria, Pakistan, Sri Lanka and the
Bolivarian Republic of Venezuela).
To the extent that these products can
be substituted for cigarettes, tobacco
taxation can be rendered ineffective
if other products remain taxed at a
much lower rate.
Differential taxation within the
same tobacco products
Several countries also apply
differential tax rates within the same
tobacco product. For example, about
20% of countries that collect excise
taxes on cigarettes impose different
rates on the cigarettes consumed
in the local market. The differential
rates vary depending on different
characteristics of cigarettes: this is
usually the retail price level, but can
also be the production volume, the
sales volume, the type of cigarette
1 No full data available for RO and LT
2 In contrast to classical fine-cut tobacco, the raw material undergoes an expansion process which leads to an increase of the tobacco volume. One expansion process is called
DIET (dried ice expanded tobacco), but there are other processes/patents (IMPEX, IMCON) with comparable effects on the volume of the tobacco. All expansion processes fall
under the generic term “volume tobacco.”
23Overview of tobacco taxationTable 2.3. Tax share of the price of 20g of RYO, chewing tobacco
and 20 cigarettes, selected countries, 2008
Country Cigarettes RYO (20g) Chewing tobacco (20g)
Paraguay 19% 19%
El Salvador 31% 61%
Nigeria 32% 32% 5%
Mongolia 37% 13%
Malaysia 48% 46%
Pakistan 52% 14%
Georgia 55% 15%
Eritrea 55% 55%
India 55% 33%
Guatemala 57% 11%
Australia 62% 67%
Swaziland 62% 20%
Samoa 63% 64%
Japan 63% 20%
Thailand 64% 15%
Thailand 64% 25%
Canada 65% 24%
Uruguay 66% 77%
Bangladesh 67% 15%
Madagascar 67% 44%
Algeria 68% 15%
New Zealand 69% 68%
Sri Lanka 72% 13%
Norway 73% 78%
Italy 75% 45%
Myanmar 75% 25%
Netherlands 76% 38%
Venezuela 78% 8%
Czech Rep 79% 77%
UK 80% 55%
Source: World Health Organization, unpublished data
(with or without filters, hand or
machine made), the packaging
(hard/soft), the cigarette length, etc.
(World Health Organization, 2010).
Tax rates can vary substantially. For
example, in Indonesia tax rates vary
by tobacco product but also within
the same product depending on the
retail price and production capacity of
manufacturers. In the case of kreteks (machine- and hand-made), the rate
varied between 65 to 310 Rupiahs per
stick in 2010. In Brazil, the excise tax
varied between 0.764 to 1.397 Reals
per pack of 20 cigarettes depending
on the size of the cigarettes and the
type of package (unpublished data
received from governments reporting
their tax rates). These differential rates
lead to price gaps within the same type of products and can easily encourage
substitution of consumption to
lower-taxed products when a tax
is increased instead of reduction
in consumption or quitting, thereby
defeating the purpose of tax policies
from a public health perspective. From
a tax administration’s perspective,
applying differential tax rates to
the same type of product is not
advisable because it makes it more
difficult for tax collectors to assess
the manufacturer’s tax liability, and it
provides incentives for manufacturers
to avoid taxation by making sure their
products fall in the lower end of the
tax rate.
The impact of tax rates and tax
structure
Impact on prices
If public health is a concern in the
tobacco tax policy, policy-makers need
to know if the tax increase will actually
lead to a price increase and to a
consequent reduction in consumption.
Under perfect competition the
consumer price cannot increase by
more than the amount of tax increase.
However, under imperfect competition
taxes may be under or over-shifted;;
that is, the consumer price may rise
by less or more than the amount of the
tax. While either specific or ad valorem
may be over-shifted, this is more likely
to happen with specific (Delipalla and
Keen, 1992). For empirical evidence,
see Chapter 3.
The tobacco industry works like
an oligopoly with a large number of
consumers and a few producers.
Seventy percent of the world’s cigarette
market is controlled by 4 multinationals
(Euromonitor International, 2009).
In China, however, the market is
controlled by only one company
owned by the governme nt. In these
non-competitive markets, instead
of absorbing a tax increase and
IARC Handbooks of Cancer Prevention
24reducing its profits, the industry
can easily pass it on to consumers
(leading to an increase in price)
without fears that this would lead
to a switching to cheaper products
offered by a competitive company.
In addition, with the growing support
to tobacco control policies and the
expected decrease in consumption
in the future, some suggest that
the industry will tend to raise prices
now and save its profits instead of
keeping prices low to stimulate future
consumption (Becker et al. , 1994).
Of course, such industry
behaviour leads to larger increases
in the price of cigarettes, which is
good for public health. However, this
means more revenues and power to
the tobacco industry, revenues that
would be more useful if they ended
up in the coffers of the government
instead.
In the case of the China National
Tobacco Co. (CNTC) government-
owned monopoly, the relation
between taxes and prices is very
different. The tax policy is not used
as an instrument to influence price,
since the government determines
both the tax and price levels.
If we compare data at the global
level, the average price of a pack of
the most-sold brand of cigarettes
is higher in countries relying only
on specific excise (2.46 US$) than
in countries relying only on ad
valorem (1.29 US$). The same is
true for countries applying a mixed
system but relying more on specific
(3.87 US$) than on ad valorem
(3.14 US$). Similar conclusions
hold also if we account for the
income level of countries (World
Health Organization, 2010). This is
not meant to hold as an empirical
justification for the above statement,
but it indicates that specific excises
seem to lead to higher prices.Impact on revenues (budgetary
stability)
Both excises may have an impact
on prices;; increases in ad valorem
duties are likely to decrease prices,
and vice versa for specific duties.
Since specific duties are independent
of changes in price, they generally
produce a more stable stream of
revenue. Revenue from ad valorem
duties is dependent on prices, and
may vary over time depending on the
consumer and producer behaviour.
Moreover, forecasting revenue in an
accurate way may be very difficult
as one must predict changes in
consumer and producer behaviour.
In conclusion, specific duties may
entail higher prices and more stable
revenues but tend to favour higher
priced and more appealing brands.
Conversely, ad valorem taxes
have several merits concerning their
impact on product quality and variety,
the share of tax in the retail price,
and their ability to keep pace with
inflation.
Chapter 9 provides an in-depth
analysis of the impact of tax rates on
tax revenues.
Adjustment of taxes for inflation
The real value of a specific tax will
be eroded by inflation and therefore
must be periodically adjusted.
Conversely, as they are value-based,
the real value of ad valorem taxes will
be preserved, as the tax will increase
to the extent that tobacco prices
follow inflation. An advantage of a
minimum tax floor (which is similar
to a specific duty) is that it will be
automatically adjusted for inflation if
it is set as a percentage of the excise
due on a premium price category
subject to ad valorem taxation (e.g.
the most popular price category
(MPPC) in most EU Member States).Impact on variety of products
Specific duties provide incentives for
more appealing and higher-priced
products as well as a greater variety
of products. Upgrading effects
of specific taxes will reduce the
relative tax burden on high quality
products, which provides incentives
for higher quality and greater
variety of products. Conversely, the
multiplier effect under ad valorem
duties provides a disincentive to
costly quality improvements. From
a tobacco control and prevention
perspective, a higher quality and
greater variety of products are not
desirable, as these increase the
attractiveness of tobacco products.
Industry profits and the share
of taxes in the retail price
The theory suggests that profits
are relatively higher under specific
taxation (Delipalla and Keen, 1992).
Specific duties will entail a relatively
lower tax burden on premium brands
as compared to cheaper brands.
Ad valorem duties ensure the same
tax burden for all price categories.
In particular in premium markets,
specific duties may entail a lower
average price/tax ratio. In high-
income countries with similar price
levels, countries relying on specific
duties have on average a lower share
of tax in the retail price. On average,
the pre-tax prices are in all income
groups the highest in countries with
specific duties only, and the lowest
in countries with mixed systems.
Countries with mixed systems
have, apart from the low-income
economies, the highest share of tax
in the retail prices.
Tax authorities may prefer ad
valorem duties to maximize the share
of tax in the retail price. Assuming
identical price levels, this would lead
to higher tax revenues. However,
25Overview of tobacco taxationad valorem duties may render price
and tax policies more vulnerable to
industry pricing policies and changes
in consumer behaviour.
Other considerations:
industry characteristics
Specific duties tend to favour more
expensive products. Conversely ad
valorem duties will entail a higher
absolute amount of tax for premium
market segments as compared to
cheaper brands. The relative price
differentials between pre-tax prices
will under ad valorem systems be
better reflected in the tax-inclusive
consumer prices. Depending
on the industry characteristics,
governments may prefer one tax
over the other. In particular in highly
concentrated markets, where around
80% of the price of cigarettes
consists of tax (excise and VAT)
and where there is to a large extent
a ban on product advertising, a
certain level of ad valorem duties
will contribute to a more competitive
environment, usually translated into
lower pre-tax prices. To balance the
tax burden on the different market
segments, countries may opt for a
mixed system.
However, the appropriate
balance is a very controversial
issue. In some countries ad valorem
duties are advocated to protect the
cheaper domestic brands against
more expensive but more attractive
international brands. Others
countries with plants manufacturing
international brands will for a similar
reason prefer specific duties.
Moreover, the current tax structure
is often a holdover from a past when
tobacco manufacturing played a more
important role (e.g. the southern EU
Member States still rely mainly on ad
valorem duties, although, apart from
Greece, the domestic production has
disappeared over time).Administration and enforcement
If the administrative capacity of a
country is weak, specific duties may
have the advantage that it is easier
to determine the physical quantity
(number of cigarettes, weight of
the tobacco) than the value of the
products. Ad valorem duties require
some monitoring of prices for
reasons of tax collection. In some
countries (e.g. Philippines and the
Russian Federation), ad valorem
duties have involved valuation
problems because manufacturers
had the potential to sell their products
to a related wholesale company at
artificially low prices (transfer pricing)
to reduce excise duties (World Health
Organization, 2010). However, in
these countries ad valorem duties
were levied on ex factory prices. In
the EU, where ad valorem duties are
levied on the maximum retail selling
price to the final consumer, such
problems have not been reported.
On the other hand, under specific
taxation the manufacturer can
manipulate the length of the cigarette
or the size of the pack to reduce
the excise duties. For example, in
the EU, to reduce the excise duties
on cigarettes, new products have
been marketed consisting of rolls
of 18 cm and separate filter tubes
(Commission of the European
Communities, COM(2008) 460/2)
(European Commission, 2008b). The
rolls are subsequently cut into three
pieces by the consumer and inserted
in the filter tubes;; as for tax purposes
the maximum length of cigarettes is 9
cm, three cigarettes are taxed as two.
Moreover in many countries, in reply
to tax increases, manufacturers have
reduced the number of cigarettes per
pack (e.g. 17, 18 or 19 instead of 20
pieces) to maintain the same price
per pack (unpublished data: Internal
Reports from EU Member States to
the EC).The choice between ad valorem
duties and specific duties is a long-
standing and controversial issue. To
have the best elements of both, it is
possible to combine an ad valorem
with a specific tax. A so-called mixed
structure applies an ad valorem
and a specific duty to all tobacco
products. Mixed systems can give
preference to more ad valorem or
to more specific duties depending
on the desired effects. The more
the structure relies on the specific
duties, the more the upgrading effect
will come into play. The more the
structure relies on ad valorem duties,
the more the multiplicator effect will
come into play and the more excise
duties will be automatically adjusted
for inflation.
Ad valorem excise duties or
mixed excise duties can also be
combined with a minimum tax floor.
Minimum excise duties are similar
to specific excise duties and are a
fixed monetary amount per quantity
or volume that ensures a minimum
tax floor. The effects of a minimum
tax floor are similar to specific duties;;
however they tend to apply only to
lower- and medium-priced brands.
Premium brands will remain taxed
at the ad valorem rate or mixed
rate, which ensures a higher tax
burden as compared to a purely
specific system and a disincentive for
quality improvements. Over the last
decade, 24 EU Member States have
introduced such a minimum tax floor.
In most cases they are a percentage
(in general between 95% and 105%)
of the taxes due on the weighted
average price or on the most popular
price category (unpublished data:
Internal Reports from EU Member
States to the EC). If these reference
prices change, the minimum tax floor
will be adjusted. As the ad valorem
duty will apply to these reference
prices, the minimum tax floor will at
least partly be adjusted for inflation.
IARC Handbooks of Cancer Prevention
26In conclusion, provided the minimum
tax floor is set at an appropriate level,
this structure will combine a high price
and tax level for lower- and medium-
priced brands with a relatively high
tax price ratio for premium brands.
Table 2.4 summarizes the
differences between structures of
excise duties and their impact.
Earmarking of tobacco tax
revenues
With the challenges governments of
low- and middle-income countries
face to finance their health systems,
and the additional problems the
recent financial crisis has imposed,
developing innovative means of
financing has become an essential
issue to address to ensure
sustainability and autonomy of health
care. Earmarking or dedicating
tobacco taxes for health programmes
is a promising efficient way of raising
resources internally.
Earmarked taxes are general or
special taxes committed to support, or
fully fund, pre-specified expenditure
items (Gwilliam and Shalizi, 1996).
Earmarking can be weak (purely
a formal undertaking to make the
system more transparent and to inform
the taxpayer of the cost of a service)
or strong (revenue determines
expenditure), wide (covering a whole
spending programme) or narrow
(specific project within a programme)
(Wilkinson, 1994).
Countries around the world
earmark part or all of their tobacco
taxes to a specific programme
or activities (e.g. Ecuador, Egypt,
Estonia, Finland, Korea and Thailand).
This is also the case for several
US states like Arizona, California,
Massachusetts and Oregon. More
than 20 countries specifically
use their tobacco taxes for health
programmes, mainly for tobacco
control or health promotion. Chapter 9 provides an overview of studies of
the effectiveness of earmarking on
tobacco use and health improvement.
Recently, the Taskforce on
Innovative International Financing for
Health Systems—established from
2008 to 2009 and chaired by United
Kingdom Prime Minister and World
Bank President—recommended
exploring the technical viability of
solidarity levies on tobacco. Assuming
that a broad range of countries would
participate in the increase of tobacco
taxes, the revenues generated
would be substantial (Taskforce on
Innovative International Financing
for Health Systems, 2009). This
demonstrates the increasing political
support for such type of financing and
the importance of tobacco taxation,
particularly for countries with limited
resources. The benefit of such
practices will be double: reducing
consumption and funding health
systems, both leading to improved
public health.
Conclusions
Worldwide different types of taxes
apply to tobacco products, with
different tax levels (rates) contributing
to significant price differentials.
Historically, revenue generation has
been the primary aim of tobacco
taxation. However, more and more the
retention and the increase of excise
duties on tobacco products aims to
improve public health by reducing
tobacco consumption and the external
cost of smoking. Nonetheless,
when determining taxation policy,
governments will take into account
other, at times competing, political,
social or economic considerations.
These considerations are often
reflected in the applicable tax
structure and rates.
Moreover, the tax levels are
in general directly related to the
income levels, with high-income countries having high taxes and vice
versa. Simultaneously, high-income
countries tend to favour specific
excise tax structures, while low- and
middle-income countries rely more
on ad valorem excise taxes.
Given the structure of tobacco
market globally, specific excise taxes
generally result in higher tobacco
product prices. In these markets,
specific excises can increase
tobacco companies’ pricing power,
raise profits and increase market
concentration.
Some countries have designed
more complex taxation structures in
an attempt to find a balance between
budgetary, health and competition
objectives.
About 75% of the world’s tobacco
product market is accounted for
by cigarettes. However, in some
countries tobacco products other
than cigarettes have an important,
sometimes significant, market share.
Tax levels are often much lower
on these products as compared
to cigarettes. Differential rates are
applied on different tobacco products
and even sometimes within the same
product category, resulting in price
gaps and opportunities for product
substitution to lower-taxed products.
Applying a similar tax level would
reduce the incentive for substitution
and increase the effectiveness of
taxation policy in reducing tobacco
use.
Given their important revenue-
generating potential, in some
countries, parts or all of tobacco tax
revenues have been used to fund
health or tobacco control activities.
This practice can be adopted in
low-resource countries as a way to
strengthen existing health systems,
as proposed by the Taskforce on
Innovative International Financing for
Health Systems (2009).
27Overview of tobacco taxationTable 2.4. Comparison of structures for excise duties
Effect on prices Specific excise Ad valorem MixedAd valorem with a specific
minimum floor Mixed with a specific
minimum floor
Tax/price structure
Impact on prices Tends to entail relatively
higher prices
Tax increases may lead to
“over shifting” or upwards
product substitutabilityRelatively lower prices
compared to specific
Tax increases may entail
down trading or price
reductions (“under shifting”)The effect will depend on
which element ( ad valorem or
specific) prevailsThe minimum tax functions as a specific duty and ensures
a relatively higher price level for low- (and medium-) priced
products
Inflation Real value will be eroded by
inflation, unless adjusted in
line with inflationThe real value will be
preserved as prices increase
to the extent that tobacco
prices follow inflationReal value of the specific
element will be eroded by
inflationReal value of the minimum
floor will be eroded by
inflationReal value of the specific tax
and the minimum floor will be
eroded by inflation
The minimum floor may be (partly) adjusted for inflation if it is
a percentage of the excise due on WAP or of a premium price
category subject to ad valorem taxation (e.g. the MPPC in
most EU Member States).
Consumers:
quality and varietySpecific excise Ad valorem MixedAd valorem with a specific
minimum floor Mixed with a specific
minimum floor
Impact on product quality and
variety Upgrading effects tend to
reduce the relative tax on
high quality products, which
provide an incentive for
higher quality and greater
variety of productsThe multiplier effect provides
a disincentive to costly quality
improvementsThe effect will depend on
which element ( ad valorem or
specific) prevailsThe multiplier effect of the ad
valorem element provides a
disincentive to costly quality
improvementsThe multiplier effect of the ad
valorem element provides a
disincentive to costly quality
improvements
Revenue Specific excise Ad valorem MixedAd valorem with a specific
minimum floorMixed with a specific
minimum floor
Budgetary stability/ ability to
forecast More stable as compared to
ad valorem . Easy to forecastVulnerable to changes in
consumers and producers’
behaviour Difficult to forecastMore specific or a minimum tax floor will entail more budgetary stability
The real value of taxes and
pricesThe excise needs to be
periodically adjusted for
inflationThe excise may have to be
periodically adjusted for down
trading or price reductionsThe excise may have to be
periodically adjusted for
inflation, down trading or
price reductionsThe excise may have
to be periodically adjusted
for inflation, down trading or
price reductionsThe excise may have to be
periodically adjusted for
inflation, for down trading or
price reductions
IARC Handbooks of Cancer Prevention
28
Revenue Specific excise Ad valorem MixedAd valorem with a specific
minimum floorMixed with a specific
minimum floor
The more the structure relies on specific or minimum duties the less vulnerable it becomes for
down trading or price reductions;; but the more the tax can be eroded by inflation
Reduction of tax induced
cross-border operations
(private imports and illicit
trade)With the same tax level at WAP, a situation of purely specific
taxation in one country/jurisdiction and purely ad valorem
taxation in a neighbouring country could result in cross-
border flow for premium brands from one country to a second
country, with cheap brands flowing in the opposite directionMixed tax structures and tax structures including a minimum floor are less vulnerable to cross-
border flow induced by the tax structure
Administrative requirements Low as compared to other indirect taxes (e.g. VAT, sales tax).
No price monitoring required
for tax purposes;; only the
volume or weight has to be
ascertainedRequires price monitoring Requires price monitoring Requires price monitoring Requires price monitoring
Manufacturers Specific excise Ad valorem MixedAd valorem with a specific
minimum floorMixed with a specific
minimum floor
Impact of taxes on the profits
of the tobacco producersWill entail a higher tax/price
ratio for cheaper market
segments and higher profits
for the manufacturerWill entail a higher absolute
amount of tax for premium
market segments, because
any increase in the producer
price will be taxedThe gap between tax/price
ratio for the cheaper and the
premium market segments
will be smaller as compared
to a purely specific systemThe minimum may ensure a
high absolute amount of tax
and consequently a high tax/
price ratio for cheaper market
segments.
The ad valorem ensures the
desired tax/price ratio for
premium market segments
(equal to the ad valorem rate)The minimum floor ensures
a high tax/price ratio for
cheaper market segments.
The ad valorem element will
apply to premium market
segments
Market shares – Protection of
domestic producersTends to favour premium
brandsMay protect the cheaper
domestic brands against
more expensive international
brandsMore specific or a minimum tax floor tend to favour more expensive brands
WAP: Weighted Average Price;; MPPC: Most Popular Price CategoryTable 2.4. Comparison of structures for excise duties
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