What Are Sin Taxes?
A ‘sin tax’ is a tax imposed on those categories of goods and services which are perceived to cause harm within the society, such as alcohol or tobacco. These are also referred to as ‘public health taxes’ as the consumption of these goods is dangerous to health (Miracolo et al. 2021, p. 790). The primary reason behind the imposition of such taxes is to help reduce the intake of harmful substances or goods by impacting the price elasticity of demand. While being impactful in helping reduce the consumption of the harmful products through an impact on the price elasticity of demand, they also help raise the revenue of the government and help ensure population health can be maintained within the State. Governments throughout the world take various measures to impact the Consumption Of Harmful Substances by the general public. For example, in 2020, Ireland imposed a ban on displaying alcohol in shops which were based on the model of the ban on retail tobacco display (Epicenter Network 2021). The ban was intended for supermarkets and other forms of mixed retail shops, so that consumption of alcohol could be discouraged for buyers. Such bans are intended in the public interest and are often accompanied by a rise in taxes or an imposition of a sin tax. Sin taxes are levied to reduce the incidences of chronic, life-threatening diseases, such as lung cancer, cardiovascular issues, etc.
In Ireland, sin taxes are imposed on tobacco products, such as cigarettes, pipe tobacco, cigars, etc. These are imposed in the form of duties and excises and have an impact on the consumption of the product, price elasticity of its demand, revenue generation, and health improvement. This makes tobacco products an efficient example of sin taxes and their various impacts on health economics. The current essay will evaluate the price elasticity of demand for cigarettes due to the imposition of sin taxes.
The price elasticity of demand aids in the measurement of the change within the consumption of a product due to changes in the price structure of the product. The Irish Tobacco Products Tax is levied on a number of tobacco-based products, namely, fine-cut tobacco, cigarettes, cigars, and other smoking tobacco (Revenue 2021). Irish duties are paid on the import of such products in the form of Irish Tobacco Products Tax, VAT, and customs duty in applicable cases (Revenue 2021). These are based on the model of differential rates of taxations because when such tax rates are applied to health-damaging products, health is promoted and consumption of the health-damaging product is deterred (Dixon and Maynard 2002, p. 14). While sin taxes can impact the price elasticity of demand, a number of other factors also have to be taken into consideration. These are the level of consumer awareness of new prices, the degree of addiction to the product within the State, and the lack of awareness of the harm caused by tobacco-based products (Miracolo et al. 2021, p. 800). Individuals may not fully take into account their consumption decisions and the impact of the consumption of such products on their health, and such taxes can help generate correct behaviour (Griffith et al. 2017).
Sin Taxes in Ireland
The imposition of differentiated taxes on cigarettes has led to a decrease in the consumption of such products in Ireland, and research suggests that the consumption of Irish based cigarettes has halved over the last decade (Kennedy et al. 2015). In 2014, the average retail price of cigarettes was highest in the U.K., followed by Ireland (Yeh et al. 2017). In Ireland in 2003, over 6 billion cigarettes received clearance from tax warehouses, and this declined to 3.1 billion in 2014 (Kennedy et al. 2015, p. 6). This has been due to the continued rise of prices for tobacco-based products. This is reflected in figure 1. Reidy and Walsh (2011) have calculated the average price elasticity of demand for cigarettes in Ireland. This is done using multivariate analysis for the period ranging from 2002 to 2009. The statistically significant factors impacting the consumption of cigarettes are the income of the individual, the price of the cigarette, workplace smoking ban, point of sale advertising ban and E.U. enlargement (Reidy and Walsh 2011). As per the model of Reidy and Walsh’s (2011) research, price elasticity of -3.6 has been suggested. This implies that there has been a 3.6% decrease in the consumption of taxed cigarettes in relation to a 1.3% rise in the price of the product.
Figure 1 – Cigarette Clearances and Price Decomposition (Ireland) (Source – Kennedy et al. 2015)
Kennedy et al. (2015) utilized six econometric models to calculate the price elasticity of demand for cigarettes in Ireland as a result of a tax increase and also took into consideration various other factors, such as unemployment and GDP during the period. The price elasticity of taxed cigarette demand can vary from -1.6 to -2.0. An average elasticity of -1.8 has been suggested (Kennedy et al. 2015). This data suggests that an 18 per cent reduction in the consumption of taxed cigarettes can be expected with a 10% rise in taxes. Furthermore, an increase in the cigarette tax is also likely to lead to an overall decline in the Exchequer receipts in association with the product (Kennedy et al. 2015).
While the estimates provided by Reidy and Walsh’s (2011) study align with my expectations of the price elasticity of the demand for cigarettes as a result of sin taxes, the research undertaken by Kennedy et al. (2015) provides a more accurate prediction of the price elasticity as the research takes into consideration a wide range of factors that are likely to impact the demand and consumption of the product. Besides the availability of substitute products, the income of the individuals (GDP) and unemployment rates were also taken into consideration as factors by Kennedy et al. (2015), though these were found to not have a statistically important impact. The study further suggests that the smoking ban and E.U. enlargement are two of the most important factors that also effect demand along with tax increase (Kennedy et al. 2015). Furthermore, the data cannot accurately take into account the illicit market for a cigarette and the consumption resulting from smuggled cigarettes in Ireland (Kennedy et al. 2015, p. 9). It has been suggested as per data that one in ten cigarettes consumed in Ireland may have been acquired through such illegal means (Kennedy et al. 2015, p. 10). Other important factors, such as lagged consumption, have also been taken into account by the Kennedy et al. (2015) research. The co-relation between sin taxes and the price elasticity of demand was expected as per my estimates. This is because sin taxes act as a measure of ‘corrective taxes’. Such tax frameworks intend to maximize social welfare and public health (Griffith et al. 2018). As per the standard economic model, individuals tend to make economic choices to make the most of a time-consistent base utility (Griffith et al. 2018). In this regard, information about increased prices of the product is bound to have an impact on their purchasing decisions. The rational consumer is likely to take into consideration their budget constraints in relation to their consumption level of the product, and thus price elasticity of demand of the product would be inversely proportional to an increase in taxes on the product.
Impact of Sin Taxes on Price Elasticity of Demand
Price elasticity of demand is also impacted by the availability of substitute products in relation to the product that has experienced an increase in price. For cigarettes, the common substitutes tend to be other tobacco products such as cigars, roll your own tobacco, e-cigarettes, non-Irish taxed cigarettes and illicit cigarettes purchased through illegal means (Kennedy et al. 2015, p. 6). The Finance Act 2005 governs the imposition of excise duty on tobacco-based products. Tax rates are provided in schedule 2 of the Act. Only manufactured tobacco is subjected to such taxes, while unmanufactured tobacco is only subject to revenue control (Revenue 2021, p. 9). There are two mechanisms imposed for the calculation of the Tobacco Products Tax on cigarettes. One method consists of the calculation of a specific number of taxes per thousand cigarettes along with an ad-valorem element (the percentage of the retail sale price of the cigarette). The second method consists of minimum excise duty on cigarettes (Revenue 2021, p. 9). For other tobacco-based products, taxes are distributed on a per kg basis. Those products on which the duty has not been paid are produced and processed in a government-approved tax warehouse (Revenue 2021, p. 10).
Non-cigarette products composed of tobacco tend to be much cheaper as compared to cigarettes due to comparatively lower tobacco taxes on such products (Jawad et al. 2019). These products have an equally adverse impact on public health, and smokeless tobacco has resulted in approximately 260,000 deaths globally each year (Jawad et al. 2019). Positive substitutability to non-cigarette tobacco products implies that tax increases should be kept uniform across all types of tobacco products. Generally, low-income consumers tend to purchase the cheapest substitutes for cigarettes, even if this implies that the product may have been obtained through illegal means (Grew 2021). Close substitutions for a cigarette pack of 20 tend to be e-cigarettes and roll your own tobacco (Grew 2021). In comparison, cigars and nicotine gum are not close substitutes to cigarettes (Grew 2021). Roll your own tobacco tends to be cheaper and is one of the most common substitutes for cigarettes in Ireland as a result of the price increase of cigarettes (Cornelsen and Normand 2014). From the perspective of public health, there is no justification for taxing roll your own tobacco at a cheaper rate as it tends to cause equal damage to the consumer’s body (Cornelsen and Normand 2014). The relationship between the price changes of cigarettes and demand for roll your own tobacco has been shown in figure 2. However, periods of income growth in Ireland led to a decrease in the demand for the substitute product as individuals tended to switch back to cigarettes (Cornelsen and Normand 2014).
Figure 2 – Consumption of roll your own tobacco and cigarette prices (Source – (Cornelsen and Normand 2014)
As per Snider et al. (2017), regardless of the frequency of the use of e-cigarettes and market conditions, the choice to use e-cigarettes is most frequently as a substitute for the use of conventional cigarettes. Smokers who do not want to quit the activity of smoking as a result of price changes often tend to use e-cigarettes as a valuable substitute (Grew 2021). Higher cigarette prices have also been associated with a rise in e-cigarette sales and their consumption, though the sale of e-cigarettes is also negatively impacted by the rise of the price of e-cigarettes (Stoklosa et al. 2016). The scale of the illicit market for cigarettes also implies the extent to which cigarettes are consumed despite the price change. The extent of the illicit market can only be derived through the seizure data of the products (Kennedy et al. 2015, p. 9). Around 28.3% of the market comprised of non-Irish duty paid cigarettes in 2013 (Kennedy et al. 2015, p. 9). This data also comprises of sale of illicit cigarettes in Ireland. Overall, while the demand for taxed cigarettes has significantly decreased in Ireland over the past decade, the demand for substitute products, such as roll your own tobacco, has significantly risen as a result of the price changes (Kennedy et al. 2015, p. 22).
Price Elasticity of Demand for Irish Cigarettes
Sheridan et al.’s (2018) research indicate that the percentage of cigarette quitters in Ireland is much greater than smokers. However, 75% of the users of tobacco use conventional cigarettes, while 24% use roll your own tobacco, and 6% utilize e-cigarettes (Sheridan et al. 2015, p. 8). Ireland has been able to showcase a strong track record on tobacco control, and this also indicates a positive impact of tobacco control policies such as the application of higher taxes on tobacco products in Ireland (Malone and O’Connell 2020). Irish tax based cigarette consumption has declined from 3.5 billion in 2013 to 2.7 billion in 2019 (Malone and O’Connell 2020, p. 6). This evidence suggests that individuals have either switched to utilizing substitute products as a response to price changes or have quit smoking altogether. In Ireland, there is a clear substitute relationship between roll your own tobacco products and cigarettes (Kennedy et al. 2015, p. 8). The relationship also indicates that policymakers may overestimate the health impact of tax raises on cigarettes as individuals have shown a tendency to use the mechanism of product substitution when faced with the high prices of cigarettes (White and Ross 2015). In response to increasing cigarette taxes, smokers may use price avoidance strategies and reduce their tobacco consumption but may continue to smoke cigarettes as well. There has also been a tendency amongst smokers to switch the brand of the cigarette in response to price increases. Smokers may switch to brands that offer a higher level of nicotine or tar so that the levels of nicotine within their body can be maintained while they are able to consume a lesser amount of the concerned product (White and Ross 2015). Manufactured cigarettes have the highest consumption in Ireland as compared to hand-rolled cigarettes, pipes and cigars (Sheridan et al. 2018, p. 16). Another survey also indicates that a significant amount of Irish population is aware of electronic cigarettes (approximately 92%). However, only 42% of the population had tried e-cigarettes in Ireland, and only 6% of the population was using e-cigarettes as a substitute for conventional manufactured cigarettes (Sheridan et al. 2018, p. 17). Currently, smoking-related chronic diseases have been considered to be the highest among those individuals that were ex-smokers as compared to the other two groups of those individuals who have never smoked and those who are current smokers (Sheridan et al. 2018, p. 19). While smoking has a negative impact on the health of smokers, the trend has been for individuals to quit smoking due to their chronic diseases in comparison to resorting to quitting smoking due to price changes and tax increases (Sheridan et al. 2018, p. 20). In Ireland, the major factors that have been associated with individuals attempting to quit smoking have been having at least a third level education, being less than 35 years of age, having non-manual jobs such as higher managerial or professional jobs etc. (Sheridan et al. 2018, p. 26). This implies that the level of the education and awareness of the individual is an important factor for them to be impacted by the rising taxes on cigarettes and for them to make a decision to reduce their consumption of cigarettes.
Factors Impacting Price Elasticity of Demand
Tobacco taxes reduce the burden on the healthcare system and also help increase the overall productivity of the State (Miracolo et al. 2021). However, the government tends to hesitate in the imposition of such taxes due to the impact of such taxes on lower-income households as compared to households with a high income (Fuchs et al. 2019). Raising taxes on cigarettes has a net effect in the form of a direct negative shock to the budget of the household (Fuchs et al. 2019). However, there are also long term positive benefits in the sense of improved health of the individuals. Welfare losses occur to the State as the price shock tends to disproportionally impact the poor population. Sin taxes are considered to be indirect taxes and have been termed regressive, particularly in the case of taxes on tobacco-based products. Individuals with lower incomes are forced to spend a greater amount of their income on heavily taxed products such as cigarettes, and this leads to sin taxes having a regressive effect (Dixon and Maynard 2002, p. 14). The same distribution concerns may also arise for different types of enterprises. The payments of sin taxes are usually concerned with the purchase and consumption of the product and not with the overall income of the consumer or the profitability of the enterprise. This is one of the major distribution concerns of levying sin taxes on cigarettes. Individuals who may not be wealthy are bound to be more price-sensitive and disproportionately impacted by any increase in indirect taxes. In case the demand for the product remains inelastic whereas the supply is elastic, the tax increase is absorbed by the consumer. In case the supply is inelastic, the producer surplus would contribute to tax increase (Grew 2021). Producers may also choose to combat the tax increases by manipulating the product, such as by reducing the weight of an average packet or reducing the number of cigarettes in a single packet (Grew 2021). This would be passing on the taxes to the consumer indirectly. The primary focus of such taxes is to ensure consumer behaviour can be corrected through their imposition and the regressive effects of the taxes are stabilized by their positive impact on the health of the citizens and the level of the productivity provided by the average citizen. This helps offset the direct negative price shock (Fuchs et al. 2019). Therefore, the immediate short term impact is stabilized due to the medium and long term benefits of the imposition of taxes.
Conclusion
The significance of the sin tax for correcting consumer behaviour is notable, as evident by the example of taxes imposed in Ireland on cigarettes. While the taxes have helped reduce the consumption of cigarettes significantly throughout Ireland, consumers have mostly switched to roll your own cigarettes substitutes, which have an equally negative impact on consumers’ health. It can be concluded that while sin taxes can have a regressive effect and adversely impact lower-income households and their budgets, they have a beneficial long term impact as they aid towards a decrease in the consumption of the harmful product through the creation of negative price elasticity of demand for the product. Therefore, sin taxes are crucial from the perspective of health economics of the State.
References
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