Public Disclosure Authorized

POLICY NOTE

IS TOBACCO TAXATION REGRESSIVE?

Public Disclosure Authorized EVIDENCE ON PUBLIC HEALTH, DOMESTIC RESOURCE MOBILIZATION, AND EQUITY IMPROVEMENTS

Public Disclosure Authorized Alan Fuchs, Patricio V. Márquez, Sheila Dutta, Fernanda González Icaza Public Disclosure Authorized TOBACCO ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM POLICY NOTE

IS TOBACCO TAXATION REGRESSIVE? EVIDENCE ON PUBLIC HEALTH, DOMESTIC RESOURCE MOBILIZATION, AND EQUITY IMPROVEMENTS

Alan Fuchs, Patricio V. Márquez, Sheila Dutta, Fernanda González Icaza1

1 Fuchs: Poverty and Equity Global Practice, World Bank ([email protected]); Marquez: Health Nutrition and Population Global Practice, World Bank ([email protected]); Dutta: Health Nutrition and Population Global Practice, World Bank (sdutta@world- bank.org); González Icaza: Poverty and Equity Global Practice, World Bank ([email protected]). Support in the preparation of this policy note has been provided by the World Bank’s Global Tobacco Control Program, co-financed by the Bill and Melinda Gates Foundation and Bloomberg Philanthropies. The team wants to thank Enis Baris, Carlos Silva-Jauregui, Tim Evans, Olena Doroshenko, Irina Guban, Sevil Salakhutdinova, Alberto Gonima, Konstantin Krasovsky, Tatiana Andreeva Darko Paranos, Mikhail Matytsin, Cesar Cancho, Giselle del Carmen, Robert Zimmermann, and Daniela Paz for comments and contributions. The findings, interpretations, and conclusions in this policy note are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the countries they represent. This report was prepared over the March-April 2019 period and published on April 8, 2019, for distribution at the 4th Annual Health Financing Forum, organized by the World Bank Group, USAID and GFF in Washington D.C. on April 9-10, 2019.

I TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM CONTENTS

Abstract VII

1. Introduction 1 2. Health and Economic Impact of Tobacco Use 5 The Health Impacts of Tobacco Use 5 The Economic Burden of Tobacco 8 Policy Instruments for Tobacco Control 9 3. Taxing Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity 11 The Effectiveness of Taxes on Tobacco 11 Higher Tobacco Taxes Boost Government Revenues 12 Recent Country Experiences: Fiscal and Health Impact 13 Empirical Findings Contradict Traditional Arguments of Illicit , Employment and Regressive Effects 20 The Price Elasticity of Tobacco Consumption 23 The Extended Cost Benefit Analysis Methodology 24 Costs of Tobacco Taxes: Short-Term Direct Price Effect (A) 25 Benefits of Tobacco Taxes: Reduced Medical Costs (B) and Additional Years of Working Life (C) 25 4. Empirical Results: Lessons from Country Case Studies 29 Chile 29 Indonesia 30 Bosnia and Herzegovina 31 Ukraine 31 Russian Federation 32 Moldova 32 Bangladesh 33 South Africa 33 New Comparative Evidence 34

Limitations of the Empirical Findings 35 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

5. Key Takeaways 39 6. Conclusion 43 References 44 Annex 55 A. Model 55 Change in Tobacco Expenditures 55 Medical Expenditures 56 The Increase in Working Life Years 56 B. Tobacco Price Elasticity, by Decile 56

IV // Table of Contents LIST OF FIGURES

Figure 1. Philippine Sin Reform: Higher Tobacco (As % of GDP) and Budgetary Allocation for Public Health 13 Figure 2. Results of Tobacco Policy Reform in Ukraine, 2008-2018 14 Figure 3. Results/Projections of Tobacco Excise Policy Reform in Moldova, 2007-2025 15 Figure 4. Tax and Price Increases in Colombia, 2017-2018 16 Figure 5. Effect of Increasing Tobacco Prices, Extended Cost-Benefit Analysis 24 Figure 6. Benefits of Increasing Tobacco Taxes: Channels of Transmission 26 Figure 7. Comparative Net Income Effects of Increasing Tobacco Prices 35

LIST OF TABLES

Table 1. Countries With the Highest Number of Deaths from Smoking, and the Highest Prevalence of Daily Smokers, 2015 2 Table 2. Trends in Prices and Taxes on Tobacco Products, Selected Countries in Europe and Central Asia 18

LIST OF BOXES

Box 1. Policies and Institutional Measures to Confront Illicit Tobacco Trade 21

V TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM ABSTRACT

Tobacco taxes are recognized as an effective particularly the poor—can benefit from policy tool to reduce tobacco consumption positive income gains by reducing tobac- and improve health outcomes; however, co-related medical expenses and avoiding policy makers often hesitate to use them premature deaths. Moreover, there will be because of their possible regressive effects. additional fiscal revenues generated that This report assesses the ability of taxes can be used to further enhance measures on tobacco to improve future health and to control tobacco use and promote equity. welfare outcomes, with a focus on their dis- Additionally, the generally positive benefits tributional impact and effects on the poor. In and impact of raising taxes on tobacco can addition to adverse consequences on health be enhanced by a set of complementary and quality of life of smokers and their family policies to leverage consumers’ responses members, tobacco-related illnesses cost toward quitting tobacco, and to target com- billions of dollars in medical expenditures prehensive interventions to help the most and losses in human capital and produc- vulnerable groups. tivity, imposing heavy economic tolls on households and governments. Developing countries bear a high and increasing share of the economic burden of tobacco. However, traditional analyses often overlook the many economic benefits of reducing tobacco consumption. This report presents empirical findings using an extended cost benefit analysis (ECBA) methodology, to incorporate a more comprehensive view of the costs and benefits of increasing prices of tobacco on household welfare, and to assess their distributional impact by accounting for dif- ferent consumer behaviors across income groups. Evidence for several countries shows that large price shocks on cigarettes can generate progressive and welfare-improv- ing medium and long-term net impacts, that particularly improve welfare of lower-income households. Large shares of societies—and

VII TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM ‘Sugar, rum, and tobacco, are commodities which are nowhere necessaries of life, [but] which are ... objects of almost universal consumption, and which are therefore extremely proper subjects of taxation.”

Adam Smith, “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776)

“Cigarettes are among the most addictive substances of abuse and by far the most deadly.”

Thomas C. Shelling, 2005 Nobel Prize Laureate in Economics

“In significant ways, sellers play to our weaknesses. They are “phishing for phools.” “Humans think in terms of stories, and decisions are consequently determined by the stories we tell ourselves. Advertisers use this to their advantage by “graph[ing] their story” onto ours, and thereby influencing the decisions we make"—in this case, to get us addicted to tobacco use, particularly teenagers and low-income people.

George A. Akerlof and Robert J. Shiller, Nobel Price Laureates, 2001 and 2013, respectively “Phishing for Phools: The Economics of Manipulation and Deception” (2015)

IX TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM 1 INTRODUCTION

With the entering into force of the (GBD 2015 Tobacco Collaborators 2017). Most Framework Convention for Tobacco Control DALYs attributable to daily smoking were (FCTC) in 2005, the first negotiated global due to cardiovascular diseases (41 percent), public health treaty, significant progress cancers (28 percent), and chronic respiratory has been observed in controlling tobacco diseases (21 percent). As observed in the use. Worldwide, the age-standardized preva- GBD 2015 study, unless daily smoking is signifi- lence of daily smoking was estimated at 25.0 cantly reduced from current levels, the total percent among men and 5.4 percent among number of smokers will continue to rise and women in 2015, representing 28.4 percent place tremendous burden on health systems. and 34.4 percent reductions, respectively, Among tobacco control interventions, since 1990 (GBD 2015 Tobacco Collaborators substantial tax and price increases are 2017). Nonetheless, nearly 1 billion people the most cost-effective policy measures still smoke daily around the world. As shown (Marquez and Moreno-Dodson 2017; NCI and in Table 1, the countries with the most male WHO 2016; World Bank 1999). By increasing daily smokers in 2015 were China, India, and prices and reducing the affordability of Indonesia, while the countries with the most tobacco products, taxes encourage current female daily smokers were the United States, smokers to quit and discourage potential China and India. In 2015, 11.5 percent of consumers, particularly the youth, to initiate global deaths were attributable to smoking, smoking, while simultaneously reducing the of which 52.2 percent took place in four health risk of secondhand smoking. They also countries (China, India, the United States, contribute to raising government revenues. and Russia). Nonetheless, policy makers often hesitate In addition, daily smoking contributes to to increase taxes on tobacco because of a significant amount of the world’s overall claims of the potentially regressive impact health burden, measured using the dis- of taxes—it is often argued that since low-in- ability-adjusted life years (DALYs) metric, come smokers spend a greater share of their which combines years of healthy life lost income on tobacco, increases in cigarette due to illness with those lost due to pre- taxes will have a disproportionately larger mature death. Smoking was ranked among impact on poor consumers' income than of the five leading risk factors by disability rich consumers. adjusted life years in 109 countries and Reducing tobacco consumption is associ- territories in 2015, rising from 88 locations ated with several economic benefits that in 1990, and 11.5 percent of global deaths are often overlooked, in addition to better were attributable to smoking worldwide

1 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

Table 1. Countries With the Highest Number of Deaths from Smoking, and the Highest Prevalence of Daily Smokers, 2015

COUNTRIES WITH THE HIGHEST NUMBER OF DEATHS FROM SMOKING (ROUNDED):

China (1.8 million)

India (743,000)

US (472,000)

Russia (283,000)

Indonesia (180,000)

Japan (166,000)

Bangladesh (153,000)

Brazil (149,000)

Germany (130,000)

Pakistan (124,000)

COUNTRIES WITH THE HIGHEST PREVALENCE OF MALE DAILY SMOKERS:

Kiribati (48%)

Indonesia (47%)

Laos (47%)

Northern Mariana Islands (46%)

Armenia (43%)

Greenland (43%)

Belarus (42%)

Ukraine (41%)

Azerbaijan (40%)

Timor-Leste (40%)

COUNTRIES WITH THE HIGHEST PREVALENCE OF FEMALE DAILY SMOKERS:

Greenland (44%)

Bulgaria (28%)

Greece (27%)

Montenegro (26%)

Croatia (26%)

Northern Mariana Islands (25%)

Kiribati (25%)

Macedonia (23%)

Hungary (23%)

Austria (23%)

Source: GBD 2015 Tobacco Collaborators.

2 // Introduction health and longer lives for smokers and their budgets. Overall, empirical applications of family members (Lancet Editorial 2017 , NCI this more comprehensive view of costs and and WHO 2016). Among other economic benefits consistently find that the effects of benefits, households and governments raising taxes on tobacco are progressive and face lower medical bills associated with the welfare-increasing. treatment of tobacco-attributable diseases The report proceeds as follows. Section 2 and workers increase their productive life reviews the literature on the well-established due to an expanded healthy life expectancy, negative health effects of tobacco, their reflected in higher earnings. Accurately economic burden, and the most common assessing the burden of tobacco and the policy instruments to control tobacco benefits of taxing tobacco products requires consumption. Section 3 summarizes the accounting for the distribution of these bene- theoretical mechanisms that allow taxes fits across the population. on tobacco to reduce consumption and This report summarizes the rapidly potentially to induce progressive and growing evidence of the ability of taxes welfare-enhancing outcomes. Section 4 on tobacco to improve future health presents results on the distributional effects and welfare outcomes, with a focus on of increasing taxes on tobacco in a set of understanding the distributional impact countries at different income levels, using and equity implications of these taxes. an extended cost-benefit analysis (ECBA) Empirical studies in a variety of low- and methodology, as well as emerging new middle-income countries show that increas- comparative evidence. Section 5 concludes ing tobacco prices is unlikely to result in with a discussion on the main policy regressive outcomes. In contrast, accounting implications of the theoretical and empirical for different behavioral responses to knowledge on taxes on tobacco. the price shock can show progressive distributional effects because poorer households are more likely to cut back on the consumption of tobacco as prices rise. Moreover, other medium- and long-term benefits of reducing tobacco consumption are often overlooked. Accounting for these benefits—such as reduced medical bills associated with the treatment of tobacco-at- tributable diseases and additional years of productive life—can increase household welfare and offset the short-term negative price shock of raising taxes on household

3 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM 2 HEALTH AND ECONOMIC IMPACT OF TOBACCO USE

The Health Impacts of Smoking is the second-leading cause of Tobacco Use death globally (GBD 2015 Collaborators). Both active smoking and exposure to The scientific evidence accumulated over secondhand smoke cause disease and kill the past five decades is clear: tobacco prematurely (Marquez and Moreno-Dodson kills. Smokers who begin early in adult life 2017). More than 7 million people die from and do not stop smoking face a three-fold tobacco use every year, a figure that is higher risk of death compared to otherwise predicted to grow to more than 8 million a similar non-smokers, resulting in a loss, year by 2030, in the absence of intensified on average, of at least one decade of life global action (WHO 2017). Annually, the (Jha and Peto 2014). The landmark Surgeon number of deaths from tobacco-attributable General’s Report on Smoking and Health, diseases exceeds the deaths from HIV/AIDS, issued in 1964 by the U.S. Surgeon General tuberculosis, and malaria combined (WHO Dr. Luther Terry, first drew wide public atten- 2008). Most of these deaths are due to direct tion to the evidence linking smoking and tobacco use, while close to 10 percent of ill health, including lung cancer and heart deaths are the result of non-smokers’ expo- disease. Since then, a vast, rigorous body of sure to secondhand smoke. Smoking also evidence has accumulated, showing that leaves chemical residue on surfaces where tobacco use imposes an unparalleled health smoking has occurred, which can persist and economic burden across countries, long after the smoke itself has cleared from hindering human capital development the environment. This phenomenon, known and economic gains worldwide (Marquez as "thirdhand smoke," is increasingly recog- and Moreno-Dodson 2017; NCI and WHO nized as a potential danger, especially to 2016; U.S. Department of Health, Education children, who not only inhale fumes released and Welfare 1964). The uptake of cigarette by these residues but also ingest residues that consumption has been influenced by get on their hands after crawling on floors or advertising and promotional expenses of touching walls and furniture (Martins-Green, tobacco companies (in 2016, for example, Adhami, Frankos et al. 2014). tobacco companies spent US$9.5 billion in marketing cigarettes and smokeless tobacco Tobacco consumption is causally linked to in the United States alone) (Federal Trade diseases of nearly all organs of the body Commission 2016). (U.S. Department of Health and Human Services 2014). The evidence is enough

5 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

to conclude that the risk of developing congenital malformations (e.g., cleft lips or lung cancer from cigarette smoking has palates); and (4) during fetal development increased since the 1950s, due to changes and adolescence has lasting adverse in the design and composition of cigarettes. consequences for brain development. Most There is also evidence for a causal relation- smokers use tobacco regularly because they ship between smoking and other types of are addicted to nicotine (addiction is charac- cancer, including liver, colorectal, and pros- terized by compulsive drug-seeking and use, tate cancers. Smoking or chewing tobacco even in the face of negative health conse- can immediately raise blood pressure, albeit quences) (Balfour 2015; Picciotto and Mineur temporarily, as the chemicals in tobacco can 2014). Research has shown that the majority damage the lining of artery walls, causing of smokers would like to stop smoking, and arteries to narrow, and increasing blood pres- each year about half try to quit permanently, sure (Marquez 2018). Secondhand smoke can but, only about 6 percent of smokers are able increase blood pressure, as well. Smoking to quit in a given year (Centers for Disease is the dominant cause of chronic obstruc- Control and Prevention (CDC) 2011). Although tive pulmonary disease (COPD), including nicotine itself does not cause cancer, at emphysema and chronic bronchitis. Smok- least 69 chemicals in tobacco smoke are ing also increases the risk of tuberculosis. carcinogenic (U.S. Department of Health and Research continues to identify diseases Human Services 2014). Evidence also shows caused or exacerbated by smoking, includ- that tar, the resinous, partially combusted ing common diseases as diabetes. Scien- particulate matter produced by the burning tists now know that the risk of developing of tobacco, is toxic and damages the smok- diabetes is 30–40 percent higher for active er’s lungs over time. Carbon monoxide, a smokers than nonsmokers. It is estimated colorless, odorless gas produced from the that for every person who dies as a result incomplete burning of tobacco, accumulates of smoking, at least 30 people live with a indoors and reduces the oxygen-carrying serious smoking-related illness (U.S. Depart- capacity of the blood. ment of Health and Human Services 2014). E-cigarettes pose similar threats to public Chemicals in tobacco have harmful health health. In recent years, the issue of whether impacts. Accumulated evidence shows that e-cigarettes and other smoke-free nicotine nicotine (a chemical in tobacco): (1) is a highly delivery systems should be classified as addictive stimulant that at high levels pro- tobacco products—and hence be regulated duces acute toxicity; (2) activates multiple in the same way as cigarettes—has biological pathways through which smoking acquired great importance (Marquez 2017). increases risk for disease; (3) adversely affects The production and marketing of these maternal and fetal health during pregnancy, products is at the core of new diversified contributing to adverse outcomes such as business plans of tobacco companies preterm delivery and stillbirth, as well as alongside the production and marketing of

6 // Health and Economic Impact of Tobacco Use cigarettes. E-cigarettes, a battery-powder Low- and middle-income countries (LMICs) device that heats a liquid containing nicotine face an increasing burden of noncommu- into a vapor that is inhaled like a cigarette, is nicable diseases (NCDs), which are now being touted as a harm-reducing technolog- the leading cause of death in the world, ical innovation to protect smokers from the killing 40 million people each year and ill-effects of cigarettes. However, a compre- representing 70 percent of all annual deaths hensive review of available evidence done (WHO 2018). Eighty percent of deaths due by U.S. Surgeon General (2016) concluded to tobacco-related NCDs—cancer, cardio- that tobacco use among youth and young vascular disease, chronic lung disease, and adults in any form, including e-cigarettes, is diabetes— occur in LMICs, straining health not safe. This report further indicated that in care systems, contributing to poverty, and recent years, e-cigarette use by youth and posing a major barrier to development. young adults has increased at an alarming An estimated 40 percent of the global eco- rate, becoming the most commonly used nomic costs of tobacco use are already borne tobacco product among youth in the United by these countries, and there is a risk that the States. The report also warned that since costs will escalate if effective and sustained e-cigarettes are tobacco products that tobacco control action is not supported over deliver nicotine, they may pose the risk that the short and medium term. many of today’s youth who are using e-cig- Global trends in smoking-prevalence arettes could become tomorrow’s cigarette reduction also mask important differences smokers to continue to feed their nicotine within countries, such as rising smoking rates addiction; using nicotine in adolescence also among youth and women in some urban can increase risk of future addiction to other areas of Latin America and Eastern Europe, drugs. The regulatory response to e-cigarettes or the marked change in South Asia from in the United States and the European Union consuming local bidis (small, hand-rolled, (EU) is clear in signaling the potential health generally untaxed cigarettes) to consuming risks of e-cigarettes.2 cigarettes (Mishra et al. 2016). This poses a Developing countries and vulnerable major challenge for developing countries groups face health risks associated with with sizable younger populations vulnerable tobacco use, and with e-cigarettes. to tobacco advertisement and marketing, and where smoking is on the rise, or that lack the resource base, health systems, or social 2 E-cigarettes, like other cigarette products, now fall under the regulatory jurisdiction of the U.S. Food and Drug Administra- safety nets to protect populations from tion (FDA). This is in accordance with the U.S. Surgeon General the negative health, social, and economic Report recommendations that comprehensive tobacco control and prevention strategies for youth and young adults should consequences of tobacco-related chronic address all tobacco products, including e-cigarettes. In May 2017, the EU's Court of Justice cleared new legislation that also places e-cigarettes under similar regulatory pressures as traditional cigarettes, including a broad ban on advertising and other promotional activity.

7 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

diseases (Marquez and Farrington 2013).3 In where more than 80 percent of smokers live high-income countries, smoking rates are also (Jha, Marquez, and Dutta 2017). substantially higher among some of the most vulnerable people in society. In the United The Economic Burden of Tobacco States, for example, the 25 percent of the pop- Smoking-related illness costs billions ulation with mental disorders, including sub- of dollars each year, imposing a heavy stance use disorders, account for 40 percent economic toll on households and govern- of the cigarettes smoked (Substance Abuse ments, both in terms of direct medical care and Mental Health Services Administration costs and productivity losses (NCI and WHO 2013), while over 40 percent of people with 2016). Calculations by Lightwood et al. (2000) low educational attainment (i.e., with only a indicate that the health cost of tobacco General Education Development certificate use in high-income countries is between 0.1 [GED]) smoke, the highest prevalence of any percent and 1.0 percent of gross domestic socioeconomic group (Jamal, Homa, O'Con- product (GDP). In the United States, for exam- nor et al. 2015). Additionally, people who live ple, smoking-related illness costs more than in rural areas use all forms of tobacco at higher US$300 billion each year, including nearly rates than people who live in urban areas US$170 billion for direct medical care for (Roberts, Doogan, Kurti et al. 2016). adults, as well as more than US$156 billion in While the hazards of smoking accumulate lost productivity, which includes US$5.6 bil- slowly, cessation is effective, helping to lion in lost productivity due to secondhand reduce tobacco-related mortality and smoke exposure (U.S. Department of Health inequality of mortality. People who quit and Human Services 2014; Xu et al. 2015). by age 40 get back nearly the full decade In high-income countries, smok­ing-related of life they would have lost from continued care already places a signif­icant burden on smoking (Jha and Peto 2014). Cessation is health care systems. As shown by the expe- now common among adults in high-income rience in the United States, it accounts for countries. For example, in Canada, there are an estimated 8.7 percent of annual health now over one million more ex-smokers than care spending (more than 60 percent of this only a decade ago. However, largely because spending is covered by public programs of the advertising, marketing and pricing such as Medicare and Medicaid) (Xu et al. strategies of the tobacco industry, including 2015). Worldwide, recent estimates suggest the use of social media to promote e-ciga- that the global burden of tobacco-related rettes among the youth, cessation remains a diseases accounts for US$422 billion in health major public health challenge in most LMICs, care expenditures annually, representing almost 6 percent of total global spending on health. The total economic cost of smok-

3 For a discussion on the economics of deception and manip- ing—including health care expenditures ulation, see the work of Nobel Laureates in Economics George and productivity losses—is estimated at Akerlof and Robert Schiller (2015).

8 // Health and Economic Impact of Tobacco Use more than US$1.4 trillion per year, equiv- promotion, and sponsorship; protecting alent to 1.8 percent of the world’s annual people from secondhand smoke; warning GDP (Goodchild, Nargis, and Tursan d’Es- everyone about the dangers of tobacco; paignet 2018). offering help to people who want to quit; and carefully monitoring the epidemic and Developing countries bear a high and prevention policies (WHO 2008). Recent increasing share of the economic burden of studies, as noted before, show that the smoking. The highest share of the estimated accelerated implementation of all key FCTC total economic costs of smoking occurs in demand-reduction measures since 2005 high-income countries (US$1.12 trillion in has been significantly associated with a PPP dollars), where the tobacco epidemic is decrease in smoking prevalence worldwide most advanced. However, nearly 40 percent (GBD 2015 Tobacco Collaborators 2017; of the health and productivity costs related Gravely et al. 2017). to tobacco use are already concentrated in developing countries (Goodchild, Nargis, However, despite the progress observed and Tursan d’Espaignet 2018). Those shares in many countries, much more needs to are expected to increase along with the be done to reduce the human, social and demographic and epidemiological transition economic toll of tobacco use. A scaled occurring in these countries. up and stronger tobacco control effort is needed to achieve the WHO-recommended Policy Instruments for target of at least a 30 percent reduction in Tobacco Control smoking prevalence by 2025, which would Since 2005, 181 countries have become avoid at least 200 million deaths among parties to the FCTC. The FCTC now covers current and future smokers by the end of nearly 90 percent of the world’s population. the 21st century (WHO 2013). A reduction Over the past decade, progress has been in smoking prevalence of this magnitude is made in expanding the coverage of the also critical to reaching the health and social FCTC’s supply- and demand-reduction targets of the United Nations Sustainable tobacco control measures (WHO 2015). More Development Goals (SDGs) by 2030 (United than half the world’s countries, accounting Nations 2015). for 40 percent of the total global population, have implemented at least one tobacco control policy measure supported under the MPOWER technical assistance package of the World Health Organization (WHO). MPOWER includes the six most important and effective tobacco control policies: raising taxes and prices; banning advertising,

9 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM 3 TAXING TOBACCO: A POLICY MEASURE TO IMPROVE HEALTH, DOMESTIC RESOURCE MOBILIZATION, AND EQUITY

needed also to reduce the number of former "As the success in rich countries shows, smokers who return to cigarettes. However, there is no mystery about how to get as discussed below, the ultimate changes in people to stop smoking: a combination tobacco use depend on both the price shock of taxes and public-health education and the behavioral responses of consumers does the job. This makes the abysmal facing higher retail prices for tobacco. record in poor countries a grave failure of Taxes work by increasing prices and reduc- public policy. The good news is that, fol- ing the affordability of tobacco products lowing recent research, it is one that has (Gruber 2008; Sunley 2009). Higher tobacco just become easier to put right." taxes help boost cigarette prices, which The Economist (2017). are highly effective in reducing demand. Currently, in high-and middle-income coun- tries, taxes average about two-thirds or more of the average retail price of a pack of ciga- The Effectiveness of Taxes rettes, while in low-income countries, they on Tobacco amount to not more than half the average Tobacco taxes are recognized as an effec- retail price of a pack of cigarettes (WHO tive policy tool to reduce tobacco use. As 2015, 2017). Evidence of cigarette taxes such, the prime objective of tobacco taxes translating to increased consumer prices is is to improve health outcomes (World Bank available globally (WHO 2015, 2017). However, 1999; Petit and Nagy 2016; Marquez and tobacco taxes only reduce tobacco consump- Moreno-Dodson 2017). To achieve this aim, tion if they reduce cigarette affordability. In aggressive increases in tobacco taxes are most LMICs, wages are rising. Thus, cigarettes required to influence cigarette smokers to will become de facto more affordable for stop or sharply cut back their tobacco con- consumers, increasing consumption, unless sumption and to persuade young people tobacco taxes rise even faster. Effective strat- not to initiate this addictive habit. This is

11 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

egies will generally involve combining big health gains and indirect benefits such initial tax increases with recurrent hikes over as reduced health care expenditures time, to keep cigarette prices climbing more and higher productivity (Furman 2016). steeply than per capita real income growth Increasing tobacco taxes can also enlarge (including inflation). In some countries, a country’s tax base to augment domestic such as the United Kingdom, governments resource mobilization (Marquez 2016a, have adopted a “tobacco tax escalator” that 2016b, 2016c). This can expand the fiscal automatically increases tobacco taxes by a space for priority investments and programs, certain percentage above the inflation rate including the expansion of universal health (HM Revenue and 2018). Going coverage, education for all, and other activi- too slowly or timidly on tax increases or ties to help countries achieve the SDGs. allowing affordability to increase should be The United Nations has recognized that recognized as condemning large numbers of tax and price measures on tobacco are an people to tobacco addiction and the risk of effective means to reduce tobacco use, ill health and premature death (Marquez and as well as related illnesses and premature Moreno-Dodson 2017). death and escalating health care costs. Beginning with its landmark report “Curbing These measures can also represent a the Epidemic” (1999), the World Bank Group revenue stream to finance development has advised policy makers who seek to reduce in many countries. This double impact of smoking to use as a yardstick tax levels that tobacco taxes was acknowledged in the amount to two-thirds and four-fifths of Financing for Development Action Agenda, the retail price of a pack of 20-cigarettes, approved by country leaders at the Third as adopted as part of the comprehensive International Conference on Financing for tobacco control policies of countries where Development in Addis Ababa (UN 2015), and cigarette consumption has fallen. Similarly, subsequently endorsed by the United Nations the WHO recommends countries to adopt at General Assembly as part of the strategies to least 70 percent excise tax share in final con- achieve the SDGs, in September 2015. Today, sumer price of a pack of 20-cigarettes, and policy practitioners concur that domestic a 75 percent total tax burden (including resource mobilization in LMICs’ will be the excise taxes, VAT, and other duties) on the primary financing engine for the next wave retail price of a pack of 20-cigarettes (WHO of development, and they point to tobacco 2015, 2017). taxation as a potentially important contribu- tor (Junquera-Varela et al. 2017).

Higher Tobacco Taxes Boost Since 2013, multisectoral teams supported Government Revenues under the World Bank’s Global Tobacco The positive impacts of higher tobacco Control Program have assisted national taxes and prices go beyond direct governments in adopting tobacco tax

12 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity Figure 1. Philippine Reform: Higher Tobacco Tax Revenue (As % of GDP) and Budgetary Allocation for Public Health

1.2% 1.1% 200.00 1.1% 1.2% 1.0% 1.0% 142.98 150.00 122.63 0.7% 0.7% 0.6% 0.6% 0.6% 86.97 100.00 0.5% 83.72 0.7% 53.23 50.00 31.83 42.16 11.40 18.91 23.67 24.65 0.00 0.2% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Department of Health Budget (In B PhP) Source: Paul, J. 2018. reforms, often as part of fiscal consolida- reconfiguration of the tobacco tax struc- tion programs, and working with other ture can be good for both fiscal revenues international partners. This has occurred in and public health. As shown in Figure 1, countries across the income spectrum, such excise tax revenue on tobacco and alcohol as Armenia, Azerbaijan, Belarus, Botswana, products has more than doubled since 2012, Colombia, El Salvador, Gabon, Georgia, Ghana, reaching US$5.2 billion in additional revenues Indonesia, Kazakhstan, Lesotho, Moldova, during the first 4 years of the Sin Mongolia, Montenegro, Nigeria, Peru, the implementation (about 1 percent of GDP). Philippines, Senegal, Sierra Leone, Tonga, Tobacco accounts for about 80 percent of Tuvalu, Ukraine, Vietnam, and Uzbekistan, these additional tax revenues. The expanded covering approximately 934 million people. fiscal space created by the Sin increased the Department of Health budget Recent Country Experiences: threefold. The number of households whose Fiscal and Health Impact health insurance premiums were paid by the The experience of the Philippines since national government rose from 5.2 million pri- the adoption of the Sin Tax Law of 2012 mary members in 2012 to 15.2 million in 2017. is one of the most compelling examples Smoking prevalence among current daily of ambitious national tobacco tax reform tobacco smokers also decreased signifi- (Kaiser, Bredenkamp, and Iglesias 2016). cantly over the 2009-2015 period, from The Philippines’ bold effort—supported by 22.5 percent to 18.7 percent (GATS 2009 and the World Bank, the WHO, and other inter- 2015). The Philippines’ success confirms that national partners—involved a fundamental tobacco taxation may be a low-hanging restructuring of the country’s tobacco excise fruit for governments that want to increase tax structure, including reduction in the domestic resources to attain the SDGs. number of tax tiers, indexation of tax rates to inflation, and substantial tax increases to The experiences of Ukraine and Moldova multiply public health impact. Such a bold are also noteworthy. Continuing the

13 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

Figure 2. Results of Tobacco Excise Policy Reform in Ukraine, 2008-2018

50 140 125 45 43.6 112 39.9 120 40 33.2 35 95 100 88 30 82 75 73 74 76 80 67 25 22.2 56 60 20 18.1 16.6 17.9 15.3 15.5 15 13.1 12 40 9.1 8.62 10 8.78.6 8.35 8.1 7.7 6.5 10.1 6.7 20 5 3.6 9.2 2.74 3.48 4.04 1.62 6.08 6.9 0.58 4.76 4.96 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Tobacco excise revenue, bln UAH Average excise per 20 cigarettes pack, UAH Number of daily smokers, mln Cigarette sales, bln sticks (RHS)

Source: World Bank Group staff based on national data collected by Konstantin Krasovsky and Tatiana Andreeva, 2019.

tobacco tax increase pathway adopted tobacco as a percentage of retail price) will since 2016 with support of the World Bank increase from 62 percent in 2015 to 77 per- Group Global Tobacco Control Program, cent in 2019. Figure 2 shows how national the Ukrainian Parliament approved a new tobacco excise revenue in Ukraine increased increase as part of the 2019 budget: from from 22 billion UAH in 2015 (1.12% of GDP) to January 1, 2019, all specific excise rates were 40 billion UAH (1.34% of GDP). increased by 20 percent, and an additional 9 Tax increases are helping to reduce percent excise increase will be effective July tobacco consumption, generating public 1, 2019.4 Building upon tobacco tax increases health benefits in Ukraine. Results from in previous years, the average excise tax the Ukraine Global Adult Tobacco Survey burden (excise tax as a percentage of retail (GATS) show that daily smoking prevalence price) after the 2019 increase will rise from has dropped by nearly 20 percent during the 45 percent in 2015 to 60 percent in 2019. last seven years, from 25% in 2010 to 20% The total tax burden (including excise taxes, in 2017 (GATS Ukraine 2017). This is largely value-added tax [VAT], and other duties on due to a reduction in smoking among men, with no significant reductions observed 4 The increases adopted in 2016 included a 40 percent specific excise tax increase on tobacco products over the 2015 level and in the share of women who smoke (GATS the increase of effective ad valorem excise rate from 10 to 12 Ukraine, 2017). Additional World Bank percent. In 2017 and 2018, the specific excise rates were further increased by 40 percent and 29.8 percent, respectively. In 2015, Group-supported microsimulation model- Ukraine introduced an additional 5 percent ad valorem excise tax paid to local budgets. ling in Ukraine estimated the public-health

14 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity Figure 3. Results/Projections of Tobacco Excise Policy Reform in Moldova, 2007-2025 A

9,000.0 € 100 ER € 91.25 8,000.0 € 90 7,000.0 6,808.0 8,008.6 € 80 5,726.9 € 73.08 € 70 6,000.0 5,550.5 5,064.0 € 60 4,890.1 4,752.7 4,819.7 5,000.0 4,520.8 € 58.57 4,112.0 € 50 4,064.2 3,917.5 4,000.0 4,312.5 3,690.7 3,311.5 € 47.00 € 40 3,000.0 2,866.0 2,449.8 € 39.05 € 30 2,051.0 € 31.23 2,170.0 2,000.0 € 27.21 1,737.8 € 20 € 22.54 1,117.6 1,392.7 € 17.73 696.8 899.0 1,000.0 483.8 586.1 € 10

T 369.5 - € - 2017 2018 2019 2020 2021 2022 2023 2024 2025

Total cigarettes taxed (million pieces) [1] Total cigarettes excise tax revenue (million MDL) [2] Average cigarette excise tax (MDL per 1000 pieces) Average cigarette excise tax (EUR per 1000 pieces)

Source: World Bank Group staff estimates; excise tax revenue and total cigarettes taxed data from MoF & Customs, 2018.

impacts of tobacco taxation measures, sure (Marquez and Guban 2018; Marquez along with other tobacco control policies. et al 2018). The government has increased The health impacts were modeled for 2025 tobacco taxes every year since 2016, with the and 2035, including coronary heart disease goal of achieving the European Union (EU) (CHD), stroke, chronic obstructive pulmonary tobacco tax directive minimum rate of 90 disease (COPD), and lung cancer. Relative EUR/1,000 cigarettes by early next decade, to a status quo scenario with no change in per its Associate Agreement with the EU. tobacco taxes, the model estimated that, by This has translated into public health gains 2035, Ukraine’s tobacco tax hike will avoid: for the country, with a reduction in the 126,730 new cases of smoking-related disease; volume of cigarettes sales taxed (used as a 29,172 premature deaths; and 267,098 poten- proxy for consumption) by about 10 percent, tial years of life lost. Reductions in disease and to 5.55 billion pieces in 2017 compared to death will save UAH 1.5 billion (about US$ 6.19 billion pieces in 2016. While reducing 57 million) in healthcare costs and UAH 16.5 tobacco use, and the related risk of develop- billion (about US$ 631 million) in premature ing tobacco-attributable diseases, Moldova mortality costs (Webber et al. 2017). has been able to collect additional tax rev- enue, partly because of still high levels of Moldova’s positive experience with taxing tobacco use and the low cost of cigarette tobacco in recent years provides some production relative to the average retail lessons, and possible encouragement, price. As shown in Figure 3, cigarette excise for other countries considering this mea- tax revenue in the country increased from

15 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

Figure 4. Tax and Price Increases in Colombia, 2017-2018 180 SPECIFIC PRICE Dec 2018 167.49 170 TAX (SUPERMARKET) Mar 2018: 162.19 160 2016: 0,54 2,51 2017: 1,08 3,10 150 2018: 1,62 4,38 Jul 2017: 142 Dec 2017: Real price % 140 2019: 1,74 4,65 143 change 42.5 130 (International dollars of 2019 per 20 stick pack) 120 Dec/2016:117 110 100 90 11 11 11 17 17 17 12 12 12 13 13 13 15 15 15 16 16 16 18 18 18 14 14 14 10 10 10 09 09 09 08 ec– ec– ec– ec– ec– ec– ec– ec– ec– ec– ec– Apr– Aug– Apr– D Apr– Apr– Apr– Apr– Apr– Apr– Aug– Apr– D Aug– Aug– Aug– Aug– D D D Aug– D Aug– D D Aug– D Apr– Aug– D D

Source: Llorente, B. and Maldonado, N. 2019

MDL 1.73 billion (US$ 87 million) in 2016 to percentage of retail price of a pack of 20 MDL 2.05 billion (US$ 110.6 million) in 2017, cigarettes) increased from 50 percent in 2016 or about 1.16 percent of Moldova’s GDP. The to 68 percent in 2018. The average price of tobacco tax increases adopted by Moldova’s a pack of 20 cigarettes increased by 42.5 Parliament for 2018-2020 are projected to percent over 2017-2018, as shown in Figure further increase excise tax revenue, hitting 4. The expected fiscal and health impacts of 3.31 billion MDL (US$194 million) or 1.45 per- this measure are noteworthy. It is estimated cent of GDP in 2020. that COP 1 trillion (about US$ 347 million) in additional revenue will be generated through The recent experience of Colombia is 2022, along with a reduction of approximately another good international example. 20 percent in the mortality associated with As part of a broad fiscal reform package tobacco consumption. In addition, the approved by Colombia’s Congress on fiscal reform law mandates the earmarking December 23, 2016, the specific excise tax on of tobacco tax revenues to finance health a pack of 20 cigarettes was increased from insurance coverage at the departmental level COP 700 (US$ 0.25) in 2016 to COP 1,400 (US$ (World Bank Group 2016).5 0.50) in 2017, and COP 2,100 (US$ 0.75) in 2018, with annual adjustments of Consumer Price The recent experience of Australia, Index (CPI) + 4 points in subsequent years. United States, United Kingdom (UK), and The ad valorem excise tax component was Russia also clearly illustrates the public maintained at 10 percent of the total sale price of a 20-cigarette pack, and the general 5 The fiscal reform program adopted by the Colombian government, including tobacco and alcohol tax increases, is VAT rate was raised from 16 percent to 19 supported under the World Bank Group’s US$ 600 million fiscal percent. As a result, the total tax burden (as Development Policy Operation, approved on March 9, 2017. The tax reforms are accompanied by stronger anti-contraband measures to prevent illicit tobacco trade.

16 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity health and fiscal gains that result from the The UK Government uses excise (& imposition of high tobacco taxes. VAT) as part of a unified approach to reduc- ing smoking, in addition to generating rev- In Australia, population use of tobacco enue. In the UK, tax accounts for 77 percent has been falling steadily since the 1980s. of the price of a pack of cigarettes and has This has resulted from the combined impact increased significantly more than the rate of of increased costliness, awareness about inflation. As a result, of high taxes and prices, health risks, declining social acceptability of smoking rates has continued to decline smoking, campaigns encouraging quitting, over the past decade. Statistical information improved treatments for tobacco depen- indicates that the number of adult cigarette dence, and greatly reduced opportunities smokers dropped nearly 20 per cent from an for smoking (Scollo and Bayly 2016). Indeed, estimated 10.2 million in 2007 to 7.4 million or the annual increases in tobacco excise taxes 15.1 percent of the population in 2017 (Cancer in the past decade have led Australia to Research UK’s site 2019; Kay 2019). Tobacco have one of the highest prices of cigarettes taxes also contributed the UK government in the world--a 20-pack of Marlboro costs an estimated £10 billion in tax revenue over approximately a high US$19, while the same 2016/17 (HM Revenue and Custom). pack costs only US$12 in the UK, US$7 in the United States and US$3.88 in South Assessments done by the World Bank Africa. The high tobacco tax level has also Group in Russia show that that life expec- contributed massive yearly tax revenue to tancy in the country for men increased the Government. to 65.4 years in 2016, up from 58 years in 2003, and among women, to 76.2 In the United States, the federal cigarette years in 2016, up from 72 years in 2003. tax for cigarettes was increased signifi- A big factor for this change has been the cantly in 2009 from US$0.39 per pack effective measures adopted to control the to approximately US$1.01 per pack to consumption of tobacco and alcohol over fund the expansion of children’s health this period, including the enactment of a insurance coverage. Besides revenue law on tobacco control in 2013 and regular mobilization, estimates suggest that this tax increases in tobacco excise taxes since 2010. increase could have reduced the number Because of tax and price increases, along of smokers in a cohort of 18 year-olds by with other tobacco control interventions, between 45,000 and 220,000 people, roughly tobacco sales fell by almost 30 percent over 3 to 15 percent (CBO 2012), and contribute to this decade. Not surprisingly, the number the reduction of the number of premature of smokers also decreased, by 21 percent deaths due to smoking by between 15,000 between 2009 and 2016, while higher and 70,000 for two young population cohorts tobacco taxes increased tax revenue for the (12-17 and 18-25) (Furman 2016). country. (Marquez and Salakhutdinova 2018, Marquez et al 2005).

17 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

Table 2. Trends in Prices and Taxes on Tobacco Products, Selected Countries in Europe and Central Asia COUNTRY PRICE AVERAGE CIGARETTE 20 OF LCU PACK, PACK, PER EXCISE LCU BURDEN TAX PRICE AVERAGE OF EXCISE TOBACCO BILLION REVENUE, LCU RATE EXCHANGE USD TO EXCISE TOBACCO MILLION REVENUE, USD LCU BILLION GDP, USD MILLION GDP, EXCISE TOBACCO OF % REVENUE, GDP (EXCISE % + VAT), ARMENIA 2015 350 100.0 45.3 23.5 470 50.0 5,044 10,732 0.47 2016 362 110.0 47.1 30.4 480 63.3 5,067 10,556 0.60 2017 386 126.4 49.4 44.3 480 92.3 5,569 11,602 0.80 2018 417 145.5 51.6 480 6,003 12,506 AZERBAIJAN 2015 1.55 0.1 20.4 1.03 54 52,997 2016 2.20 0.1 18.9 1.60 60 37,863 2017 1.56 0.1 20.4 0.0 1.72 28.8 70 40,868 0.07 2018 0.2 1.70 80 46,940 BELARUS** 2015 0.93 0.3 47.5 1.59 90 56,541 2016 1.09 0.3 44.6 0.8 1.99 395.5 95 47,688 0.83 2017 1.29 0.3 42.0 0.9 1.93 467.9 106 54,767 0.85 2018 1.39 0.4 43.8 1.2 2.04 603.9 GEORGIA 2015 2.40 1.0 52.4 0.4 1.77 213.0 32 17,944 1.19 2016 2.95 1.4 56.4 0.5 2.27 241.9 34 14,991 1.61 2017 4.03 2.0 60.3 0.7 2.37 283.5 38 15,970 1.78 2018 4.36 2.1 58.9 2.51 41 16,367 KAZAKHSTAN 2015 296 78.0 37.1 96.1 222 433.4 40,884 184,387 0.24 2016 324 100.0 41.6 121.4 342 354.8 46,971 137,278 0.26 2017 358 124.0 45.4 137.8 326 422.7 53,101 162,887 0.26 2018 397 150.0 48.5 165* 345 445.9 58,786 170,537 0.28 MOLDOVA 2015 16 6.0 54.2 1.4 19 71.9 146 7,674 0.94 2016 22 8.0 53.0 1.7 20 86.7 161 8,040 1.08 2017 24 9.2 55.0 1.8 18 101.5 179 9,939 1.02 2018 26 10.8 58.2 17 190 11,176 UKRAINE 2015 16 6.1 59.6 22.2 21.85 1,016.0 1,989 91,007 1.12 2016 17 8.5 71.7 33.2 25.55 1,299.4 2,385 93,362 1.39 2017 23 11.9 73.4 39.9 26.6 1,500.0 2,984 112,177 1.34 2018 29 15.5 74.9 43.6 27.2 1,602.9 3,559 130,846 1.23

Source: World Bank Group team based on national and international data collected by Konstantin Krasovsky and Tatiana Andreeva, 2019. Notes: LCU = Local currency units. * Preliminary. ** Revenue includes excise and other taxes.

18 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity In the European Union (EU) member states, cent that year, and by 2.5 percent in 2016. the consumption of cigarettes has been Smoking prevalence among youth in Korea declining over the years, as reflected in also declined from 9.2 percent in 2014 to 7.8 the number of cigarettes released for con- percent in 2015, and to 6.3 percent in 2016. sumption between 2002 and 2015, from At the same time, total tax revenue signifi- almost 800 billion pieces in 2002 to just cantly increased by 20 percent (0.9 trillion below 500 billion pieces in 2015 (Bouw won) – a figure that continued to rise in 2016. 2017). Also, in the EU, the total revenue of In addition, as shown by a recent study, excise duties on cigarettes has been stable reduced tobacco use and related health between 2008 and 2015, despite declining risks are estimated to lower national health consumption. The latter is explained by the expenditure by 1.02 billion won and by 14.08 increase in tax rates—since 1992, the EU billion won over 10 years (KIPF 2015). tobacco excise duty directive requires mem- Table 2 above summarizes trends in tobacco ber states to levy a minimum overall excise prices and tax systems in Eastern Europe and duty on cigarettes consisting of at least €90 Central Asia. Data for countries like Armenia, per 1000 cigarettes and least 60 percent of Azerbaijan, Belarus, and Uzbekistan, show the weighted average retail selling price. the potential of tobacco tax and price hikes And in the Republic of Korea, the 2015 to increase government revenues, as a tobacco tax reform introduced a series of secondary effect to reducing health risks extensive tax increases for all tobacco prod- associated with tobacco use. Since 2018, ucts, including cigarettes, e-cigarettes, pipe other countries across the world—including tobacco, cigars, waterpipes, roll-your own China, Gabon, Indonesia, Lesotho, and Nige- tobacco, chewing tobacco, snus, and snuff ria—have undertaken reforms on tobacco (Eun Choi, S. 2018). There are several taxes tax structures and increased tax rates, and and charges imposed on tobacco products Kazakhstan will start taxing e-cigarettes to reduce consumption but also to mobi- beginning in 2020. lize revenue (Local Education Tax, National Overall, as clearly observed on a Interna- Health Promotion Charge, Waste Charge, tional Monetary Fund (IMF) how-to note Public Fund, Tobacco Production Stabiliza- (Petit and Nagy 2016), “in many countries, rais- tion Charge, Special , and ing tobacco taxes can offer a “win–win”: higher General VAT). As a result of the 2015 reform, revenue and positive health outcomes. Coun- the price of a pack of cigarettes rose by 80 tries’ circumstances and governments 'weight- percent (from 2,500 won per pack to 4,500 ing of revenue, health, and other objectives won). Tax as a percentage of cigarette retail vary, and hence so too will the desirable level prices increased from 62 percent to 74 per- of tobacco tax rates. In many cases, however, cent. The 2015 tobacco tax reform prompted current tax rates are evidently far below what is male smoking prevalence to fall by 3.8 per- feasible in terms of revenue potential. Thus, tax

19 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

increases could serve revenue purposes as well Countries reporting significant progress as health and other objectives. Of course, coun- in the control of illicit tobacco trade tries putting more weight on health objectives adopted some key policy and institu- could raise taxes even further.” tional measures which contributed to their success. A good example is Ireland, Empirical Findings Contradict where a high rate of tobacco excise, and the Traditional Arguments of consequent high price of tobacco products, Illicit Trade, Employment and makes the country attractive to those Regressive Effects involved in the illicit tobacco trade. However, Illicit trade undermines global tobacco Ireland’s comprehensive and effective prevention and control interventions. system of customs and tax enforcement, However, a recent global report by the alongside strong regulatory control of the World Bank (2019) also shows that, contrary tobacco market, has contained the illicit flow to tobacco industry arguments, tobacco of tobacco products onto the Irish market. taxes and prices have only a limited impact Box 1 summarizes these measures, which are on the illicit market share at country fully consistent with the provisions of the level. From a public health perspective, WHO FCTC Protocol to Eliminate Illicit Trade illicit trade weakens the effect of tobacco in Tobacco Products, which entered into excise taxes on tobacco consumption—and force in September 2018, and needs to be consequently on preventable morbidity and ratified and adhered by all FCTC Parties. mortality—by increasing the affordability, Policymakers considering tobacco tax attractiveness, and/or availability of tobacco hikes are often concerned about impacts products. Furthermore, tobacco illicit trade on employment. However, increase in often depends on and can contribute to tobacco taxes does not negatively affect weakened governance. However, evidence employment, as evidence from Indonesia presented in the report from over 30 coun- shows. Recent assessments done by the tries across the income and development World Bank Group (Araujo et al 2018), with spectrum, shows that raising tobacco taxes the participation of the American Cancer is not the primary cause of illicit trade. The Society, indicate that share to industry-wide evidence indicates that the illicit cigarette employment is about 5 percent, or .60 per- market is relatively larger in countries with cent of total employment in Indonesia. This low taxes and prices, while relatively smaller share is smaller in comparison to employ- in countries with higher cigarette taxes and ment in the food (27 percent), garment (11 prices. Non-price factors such as governance percent), and textile (8 percent) sectors in status, weak regulatory framework, and the Indonesia. The core-sector employment availability of informal distribution networks includes about 2.5 million manufacturing appear to be far more important factors. workers: 693 thousand farmers, 1.04 million

20 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity Box 1. Policies and Institutional Measures to Confront Illicit Tobacco Trade

Findings from the country case studies and and they should be destroyed when the assessments included in the World Bank pack is opened (also to prevent reuse). Group report “Confronting Illicit Tobacco The absence of secure excise marking Trade: A Global Review of Country Experi- in Southern African Customs Union ences” (2019), suggest the following spe- countries, Chile, and Mexico weakens cific actions: the ability of the tax authorities to collect taxes, as noted in the case studies. • Require licensing for the full tobacco • Establish effective track-and-trace supply chain. At present there is licensing systems to follow tobacco products at least for all manufacturers, importers, through the supply chain from produc- exporters, and distributors in almost all tion or import to sale to consumers. country cases. What is needed is for each Secure excise stamps are crucial but country to assess its capacity to require not sufficient to prevent if licensing the rest of the supply chain, there is no downstream verification that particularly retail. As noted in the Canada cigarettes have tax stamps and that they case study, the best example of using are authentic. A track-and-trace system licensing to control the supply chain is would help address, for example, the in the province of Quebec, where the challenge posed by under-declared entire supply chain is licensed including domestic cigarette production or pro- tobacco growers, transporters, manufac- duction declared for but then sold turers, those who store raw tobacco and/ on the domestic market. The Mexico, or final products, importers, wholesalers, Chile, and Southern African Customs retailers, as well as those in possession Union case studies identify the absence of manufacturing equipment. Tobacco of a track-and-trace system as the major importers are licensed in Malaysia and obstacle to controlling illicit trade in the Philippines requires suppliers of raw tobacco products. Notably, as detailed in materials to the production process, the case studies, Ecuador’s tax track-and- including those providing tobacco papers trace system for domestically produced and filter components, to be licensed. cigarettes, alcoholic beverages, and beer • Require use of secure excise tax stamps was implemented by its Internal Reve- and other product markings to facili- nue Service in 2017 and is the first track- tate enforcement and tax collection. and-trace to comply with the Protocol to These markings should possess multiple Eliminate Illicit Trade in Tobacco Products. layers of security (as implemented in • Establish effective enforcement teams Kenya, Georgia, and the Philippines, for equipped with automated reporting example); they should not be removable; devices, to reduce human discretion

21 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

in tobacco tax administration. This tobacco products. In contrast, Colombia feature played a major role in improving and Malaysia both established a strict the level of enforcement in Kenya and regulatory framework for Georgia. However, the Kenya case also zones to prevent this challenge. underlines the importance of enforce- • Set and enforce significant financial ment agents with the power to carry out penalties and penal provisions for illicit inspections at any time and at any point trade in tobacco products. Seizures, in the supply chain, to seize illicit prod- financial penalties, and other punish- ucts on the spot, and to bring immediate ment severe enough to be a deterrent charges against offenders. (unlike some of those reported in the • Obtain detection equipment and use it Kenya case study) are important. Crimi- effectively at customs posts. Most coun- nal prosecutions are particularly import- tries already have access to detection ant as deterrents, as indicated in both equipment, although not necessarily in the UK and the Colombia case studies. adequate quantity. Potential governance • Provide for secure and environmentally challenges, with respect to the use of friendly destruction of seized cigarettes, this equipment, can be further reduced carried out by the regulatory authorities by separating the roles of generating and not by the tobacco industry. In Mex- and interpreting scans (as noted in the ico, customs officials destroy seized cig- Kenya case study). arettes, while in the Philippines approval • Develop a risk profile to target inspec- and presence of a Bureau of Internal tions. The Chile case highlights the use of Revenue representative is required. In a risk analysis tool for targeting suspicious contrast to this guidance, in South Africa cargos and to generate customs alerts. an industry-representative body is respon- • Set relatively low duty-free allowances sible for the destruction of illicit goods. for tobacco product purchases, both in • Educate the public on the impact of terms of amounts (e.g. only two packs, tobacco illicit trade. Getting the public as in Australia) and frequency (e.g. only involved supports enforcement and once every 30 days as in Georgia). Chile reduces the demand for illegal products. shows how the lack of restrictions on As noted in the case studies, the Phil- frequency led to substantial but legal ippines and Kenya introduced apps for small-scale . the public to verify the authenticity of • Regulate or ban trade in tobacco cigarette packs, while the UK ran a public products in free trade and other special awareness campaign explaining how economic zones. The Chile case study purchasing illegal cigarettes harms the illustrates how the relative freedom from country and local communities. regulation in these zones can make them gateways for domestic sale of untaxed Source: World Bank 2019

22 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity clove farmers, and 750 thousand tobacco inclusive analytic model reverses the initial farmers. Most tobacco sector workers are appearance of tobacco tax regressivity. Far females and unskilled (66 percent manufac- from unfairly burdening the poor, tobacco turing workers and 92 percent production taxes deliver the greatest share of their workers). About 43 percent of households potent long-term benefits to people with with tobacco workers are poor; they contrib- low incomes. It is smoking that is regressive ute, on average, to 60 percent of household and tobacco tax increases that are progres- income. There is also a male-female wage sive (Marquez and Moreno-Dodson 2017). gap: female production workers earn 25 per- The next sections discuss the main theoreti- cent less than males. The assessments also cal elements of this approach, as well as the estimated that raising cigarette taxes by an main findings of the country studies. average of 47 percent and simplifying the cigarette tax structure to 6 tiers in Indonesia The Price Elasticity of would reduce cigarette demand by 2 per- Tobacco Consumption cent, increase by 6.4 The distributional impact of raising taxes percent, and reduce gross employment in on tobacco—whether the poor are more tobacco manufacturing sector by only heavily burdened or see the greatest ben- 0.43 percent. efits—depends on the responsiveness of Another often-cited concern among pol- low- and high-income consumers to the icy makers is that tobacco taxes are regres- price changes in tobacco ( WHO 2011a). sive, as they disproportionately burden The responsiveness of consumers to price poorer smokers, who spend a larger por- changes can be expressed by the price elas- 6 tion of their incomes on tobacco products, ticity of demand. Because of their highly relative to wealthier consumers. To assess addictive nature, tobacco products may be this argument, empirical analyses by the expected to be more price-inelastic—have World Bank in several countries over 2016–19 lower price elasticities in absolute value, provide an in-depth picture of the sociode- or less responsiveness among consumers mographic distribution of tobacco use. They to price changes—than other non-addictive use the ECBA framework, described below, products. This intuition may be used to to incorporate a wider view of longer-term advocate against raising tobacco taxes. health and economic costs and benefits However, the magnitude and distribution of by income group. This approach allows the elasticities remain an empirical question to adjustment behaviors to be compared if be determined in each country context and tobacco taxes rise for poorer and wealthier population group. Understanding the price smokers. It also allows health benefits and elasticities of tobacco across the population productivity gains because of taxes to be incorporated that are neglected in tradi- 6 This parameter—often used in economics—captures the change in the quantity of cigarettes demanded by consumers in tional fiscal incidence analyses. This more reaction to a 1 percent rise in the price of cigarettes.

23 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

Figure 5. Effect of Increasing Tobacco Prices, Extended Cost-Benefit Analysis

Change in Change in med- Change in years Net Income = tobacco expen- + ical expenses + of productive Effect diture (A) (B) life list (C)

Source: World Bank Group elaboration.

is therefore crucial in calibrating the correct China, Indonesia, the United Kingdom, and policy actions and estimating the welfare and the United States, suggests that the sensitiv- distributional effects of tobacco tax systems. ity of smoking prevalence to changes in cig- arette pricing is greater among lower socio- An extensive body of evidence attempts to economic strata. However, the evidence is estimate the relationship between tobacco still mixed in other cases, including Egypt, prices and consumption. Meta-analyses Bulgaria, and Turkey (IARC 2011). of the relationship between tobacco prices and use suggest that the overall elasticity of Tobacco elasticities can be expected to demand among adults lies between -0.3 and increase in the future as more-responsive -0.8, signifying that a 10 percent increase in young generations become the largest cigarette prices will lead to a 0.3 percent to consumer group (Fuchs and Del Carmen 0.8 percent decline in consumption (CBO 2018). It is often argued that younger indi- 2012; Chaloupka and Warner 2000; Gallet viduals and low-income groups are more and List 2003; IARC 2011). responsive to price changes relative to their peers. Lower dependence on nicotine, larger Such relationships, however, are not peer effects, and limited disposable income homogeneous across countries and may cause younger people to be more income groups. In high-income countries, responsive to tobacco price shocks (Jha and raising the price of cigarettes by 10 percent Peto 2014). Chaloupka and Grossman (1996) leads to an estimated reduction of 4 percent and Lewit and Coate (1982) find that, in the in the demand for cigarettes (World Bank United States, individuals ages under 18 1999). An equivalent price change in low- and exhibit much larger tobacco price elastici- middle-income countries would likely result in ties (between −1.44 and −1.31) than adults a 6 percent average fall in demand (IARC 2011). (between −0.27 and −0.42). Lower-income households tend to show higher price elasticity of demand relative to The Extended Cost Benefit medium- and higher-income groups (World Analysis Methodology Bank 1999). Empirical research in a variety ECBA can be used as a theoretical frame- of countries, including Bangladesh, Canada, work to understand the mechanisms

24 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity through which taxes on tobacco affect which tend to allocate a larger proportion of household welfare and equity outcomes. their budgets to tobacco. While the ECBA methodology can vary, However, consumers respond to price two main features allow the distributional increases by adjusting their consumption impact of increasing taxes on tobacco to be behavior. This response depends on the assessed. First, incorporating decile-specific sensitivity of consumers to price changes, price elasticities of tobacco products allows captured by price elasticities of demand. While the stylized fact that different income groups the effect may still inflict a short-run welfare can have different behavioral responses loss on some households, its magnitude to price changes to be taken into account. and distribution depend on the initial distri- Second, accounting for both the costs and bution of consumption across households, the benefits of increasing prices provides a household elasticities of demand, and the more comprehensive understanding of the magnitude of the price shock. net effects, as well as likely short-, medium-, and long-term policy outcomes. Benefits of Tobacco Taxes: Figure 5 summarizes the mechanisms that Reduced Medical Costs (B) have thus far been incorporated in empir- and Additional Years of ical applications of the ECBA by the World Working Life (C) Bank. And the next two sections describe By discouraging consumption, taxes on the main cost and benefit components. (For tobacco products reduce the adverse further methodological details, see Fuchs health effects of tobacco, as well as the and Meneses, various years; Pichón-Riviere large associated medical and human et al. 2014; Verguet et al. 2015.) capital costs to households and societies. Medical treatment of the numerous chronic Costs of Tobacco Taxes: Short- diseases caused or exacerbated by tobacco Term Direct Price Effect (A) swells annual health care costs in public All else being equal, increasing prices of health care systems and households (World tobacco necessarily translate to a welfare Bank 2017). Smoking reduces household loss among consumers, who must spend earning potential and labor productivity, higher shares of their budgets to continue negatively affecting human capital accu- to purchase the same quantities of tobacco. mulation and development (WHO 2015). Such a mechanism is generally behind Hence, reducing tobacco use translates to the claims of regressive effects. A naïve lower smoking-related medical expenses, complete pass-through scenario whereby increases in life expectancy at birth, and households continue to purchase the same reductions in disability. quantity of tobacco at higher prices dispro- portionally affects lower-income households,

25 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

Figure 6. Benefits of Increasing Tobacco Taxes: Channels of Transmission

Averted premature mortality Fewer cases of impoverishment Reduced Lower Lower out-of- as a result of consumption of incidence pocket health out-of-pocket tobacco products of tobacco- spending on expenditures [higher reduction related tobacco-related among the poorer diseases diseases wealth quintiles] Fewer cases of Lower government catastrophic Higher Higher health spending health excise expenditures taxes price on tobacco- related diseases

Incremental Additional government financing for revenues health and other sectors Source: Postolovska et al. 2017.

Public and private health care accounts The indirect costs of smoking on house- for the major share of the costs of tobacco hold welfare may include losses in labor use, beyond the price of household con- incomes because of lower productivity or sumption. Tobacco-related health care costs working days forgone because of illness, can be either direct or indirect. Direct costs as well as the value of lives prematurely include the monetary value of the consump- lost because of tobacco (WHO 2011b). tion of goods and services that is motivated Hence, raising the prices of tobacco may or compelled because of tobacco use. These expand the years of productive life. Verguet include health care costs (hospitalization, et al. (2015) analyze the health effects of a pharmaceuticals and supplies, medical price increase in China and conclude that a equipment, and so on) and non–health care 50 percent rise in prices would result in 231 costs (insurance, job replacements for sick million life years gained over 50 years and smokers, cleaning up cigarette residues and would have a significant impact among the packaging, and so on). For example, in the poor. In contrast, Pichón-Riviere et al. (2014) United States, tobacco-related diseases are estimate that tobacco use in Chile would associated with direct health care costs of reduce life expectancy by nearly 4.0 years 1.1 percent of GDP or 8.7 percent of annual among women and 4.3 years among men. health care spending (Xu et al. 2015). Ahsan et al. (2013) estimate that, if taxes were raised to 57 percent of the retail price of tobacco products, 1.96 million tobacco-re-

26 // Taxes on Tobacco: A Policy Measure to Improve Health, Domestic Resource Mobilization, and Equity lated deaths would be averted in Indonesia. Similarly, if taxes were raised even more, to 70 percent, more than 5 million deaths would be averted.

Other indirect and second-round effects may also be significant. Raising taxes on cigarettes may reduce exposure to second- hand smoke, with significant health and economic benefits. Households may likewise benefit from increased public expenditure because governments have typically ear- marked tax revenues from tobacco sales for health care and social programs.

Figure 6 summarizes the channels of trans- mission from taxes to health and economic benefits. It is assumed that the excise tax is directly passed on to the consumer in the form of higher prices. This results in reduced consumption of tobacco products, leading to a decline in the incidence of tobac- co-related diseases, such as stroke, lung cancer, cardiovascular disease, and chronic obstructive pulmonary disease. In turn, this reduces premature deaths associated with tobacco use. In addition, it leads to lower out-of-pocket spending for the treatment of tobacco-related diseases, resulting in fewer cases of impoverishment and catastrophic health spending. Given that a large share of health services is financed by governments, this would also result in government savings on tobacco-related health expenses. Com- bined with the revenues from tobacco taxes, the additional resources could be used to finance health care and other sectors.

27 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM 4 EMPIRICAL RESULTS: LESSONS FROM COUNTRY CASE STUDIES

A growing body of evidence has success- income groups; accounting for benefits fully applied the ECBA methodology facilitates a more comprehensive long- to different countries and consistently term picture of the effects of tobacco tax found evidence of medium- to long-term policy. Fuchs and Meneses (2017b) simulate progressive distributional effects. This the effect of increasing taxes on cigarettes in section summarizes the lessons learned Chile. As expected, a naive assumption that through eight country studies carried out smokers do not adjust their consumption to by the World Bank. Most studies highlight the price changes would appear to confirm that lower-income households are more the concerns about regressive policy effects. likely to reduce consumption of tobacco To keep on purchasing the same quantity when facing higher prices. They also find of tobacco, the poorest 20 percent of the that the medium- and long-term benefits of population would have to reduce their con- reduced consumption can often outweigh sumption of other goods more than three the short-term costs, resulting in net income times the equivalent reduction among the gains, particularly among lower-income wealthiest decile (as a percentage of income). groups. In addition to the eight cases pre- However, accounting for behavioral changes sented below, the World Bank Group also by incorporating price elasticities reduces produced assessments following a similar the negative shock across all deciles because methodology in Armenia (Postolovska et smokers react by switching consumption al 2017), Colombia (James et al 2017), and away from tobacco products and toward Kyrgyz Republic (Postolovska et al 2018). other goods. This price effect remains neg- (For full methodological details, results, and ative before taking into account of health further information, the reader should refer and earnings benefits, but simulations to the individual country studies that can be suggest that, in the long term (under accessed at the World Bank Group Global an upper-bound elasticity scenario), the Tobacco Control Program site). price effect on household budgets would approach zero, as tobacco consumption is Chile further abandoned. Findings from Chile illustrate the rele- The net effect of increasing taxes on vance of the price responsiveness across tobacco is calculated by incorporating the

29 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

benefits of reducing the medical costs and budget in some middle-income groups years of life lost to the direct price effect. (deciles 3–6). The ECBA allows the relevant Medical costs because of tobacco-related benefits of reducing tobacco consumption diseases are estimated at US$496 million in in Indonesia to be incorporated that would Chile by Pichón-Riviere et al. (2014). Almost be underestimated under a traditional 30,000 people are estimated to die prema- naive estimation. Approximately 153,108 turely from tobacco-related diseases annually. people (mostly men) died prematurely from Simulations under a lower-bound elasticity tobacco-related diseases in Indonesia in 2016, scenario, show that the net effect of increas- which translated to more than 4 million years ing the price of cigarettes by 25 percent is of life lost. Additionally, in 2015, annual direct negative and regressive, affecting the low- health care costs attributable to tobacco use er-income groups of the population more amounted to US$2.2 billion (equivalent to 2.5 severely. However, as elasticities increase, the percent of GDP). effects become more progressive. Assuming The case of Indonesia raises a variety of a long-term (or high-elasticity) scenario, the complexities in applying ECBA, and it price increase has a progressive distributional sheds light on many questions that may effect, has a positive effect on all income be applicable to countries with local groups, and shows a progressive pattern, substitutes for cigarettes. White and that is, greater benefits among lower-in- clove cigarettes are widely consumed in come groups. Indonesia. Hence, price elasticities and cost Indonesia benefits were estimated separately. Clove cigarettes are cheaper and, on average, have The ECBA in Indonesia highlights the lower price elasticities than white cigarettes need to account for different tobacco (−0.52 vs. −0.63). However, in both cases, the products that raise further complexities distribution of elasticities is consistent with in understanding the effects of tobacco the literature; lower-income households are tax increases. Using data from the 2015–16 more responsive to price changes. Assuming Indonesia National Socioeconomic Surveys, a 25 percent price shock, the benefits of Fuchs and Del Carmen (2018) estimate that reducing tobacco-related medical bills and the net distributional effect of increasing years of life lost contributed to offsetting prices on white and clove cigarettes in the direct price shock of increasing taxes. In Indonesia will likely be progressive. Smoking the case of white cigarettes, the net effect is prevalence in Indonesia is among the highest always positive, but regressive; irrespective in the world, with two households in every of the elasticity assumption, poorer deciles three-reporting positive expenditure on benefit less than richer ones. In contrast, tobacco products. The amount spent on clove cigarettes show heterogenous effects, tobacco among these households is large, depending on the elasticity assumptions. reaching almost 10 percent of the household Under lower-bound elasticities, the results

30 // Empirical Results: Lessons from Country Case Studies show that the net effect of clove percent of households have elasticities above is negative and regressive. In the case of unit (in absolute value). Because of their high the medium-bound elasticity, the tax is sensitivity to prices, households at the lower progressive, with positive gains among end of the income distribution change their the poorest 20 percent of the population. consumption not only to reduce the quantity For upper-bound elasticity, the tax would of cigarettes, but also to allocate less money to have a positive effect on most income cigarette purchases than before the increase. groups and a progressive pattern. Further Similar to the findings in other countries, research into the heterogeneity of results in considering the two additional effects and possible substitution effects is needed derived from the decrease in tobacco to formulate appropriate policy responses consumption, households would see their that curtail tobacco consumption altogether, welfare eventually increase. For example, avoiding substitution to cheaper (and often households could save resources with lower-quality) tobacco products. a reduction in health expenditures on a lower incidence of tobacco-related illnesses. Bosnia and Herzegovina Moreover, additional income brought about The case of Bosnia and Herzegovina by an increase in life expectancy means that provides some evidence to question the the bottom 60 percent of the income dis- traditional view of tobacco as a highly tribution could end up with more resources price inelastic product, particularly among than before the price increase. lower-income groups. Based on data from the 2015 Household Budget Survey, Fuchs, Ukraine Cancho, and Orlic (2019) simulate the impact Reducing medical expenses is the main of increasing cigarettes prices by 25 percent, mechanism driving the progressive effects a similar increase to the one registered on the of raising taxes on cigarettes in most case average 20-pack of cigarettes between 2015 studies on middle-income countries. In and 2018, according to the Indirect Taxation line with patterns in other country cases, Authority. When faced with increases in Fuchs and Meneses (2017) find that the tobacco prices, households with the least results in Ukraine are mixed and highly financial resources reduce consumption dependent on the assumptions of price considerably more than those with more elasticities. Under a lower-bound elasticity resources. After an increase of 10 percent in scenario whereby the population has low price, people at the lowest income curtail responsiveness to the price changes, the consumption by up to 10 percent, while net effect is negative across all households people at the highest income reduce though the incidence is progressive, with consumption by only 3 percent. In fact, the a smaller shock on lower-income groups. In distribution of elasticities found in Bosnia and the case of a medium-bound elasticity, the Herzegovina suggests that the poorest 10

31 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

tax has a progressive impact, with net income particularly among men and lower-in- gains among lower-income groups and a come households (Fuchs, Matytsin, and negative effect on higher-income groups. In Obukhova 2018). Tobacco-related medical the case of the upper-bound elasticity, inci- expenses are likely to be a considerable dence is progressive, and the income effects burden on Russian households. Medical are mostly positive. Only the highest income expenses for tobacco-related diseases groups face long-term income losses. are estimated at Rub 418 billion in 2017. Averting these medical expenses has a The progressive effect is mostly driven by much larger effect on average household the offsetting effect of reduced medical welfare than the short-term negative costs. The same mechanism is found in the impact of increasing tobacco prices. If ECBAs on most countries, except Bangladesh. reduced tobacco consumption translates Reducing medical bills is highly progressive directly into improved health outcomes, the because treating a tobacco disease would poorest 10 percent of households in Russia represent a much higher share of the budget could increase their available household among lower-income households. In addition, budgets by over 1 percent when facing a lower-income individuals may have less 25 percent price increase in cigarettes. The access to risk management instruments, and, equivalent elasticity-adjusted price shock thus, should catastrophe occur, this group on these households would be less than a will suffer even more than the rest. On the 10th of the benefits from reduced medical other hand, available data still present limita- bills (a 0.01 percent income loss). Hence, tions on capturing the exact smoking-related Fuchs, Matytsin, and Obukhova (2018) find medical expenses across income groups. that taxing tobacco in Russia exerts a net Finding ways to estimate the distribution of positive and progressive long-term effect medical expenses more accurately across the on household incomes. However, as theory population is key to improving the knowledge and empirical applications suggest, the on the equity effects of tobacco tax policy, as magnitude depends on the structure of well as interventions in the health system to price elasticities. If the population is more tackle possible catastrophic expenses associ- responsive to tobacco price changes, it will ated with tobacco-related diseases. experience greater gains from the medical and extended work-life benefits. Russian Federation In Russia, the reduction in medical Moldova expenses is also the most relevant chan- In Moldova, simulations show a poten- nel of transition to improve household tially progressive impact, despite data welfare by increasing taxes on tobacco. limitations and only a partial view of the Despite gradual reductions in recent ECBA. Tobacco-related diseases are the years, smoking is still common in Russia, leading cause of premature adult deaths.

32 // Empirical Results: Lessons from Country Case Studies Consistent with other country cases, Fuchs households to respond firmly to the and Meneses (2018) find that the net effect price changes. First, increasing the price of increasing taxes on tobacco in Moldova of cigarettes in Bangladesh has only small would be progressive, ultimately benefiting consumption impacts. The effect on poverty low-income households most. The gains and inequality would be negligible. Relative in reduced medical expenses seem to be to other country studies, the lack of pro- sufficiently large to offset the negative price gressive effects seems to stem from a more effect on household budgets, with a pro-eq- uniform distribution of elasticities among uity result. The ECBA is estimated in Moldova less and more well-off households. Second, to account for the direct price shock, as well in contrast to other countries, reducing as reductions in tobacco-related out-of- medical bills seems to be less significant in pocket medical expenses. Bangladesh. However, this finding may be driven by an underestimation of tobacco-re- Information on the years of life lost lated medical expenses. Even if medical because of tobacco-related premature expenses are correctly calculated, given the deaths is not incorporated because of low household incomes in Bangladesh, they limitations in the mortality data. Despite are likely to increase in the future as incomes this, under the long-term (high elasticity) rise and the epidemiological transition scenario, the bottom 40 percent of the toward NCDs kicks in. population would capture net positive gains in income. The progressive effect is driven There are relevant policy implications. by two factors that are common in most While elasticities are taken as exogenous country studies. First, lower-income house- parameters in the ECBA methodology, holds capture higher benefits because they policy may still aim to influence respon- are most likely to reduce smoking given their siveness to tobacco price changes. For higher elasticities of demand. Second, reduc- example, complementing tax reforms with ing the high costs of treatment represents a other programs to support quitting among large share of the lower income base among smokers may increase the overall magnitude the poorer households. While the progres- of the effects. Reaching lower-income sive findings are impressive, accounting for households through these efforts would the change in medical expenses as well as likely improve equity and poverty reduction. other channels is fundamental to acquiring a full picture. South Africa Efforts to reduce tobacco consumption Bangladesh can feed back into future consumer The results in Bangladesh highlight the behavior and become increasingly diffi- need to improve the estimation and pre- cult, highlighting the need to complement diction of medical expenses and underline tobacco taxes and other policy inter- that the progressivity of tobacco taxes ventions to maximize impact. The price may depend on allowing lower-income responsiveness of smokers seems less in 33 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

South Africa than in other countries. Fuchs, likelihood of smoking initiation among Del Carmen, and Mukong (2018) calculate younger individuals. A uniform increase in elasticities of tobacco demand in South tobacco taxes should not be the only policy Africa, using longitudinal data with repeated in place to reduce tobacco consumption observations on the cigarette purchases of in South Africa. Along with price increases, individuals over time, allowing an improve- complementary policies to induce quitting ment on earlier calculations based on more will likely be required. aggregated time series data. They find that the poorest decile has a medium-bound New Comparative Evidence elasticity of −0.36, whereas the richest Fuchs et al. (2019) have conducted a has an elasticity of −0.22. Such estimates comparative study to simulate tax policy are below the range of −0.4 and −0.8 changes in the eight low- and middle-in- usually estimated for developing countries come countries in (circa) 2016. Using (Chaloupka et al. 2000). Despite low elasticity updated and comparable data sources estimates, Fuchs, Del Carmen, and Mukong across countries, they confirm previous (2018) continue to find a progressive net findings of a progressive net distributional effect of increasing taxes on tobacco. And effect of raising taxes on cigarettes. Similar aggregate welfare gains are positive among to the previous country studies, they find the bottom five deciles (under the medi- that elasticities help mediate the direct price um-bound elasticity scenario). shock among lower-income households. Possible explanations for the more Incorporating the reductions in medical inelastic tobacco consumption in South expenditures and the additional years of Africa are the country’s past in substantial working life because of lower premature antitobacco policies and the changing mortality help offset the negative price structure of the tobacco market in recent effects in all countries. However, this years. Following profound changes in depends on the initial distribution of smok- tobacco legislation, smoking prevalence ers and price elasticities. Figure 7 shows decreased by over 10 percentage points. the net effects under 25 percent and 50 Today, smoking prevalence is lower in South percent price shock scenarios, assuming a Africa than in other developing countries. medium-bound price elasticity scenario. While these are highly desirable policy In sufficiently high price shocks and outcomes, they seem also to indicate that elasticity scenarios, incidence is pro- impactful policy interventions will become gressive, and net welfare changes are increasingly more difficult to achieve. It is positive among a large proportion of the likely that people who continue to smoke population. Half the population in these are more addicted and possibly less sensitive countries could potentially benefit in the to price changes. Despite this, it is essential medium term from net household income that policies be focused on reducing the

34 // Empirical Results: Lessons from Country Case Studies Figure 7. Comparative Net Income Effects of Increasing Tobacco Prices

1.2 1.0 0.8 G

I 0.6 Bosnia and Herzegovina 0.4 Indonesia 0.2 South Africa Russian Federation 0.0 Ukraine -0.2 Moldova Bangladesh -0.4 Chile -0.6 -0.8 1 2345678910

2.5

2.0

1.5 Bosnia and Herzegovina G I 1.0 Indonesia 0.5 South Africa Russian Federation 0.0 Ukraine -0.5 Moldova Bangladesh -1.0 Chile 1 2345678910

Source: Fuchs et al 2019 Note: Deciles calculated from household per capita consumption (excluding identifiable rent and lumpy expenses). Years of life lost calculated form death events related to the risk of smoking tobacco. gains—in addition to health and quality of Limitations of the life improvements and the potential benefits Empirical Findings from increased revenues—if cigarette prices The main theoretical limitation of rose by 50 percent. The updated evidence the ECBA methodology is the partial collected on the eight countries supports equilibrium approach, while data lim- the view that resolute tax policy, combined itations continue to constrain empirical with actions to induce behavioral changes applications in many countries. The sec- among smokers, can generate progressive, ond-round effects and general equilibrium pro-poor and welfare-improving outcomes changes of increasing taxes on tobacco in the long term. are excluded from the model and may be

35 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

significant. For example, the ECBA does not cover additional behavioral changes among economic agents that could unleash econo- my-wide reactions that are difficult to predict. Other effects, such as labor productivity gains, reductions in secondhand smoking, or time allocation to care for sick family members, can be potentially incorporated in the ECBA at higher complexity and data requirements. The incorporation of nonlinearities in elasticities could also be complex. Data lim- itations and higher theoretical and estimation complexities have prevented such efforts thus far. Moreover, lack of data continues to be a constraint on the application of empirical estimations of the ECBA to other develop- ment settings.

36 // Empirical Results: Lessons from Country Case Studies 37 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM 5 KEY TAKEAWAYS

A growing body of evidence in different of the ECBA to eight low- and middle-in- countries finds no support for the claims come countries. To simulate the distribu- that the impacts are regressive and tional impact of increasing taxes on ciga- highlights the relevance of the long-term rettes, the methodology allows for different benefits of increasing taxes on tobacco. consumer responses across income groups, Increasing taxes on tobacco can generate and it incorporates both the negative bud- health and equity improvements and help get shock and the benefits derived from mobilize additional domestic resources to improved health and productivity. The results expand the fiscal space for priority invest- on these countries contradict the regressivity ments and programs that benefit the entire claim. Increasing taxes of tobacco is in general population, particularly the poor. The results pro-poor even without taking into account of in eight countries show that, for large price all important benefits for the poor—therefore shocks, the aggregate benefits of tobacco a progressive policy. taxes can exceed increased tax liabilities, To assess the net welfare gains of this with progressive effects that particularly policy, one must consider the behavioral improve the welfare of lower-income responses of consumers facing a price households. The net income and distribu- change, look beyond the direct impact tional effects of increasing taxes on tobacco on household budgets, and assess other depend on the distribution of smoking prev- benefits derived from lower tobacco use alence and the magnitude and distribution of and consumption. Considered by itself, a price elasticities across income groups. price increase in tobacco through higher Tobacco taxes are recognized as an effec- taxes generates negative income variations tive policy tool to reduce tobacco con- across all groups in the population. However, sumption and improve health outcomes; if price elasticities are incorporated, these however, policy makers often hesitate results no longer hold because the poorest to use them because of their perceived individuals tend to have higher price elastic- regressive effects, that is, poorer house- ities than their richest peers. As individuals holds are disproportionally more affected reduce tobacco consumption, reductions than richer households when faced with in medical expenses and gains in potential increased prices due to higher taxes. This working years also work to offset the direct policy note summarizes the findings on the negative income changes. effects of tobacco taxes on distributional Several channels translate the increase in and fiscal outcomes across several coun- tobacco taxes into health and economic tries. It presents results from the application

39 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

improvements among households, methodological problems. There is a clear particularly households at lower income. need to refine the methods used to estimate It is well established that reducing tobacco the medical costs of tobacco (Lightwood consumption improves health outcomes et al. 2000). Improving the estimation of and the quality of life among smokers and these costs and understanding their burden their family members. Moreover, by increas- across population groups will be key in the ing prices and discouraging consumption, research agenda. Implementing policies taxes on tobacco also affect household to shield the poor from these catastrophic economic welfare through several channels. expenses will be necessary during a transi- Lower smoking prevalence reduces the tion period. tobacco-related burden of disease, freeing Policies should aim to induce and leverage households from medical bills and averting the behavioral responses among consum- premature deaths. In addition to the intrinsic ers by complementing tax increases and value of human lives (conservatively not other policy interventions to reduce smok- taking into account of here), averting the ing. Higher elasticities increase the potential premature deaths also increases the poten- gains from reducing health expenses and tial earnings of workers, both by increasing years of working life lost (Fuchs and Del their productivity (not covered here), as Carmen 2018). Hence, long-term positive well as extending their working lifetimes. gains from tobacco taxes require inducing The ECBA allows for the incorporation of relevant behavioral changes in consumers these mechanisms—averted medical bills that allow health-related benefits to kick in. and additional working —to estimate the After a few decades, it is expected that the changes in household welfare. To the extent impact of the tax policy would resemble the that lower-income households face higher upper-bound elasticity scenario. High price relative burdens of tobacco, the benefits will shocks and targeted tobacco control policies be progressive. Other transmission chan- (on groups with higher smoking rates) may nels—for example, increases in productivity be justified to reach welfare-improving and because of reduced days of sickness or the progressive policy outcomes. Taxes will be effects of curtailing secondhand smoking most effective if they are complemented by among children—can generate additional policies such as smoking cessation programs welfare benefits. or media campaigns. A population that Tobacco consumption affects household is not sensitive to tobacco price changes welfare and equity in societies negatively will not reduce consumption sufficiently mostly through medical expenses. to allow health and work benefits to offset The reduction in medical expenses is cost increases. the main driver of the increase in net Short- and long-term policy outcomes will incomes. However, current estimates of likely differ. While it is possible that tobacco medical expenses are associated with taxes will remain regressive in the short run

40 // Key Takeaways because health effects take time to kick in, grassroots support for proposed tobacco the results of this report are helpful as lower- tax hikes, as well as enhance the progres- and upper-bound estimates of the benefits sivity of tobacco taxation (Furman 2016; of tobacco taxation. Adult smokers tend Marquez and Moreno-Dodson 2017). to exhibit small changes in their behavior Improved data availability and further if price increases, while younger groups research should build on the quality and show more elastic demand. After a few specification of the model. While an exten- decades, the impact of the tax policy would sive research on the health and economic be expected to resemble the upper-bound effects of tobacco has accumulated, knowl- elasticity scenario. edge on the distributional effects of tobacco Tobacco control policy should target the is still nascent in many developing settings. most vulnerable groups. The heterogeneity Collecting relevant data to understand the in price responsiveness that has been found distribution of tobacco consumption and across a variety of country cases highlights elasticities across population groups is fun- the opportunity to maximize policy impact damental to implementing policy reforms by targeting specific population groups. and to help smokers and poor households For example, governments may consider to overcome the burden of tobacco. complementing tax policies with tailored Exploring other mechanisms through which interventions to leverage higher price tobacco affects equity will be fundamental. responsiveness among youth or women to prevent smoking initiation. And tax systems must be well designed to ensure that afford- ability is reduced across all tobacco products, with attention to potentially cheaper substi- tutes to cigarettes that may disproportionally affect the most vulnerable groups.

Smart policy design and implementation can also help to maximize health impacts and to raise support for tobacco tax policies. As shown by the experience in countries such as Botswana, Colombia, Ecuador, Republic of Korea, Philippines, and the United States, “soft” earmarking of public funds—for example, linking increased taxes to increased health spending or other priority programs and investments that benefit low-income populations—helps generate

41 TOBACCO TAXES ARE RECOGNIZED AS AN EFFECTIVE POLICY TOOL TO REDUCE TOBACCO CONSUMPTION AND IMPROVE HEALTH OUTCOMES; HOWEVER, POLICY MAKERS OFTEN HESITATE TO USE THEM 6 CONCLUSION

The key take-away message to convey in averted treatment costs, the bottom to policy makers and other actors is income group would avert 4.6 times more that higher prices of cigarettes provide costs than the top income group (US$46 more health and financial gains to the billion v US$10 billion). About 15.5 million poorest than to the richest groups of the men would avoid catastrophic health population. As such, higher excise taxes expenditures in a subset of seven countries that lead to higher prices and reduced without universal health coverage. As consumption and health risks associated result, 8.8 million men, half of them in with tobacco-attributable diseases support the bottom income group, would avoid the targets of the sustainable development falling below the World Bank definition of goals on non-communicable diseases and extreme poverty. These 8.8 million men poverty, and provides financial protection constitute 2.4 percent of people living against illness. in extreme poverty in these countries. In contrast, the top income group would Indeed, as shown by the results of a recent pay twice as much as the bottom income study on which we collaborated, a 50 per- group of the US$122 billion additional cent increase in cigarette prices would lead tax collected. Overall, the bottom income to about 450 million years of life gained group would get 31 percent of the life years across 13 diverse middle income countries saved and 29 percent each of the averted (lower middle income, India, Indonesia, disease costs and averted catastrophic Bangladesh, the Philippines, Vietnam, and health expenditures, while paying only Armenia, and upper middle income, China, 10 percent of the additional taxes (Global Mexico, Turkey, Brazil, Colombia, Thailand, Tobacco Economics Consortium 2018). and Chile) from smoking cessation. Half of these are estimated in China. Across all countries, men in the bottom income group (poorest 20 poorest of the population) would gain 6.7 times more life years than men in the top income group (richest 20 percent of the population; 155 v 23 million).

The average life years gained from cessa- tion for each smoker in the bottom income group was 5.1 times that of the top group (1.46 v 0.23 years). Of the US$157billion

43 IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

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Address of site of the World Bank Group Tobacco Control Program: http://www.worldbank.org/en/topic/tobacco

54 // References ANNEX

A. Model ThisAnnex section A describes the partial equilibrium approach used to simulate the impact on

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The focus is on the impact of This section describes the partial equilibrium approach used to simulate the impact on consumptionof anA. increase ofModel an increase in the pricein the of price cigarettes. of cigarettes. This approach This approach is used isto used evaluate to evaluate the first the-order first effects-order effectsof of a rise in theThisThis price sectionsection of cigarettes, describesdescribes a the thecommon partialpartial target equilibriumequilibrium of tobacco approachapproach tax reform. usedused toto simulatesimulate thethe impactimpact onon consumptionconsumption of an increase in the price of cigarettes. This approach is used to evaluate the first-order effectsTo a change assess of a change inthe Thisprices. distributional sectionin prices.It relies describes It mainly relies impact mainlytheon household partialof anon householdincreaseequilibrium expenditure in expenditure approachthe patterns.price used of patterns. cigarettes,The to simulatefocus The is focusthe on the the simulation impactis impacton the on impactof consumption of ofof anan increaseincrease inin thethe priceprice ofof cigarettes.cigarettes. ThisThis approachapproach isis usedused toto evaluateevaluate thethe firstfirst--orderorder effectseffects ofof a change in prices. It relies mainly on household expenditure patterns. The focus is on the impactallowsThisa rise sectionof in for a therise differences ofdescribesprice in an the increaseof price cigarettes, the in of the partialin cigarettes, the responses a equilibriumpricecommon aof common cigarettes.across target approach consumption oftarget tobaccoThis used of approach tobacco totax simulate reform.deciles istax used reform. tothe reflectto impact evaluate onthe consumptionthefact firstthat-order poor effects of To assess theaa changechange distributional inin prices.prices. impact ItIt reliesrelies of mainlymainlyan increase onon householdhousehold in the price expenditureexpenditure of cigarettes, patterns.patterns. the simulation TheThe focusfocus allows isis onon theforthe impactimpact ofof a rise in the price of cigarettes, a common target of tobacco tax reform. of an increase a change in the inprice prices. of cigarettes. It relies mainly This approach on household is used expenditure to evaluate patterns. the first The-order focus effects is on ofthe impact of householdsdifferencesaa inriseriselikely the inin have theresponsesthe priceprice different ofof across cigarettes,cigarettes, price consumption elasticities aa commoncommon deciles relative targettarget to ofofto reflect tobaccotobaccohouseholds the taxtax fact reform.reform. withthat poor more resources.households aTo change assessTo intheassess aprices. risedistributional the in It the distributionalrelies price mainly impact of cigarettes, on impactof householdan increase of a ancommon increase expenditure in the target price in the patterns.of price cigarettes,tobacco of Thecigarettes, tax thefocus reform. simulation is the on simulationthe allowsimpact forallows of for likely have different price elasticities relative to households with more resources. The different To assess the distributional impact of an increase in the price of cigarettes, the simulation allowsTheadifferences rise fordifferent in differences the inprice theelasticities, of responsesin cigarettes, the responses combined across a common acrossconsumption with target consumption the initialof deciles tobacco consumption decilesto tax reflect reform. to reflectthe patternsfact the that fact acrosspoor that households poordeciles, households elasticities,ToTo combined assessassess thethe with distributionaldistributional the initial consumption impactimpact ofof anan increaseincreasepatterns in inacross thethe priceprice decile ofofs, cigarettes,cigarettes, explain whether thethe simulationsimulation a price allowsallows forfor differences in the responses across consumption deciles to reflect the fact that poor households likely have likely To different have assess different the price distributional elasticities price elasticities relativeimpact relative of to an households increase to households in withthe price more with of resources. morecigarettes, resources. Thethe simulation different The different allows for explainreform willwhetherdifferencesdifferences be more a price regressive, inin thereformthe responsesresponses more will be neutral, acrossacrossmore or regressive,consumptionconsumption more progressive. more decilesdeciles neutral, toto reflectreflect or more thethe progressive.factfact thatthat poorpoor householdshouseholds likely have different price elasticities relative to households with more resources. The differentToelasticities, assess elasticities, the differencescombined distributional combined with in the theimpact with responses initial theof anconsumption initial increase across consumption consumption in patternsthe price patterns across of deciles cigarettes, decileacross to reflects, decilethe explain simulation thes, explain whether fact thatallows whether a poorprice for ahouseholds price likelylikely have have different different price price elasticities elasticities relative relative to to households households with with more more resources. resources. The The different different elasticities, combined with the initial consumption patterns across deciles, explain whether adifferencesreform price reformwill belikelyin willthemore have beresponses regressive, more different regressive, across more price consumption neutral, more elasticities neutral, or more relativedeciles or progressive. more to to reflectprogressive. households the fact with that more poor resources. households The different The loss ofelasticities, elasticities,real consumption combinedcombined arising withwith from thethe initialinitial the price consumptionconsumption increases patternspatterns in a product acrossacross i is deciledecile obtaineds,s, explainexplain as follows: whetherwhether aa priceprice reform will be more regressive, more neutral, or more progressive. likely have elasticities, different price combined elasticities with relativethe initial to consumption households withpatterns more across resources. decile s, The explain different whether a price The loss ofreformreform real consumption willwill bebe moremore arising regressive,regressive, from the moremore price neutral,neutral, increases oror moremore in a progressive.productprogressive. i is obtained as follows: elasticities, reformcombined will with be more the initial regressive, consumption more neutral, patterns or acrossmore progressive. deciles, explain whether a price

reformThe loss Thewill of reallossbe more ofconsumption real regressive, consumption arising more arisingfrom neutral, the from priceor morethe increases price progressive. increases in a product in a product i is obtained i is obtained as follows: as follows: , (A.1) The loss of real consumption arising from the price increases in a product i is obtained as follows: ∆+ TheThe lossloss ofof realreal consumptionconsumption#$,& #$arisingarising, ,fromfrom thethe priceprice increasesincreases(A.1) in in aa productproduct ii isis obtainedobtained asas follows:follows: where isThe the loss share of ofreal product !consumption𝜔𝜔 +i in∆ total𝜔𝜔 arising) household∗ + from the,expenditure price increases for a household in(A.1) a product in decilei is obtained j; is as follows: ∆+ ∆+ , (A.1) Thethe loss price of increase; real consumption and arising#$is, & the from change#$ the in,price consumption increases in of a product the good i is that obtained depends as follows: on price wherewhere ω_#$ isis thethe share share of of product product𝜔𝜔 +i in i∆ #$intotal𝜔𝜔,& total household∗ + household#$ , expenditure ,,expenditure for a forhousehold a household(A.1)(A.1) in decile in jdecile; # is ∆+ 𝜔𝜔where8 is the share! of product!𝜔𝜔 +i) in∆ total𝜔𝜔 ) household∗ + , expenditure for a (A.1)household in decile∆𝑝𝑝 j; is elasticity. ∆∆++ #$,& #$ +, the price increase; and #$ is the change in consumption∆+ of the good that depends on price where is the share of product𝜔𝜔 +i in∆ total𝜔𝜔 household∗ expenditure for a household in decile j; ∆p is thethe#$ price increase;∆ 𝜔𝜔 and ∆ω isis the the#$#$,,&& change change#$#$ in in consumption consumption, ofof thethe goodgood that that dependsdepends# on price ! ) 𝜔𝜔 8where#$ is the share of product𝜔𝜔 +i in∆, total𝜔𝜔 household∗ ++, expenditure(A.1) for a household in∆𝑝𝑝 decile j;# is where 𝜔𝜔 8 is the share of product!𝜔𝜔 #$,& +i in∆ total𝜔𝜔 #$) household∗ +, expenditure for a household in decile∆ 𝑝𝑝j; is the price increase; and is the change in consumption of the good that depends onelasticity. price elasticity. where 7 is the #$share of product!!𝜔𝜔 ∆ +i in∆ total𝜔𝜔 )) household∗ expenditure for a household in decile j; is #$ onChange price# in elasticity. thetobaccothe price price expenditures increase; increase;∆𝜔𝜔 and and #$ isis the the change change in in consumption consumption of of the the good good that that depends depends on on price price 𝜔𝜔 8 where∆𝑝𝑝 isthe the price share#$#$ increase; of product𝜔𝜔#$ , and∆& 𝜔𝜔+i in ∆ total𝜔𝜔#$ ishousehold∗ + the, change expenditure in consumption for a household of the good in decile that j ; depends is on price## elasticity. 𝜔𝜔𝜔𝜔 88#$ ! ) ∆∆𝑝𝑝𝑝𝑝 # ∆𝜔𝜔#$ elasticity.elasticity. 𝜔𝜔 8 ∆𝑝𝑝 theChange priceChange in increase;tobaccoelasticity. in tobacco expenditures and expendituresis the∆ 𝜔𝜔 change#$#$ in consumption of the good that depends on price To estimate#$ the variation in cigarette∆∆ 𝜔𝜔consumption𝜔𝜔#$ after the price increase, the model considers the# Change in tobacco expenditures elasticity. 𝜔𝜔 8 ∆𝑝𝑝 Changechange in in ChangeChange prices Tobacco (inin tobaccotobacco ),Expenditures the #$ tobacco expendituresexpenditures price elasticity ( ) for decile j, and the share of cigarette To estimateTo estimateChange the variation the in tobacco variation ∆in𝜔𝜔 cigarette expenditures in cigarette consumption consumption after the after price the increase, price increase, the model the considersmodel considers the the expenditure in period 0 ( ). The change in the expenditure of household i in decile j is presented changechange in prices in prices( ), the ( tobacco), the tobacco price elasticity price elasticity ( $) for ( decile) for j decile, and j the, and share the of share cigarette of cigarette To estimate the variation in cigarette consumption after the price increase, the model considersToasChange estimatea the share in oftobacco the total variation expenditure ∆expenditures𝑝𝑝 in cigarette and averaged consumption by decile 𝜀𝜀afterto quantify the price the overallincrease, impact, the model as follows: con- expenditureToTo in estimateestimate period 0 thethe ( #$variationvariation,&). The change inin cigarettecigarette in the consumptionconsumption expenditure afterafter of household thethe priceprice iincrease,increase, in decile thethej is presented modelmodel considersconsiders thethe change in prices ( ), the tobacco price elasticity ( ) for decile j, and the share of cigarette expenditureTo estimate in period the𝜔𝜔 variation 0 ( ). in The cigarette change consumption in the$ expenditure after the of householdprice increase, i in decilethe model j is presented considers the siders the changechange in in∆𝑝𝑝 prices prices∆𝑝𝑝 ( ( ),), thethethe tobacco tobacco tobacco price price price elasticity elasticity elasticity𝜀𝜀 𝜀𝜀$ ( ( ( )) for for decile decile decile jj,j ,,and and and the the the share share share of of of cigarette cigarette expenditure in period 0 ( ). The change in the expenditure of household i in decile j is presentedasTo aestimate share as a of sharechange the total variation of expenditure intotal prices expenditurein#$ cigarette,& ( and), averagedthe consumption and tobacco averaged by decile price after by todecile elasticity the quantify price to quantify (increase, the) foroverall the decile the overallimpact, model j, and impact, asconsiders thefollows: shareas follows:the of cigarette $ expenditureexpenditure inin𝜔𝜔 periodperiod 00#$ ((,& ).). TheThe changechange inin thethe expenditureexpenditure ofof householdhousehold ii inin deciledecile jj isis presentedpresented ∆𝑝𝑝 𝜀𝜀 expenditure in period𝜔𝜔 0 ( ). The change in the expenditure$$ of household i in decile j is presented as a share of total expenditure and averaged by decile to quantify the overall impact, as follows:cigarettechange in expenditure prices∆ ( ), inthe period tobacco=∆∆ (𝑝𝑝𝑝𝑝 0 ( price ). The elasticity change (-1) )in for the decile expenditure𝜀𝜀𝜀𝜀 $ j, and the of household share (A.2) of cigarette i in #$,& as a share of total expenditure∆𝑝𝑝 and averaged by decile to@𝜀𝜀 AB,quantify the overall impact, as follows: 𝜔𝜔 as a share of total expenditure#$#$,,&& and averaged by decile to quantify the overall impact, as follows: expenditureas in a period share 0of ( total). expenditure The𝜔𝜔 change#$,& andin the averaged expenditure by decile of household to quantify i in the decile overall j is presentedimpact, as follows: decile j is presented ∆ ∆ as a share:,; = ( of total𝜔𝜔=𝜔𝜔 ( expenditure; - and1)$ CDEFGaveraged-1) HIJHKL:EMNH by decileAB, to quantify (A.2) the(A.2) Expenditure∆𝑝𝑝 (1 + ∆p)!1 + ε ∗ ∆p) 𝜀𝜀 ∗ AB, as a share of total expenditure and averaged by decile to quantify @the overallAB, impact, as follows: ∆ = ( -1) (A.2) overall impact, as follows:#$,& @ 𝜔𝜔:,; :,; ; ; CDEFG HIJHKL:EMNHAB, @AB, Medical expendituresExpenditureExpenditure∆∆ (1 + ∆p=1=) ! ((+1 +∆pε ∗1∆+p)ε ∗ ∆∗ p ∗--1)1) CDEFG HIJHKL:EMNHAB, (A.2)(A.2) ∆ ( = ( )! ) -1) @AB,AB, (A.2) :,; ; @ AB, Expenditure 1 + ∆p 1 + ε ∗ ∆p ∗ CDEFG HIJHKL:EMNHAB, :,; ; @ ( )! ) Medical expenditures∆ = ( :,; -1) ; CDEFGCDEFG HIJHKL:EMNHHIJHKL:EMNH AB,AB,(A.2) Medical expendituresExpenditureExpenditure : ,; ((11++∆∆pp))!11++εε ∗;∗∆∆pp) ∗∗ CDEFG HIJHKL:EMNHAB, The change in medical expendituresExpenditure associated (1 + ∆ withp!)!1 tobacco+ ε ∗ ∆-prelated)) @AB,∗ diseases is estimated using Medical expenditures :,; ; equation A.3,MedicalExpenditure for which expenditures the cost1 +of ∆treatmentp 1 + ε ∗of∆ tobaccop ∗ -CDEFGrelated HIJHKL:EMNH diseasesAB, for income decile is The changeMedicalMedical in medical expenditures expenditures expenditures( associated)! with) tobacco-related diseases is estimated using obtainedThe from change administrative in medical data. expenditures The cost ofassociated tobacco- relatedwith tobacco medical-related expenditures diseases is isdistributed estimated using equation A.3, for which the cost of treatment of tobacco-related diseases for income decile is The change in medical expenditures associated with tobacco-related diseases is estimatedacrossMedical using equation income expenditures decile A.3, for according which the to cost the of share treatment of households of tobacco that-related consume diseases tobacco for income in decile 𝑖𝑖decile . is obtained fromTheThe changeadministrativechange inin medicalmedical data. expendituresexpenditures The cost of tobacco associatedassociated-related withwith medical tobaccotobacco expenditures--relatedrelated diseasesdiseases is distributed isis estimatedestimated usingusing equation A.3, for which the cost of treatment of tobacco-related diseases for income decileEquation is obtained A.3The shows changefrom the administrative incomein medical gains expenditures associateddata. The cost with associated of the tobacco reduction with-related tobacco in medical medical-related expenditures expenditures diseases because is is estimateddistributed using across incomeequationequation decile A.3,A.3, according forfor whichwhich to thethe the costcost share ofof treatment treatment of households ofof tobaccotobacco that consume--relatedrelated diseasesdiseases tobacco forfor in decileincomeincome𝑖𝑖 . deciledecile𝑖𝑖 isis obtained from administrative data. The cost of tobacco-related medical expenditures is distributed7 The change acrossequation in incomemedical A.3, 𝑖𝑖 decile expenditures for which according the associated cost to the of treatment sharewith tobacco of households of -tobaccorelated - thatdiseasesrelated consume diseases is estimated tobacco for income using in 𝑖𝑖 decile decile . is ofFor reduced a detailedobtained obtaineddiscussiontobacco of fromconsumpfrom the methodology, administrativeadministrativetion over see Coady the data.data. long et al. TheThe (2006);term. costcost Kpodar ofof tobaccotobacco (2006). --relatedrelated medicalmedical expendituresexpenditures isis distributeddistributed across income decile according to the share of households that consume tobacco in decileEquationequation𝑖𝑖 . Equation A.3A.3,obtained shows for A.3 which theshows from income the administrativethe cost income gains of associatedtreatment gains data. associated The withof tobaccocost the with ofreduction tobacco- therelated reduction in- relateddiseases medical in medicalmedical forexpenditures income expendituresexpenditures decile because isbecause distributed acrossacross income income𝑖𝑖 decile decile accordingaccording to to the the share share of of households households that that consume consume tobacco tobacco 𝑖𝑖 in in decile decile𝑖𝑖𝑖𝑖 .. Equation A.3 shows the income gains associated with the reduction in medical expenditures becauseofobtained reduced of fromreduced tobaccoacross administrative tobacco income consump consump deciletion𝑖𝑖 data. over Theaccordingtion the cost over long of the to tobaccoterm. thelong shareterm.-related of householdsmedical expenditures that consume is distributed tobacco in decile𝑖𝑖 𝑖𝑖 . 𝑖𝑖 𝑖𝑖 EquationEquation A.3A.3 showsshows thethe incomeincome gainsgains associatedassociated withwith thethe reductionreduction inin medicalmedical expendituresexpenditures becausebecause of reduced tobacco consumption over the long term. across incomeEquation decile A.3 according shows the𝑖𝑖 toincome the share gains ofassociated households with thatthe reduction consume in tobacco medical in expenditures decile𝑖𝑖 55. because𝑖𝑖 ofof reducedreduced tobaccotobacco consumpconsump𝑖𝑖𝑖𝑖 tiontion overover thethe longlong term.term. 𝑖𝑖𝑖𝑖 Equation A.3 of shows reduced the tobaccoincome gains consump associatedtion over with the the long reduction term. in medical expenditures because

of8 For reduced a detailed tobacco discussion consump of𝑖𝑖 the methodology,tion over thesee Coadylong term.et al. (2006); Kpodar (2006). 𝑖𝑖

8 For a detailed8 For a detaileddiscussion discussion of the methodology, of the methodology, see Coady see et Coady al. (2006); et al. Kpodar (2006); (2006). Kpodar (2006). Page 40 8 For a detailed discussion of the methodology, see Coady et al. (2006); Kpodar (2006). 88 For8For aa detaileddetailed discussiondiscussion ofof thethe methodology,methodology, seesee CoadyCoady etet al.al. (2006);(2006); KpodarKpodar (2006).(2006). Page 40 For a detailed discussion of the methodology, see Coady et al. (2006); Kpodar (2006). Page 40

8 PageFor a 40 detailed discussion of the methodology, see Coady et al. (2006); Kpodar (2006). PagePage 4040 Page 40

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IS TOBACCO TAXATION REGRESSIVE? Evidence on Public Health, Domestic Resource Mobilization, and Equity Improvements

Medical Expenditures The change in medical expenditures associated with tobacco-related diseases is estimated using equation A.3, for which the cost of treatment of tobacco-related diseases for income decile i is obtained from administrative data. The cost of tobacco-related medical expen- ditures is distributed across income decile i according to the share of households that consume tobacco in decile i. Equation A.3 shows the income gains associated with the reduction in medical expenditures because of reduced tobacco consumption over the long term.

∆ = ( -1) (A.3) UDVE CNHFE.CDXFYYDZ[HGFEHL \:VHFVHVA :,; ; B, Medical expenditure !1 + ε ∗ ∆P) ∗ CDEFG HIJHKL:EMNH AA reductionreduction in tobacco consumptionconsumption in in the the long long run run would would be bestrongly strongly related related to ato reduction a in tobacco-related diseases. The model assumes that the health effects of tobacco-related diseases reductionwill immediately in tobacco-related diminish with diseases.the reduction The in model tobacco assumes consumption. that the Even health though effects this assumption of tobac- co-relatedis implausible diseases in the shortwill diminish term because with changesthe reduction in the effects in tobacco of tobacco consumption.-related diseases Even though take time thisto materialize, ∆assumption it providesis implausible an =upper ( in the-bound short estimate -term1) because of the effects changes of tax in increases. the effects of tobac(A.3)- UDVE CNHFE.CDXFYYDZ[HGFEHL \:VHFVHVA co-related diseases take time:,; to materialize,; it provides an upper-boundB, estimate of the The increaseMedical in expenditure working life years !1 + ε ∗ ∆P) ∗ CDEFG HIJHKL:EMNH effects A reduction∆ of tax in increases. tobacco consumption= ( in the -long1) run would be strongly related to a reduction(A.3) in tobacco-related diseases.∆ The model assumes= (thatUDVE theCNHFE health.CDXFYYD-1) effectsZ[HGFEHL of \:VHFVHVtobaccoA -related diseases (A.3) The model estimates the impact on income arising from the increaseUDVE CNHFE in .workingCDXFYYDZ [HGFEHLyears (equation \:VHFVHVA will immediatelyMedical expenditure diminish with:,; the1 + reductionε; ∗ ∆P in ∗tobacco consumption.CDEFG HIJHKL:EMNH EvenB, though this assumption A.4). To estimate the increase !in working :)years,,; the ;years of life lost, YLLCDEFG, from HIJHKL:EMNH tobaccoB, -related A reduction in tobaccoMedical consumption expenditure in the long ! 1run+ εwould∗ ∆P) be ∗strongly related to a reduction in diseasesis implausible are distributed in Athe reduction short across term in becausedecilestobacco changesconsumptionproportionally in the in effectsto the the long ofnumber tobacco run wouldof- householdsrela tedbe stronglydiseases that takerelatedconsume time to a reduction in Thetobacco Increase-related in diseases. Working The Life model Years assumes that the health effects of tobacco-related diseases tobaccoto materialize, (equation ittobacco provides A.5).- related Subsequently, an upper diseases.-bound the Theestimate income model of lost assumes the is effects estimated that of thetax as increases.health the a effectsverage of income tobacco per-related diseases will immediately diminish with the reduction in tobacco consumption. Even though this assumption Thehousehold model inestimates decilewill immediately. theOverall, impact the diminish onmodel income𝑖𝑖 with anticipates thearising reduction thatfrom income thein tobacco increase will consumption.increase in working as the Even years number though of this assumption is implausible in the short term because changes in the effects of tobacco-related diseases take time Theyears increase lost because in workingis implausible of premature life years in thedeaths short from term tobacco because consumption changes in the declines. effects of tobacco-related diseases take time (equationto materialize, A.4). it To provides estimate an theupper increase-bound inestimate working of years,the effects the yearsof tax ofincreases. life lost, YLL, from to materialize,𝑖𝑖 it provides an upper-bound estimate of the effects of tax increases. tobacco-relatedThe model estimates diseases the impactare distributed on income across arising deciles from ithe proportionally increase in working to the numberyears (equation of The increase∆ in working= (life years -1) (A.4) householdsA.4). To estimate thatThe consume the increase increase tobacco in workingin working (equation life`DNa:Kb years, years A.5). cHFNVthe Subsequently,yearsA∗CDEFG of dIJHKL:EMNH life lost, the AYLL income, from losttobacco is estimated-related

diseases are distributedIncome : across1 + ε ;deciles∗ ∆P proportionally∗ CDEFG HIJHKL:EMNH to the numberA of households that consume asThe the model average estimates income the per! impact household on income) in decile arising i. fromOverall, the the increase model in anticipates working years that (equation income tobacco (equationThe A.5).model Subsequently, estimates the the impact income on lostincome is estimated arising from as the aincreaseverage(A.5) income in working per years (equation willA.4). increase To estimate as the the number increase of in years working lost𝑖𝑖 becauseyears, the of years premature of life lost,deaths YLL from, from tobacco tobacco con-related- household in decileA.4). To. Overall, estimate the the model increase anticipates in working that years,income the will years increase of life as lost,the numberYLL, from of tobacco-related diseases are𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 distributed𝑊𝑊𝑊𝑊𝑊𝑊 𝑌𝑌𝑌𝑌𝑌𝑌 across𝑌𝑌𝑌𝑌# = deciles(𝑌𝑌𝑌𝑌𝑌𝑌# ∗ proportionally𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎 𝑜𝑜𝑜𝑜 𝑆𝑆𝑆𝑆 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆to the# )number/𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑃𝑃of𝑃𝑃 𝑃𝑃𝑃𝑃𝑃𝑃households# that consume sumptionTheyears total lost income becausedeclines.diseases gains of premature in are each distributed income deaths group fromacross aretobacco deciles estimated consumption proportionally by adding declines. the to theresults number of the of increase households in that consume tobacco (equation A.5).𝑖𝑖 Subsequently, the income lost is estimated as the average income per tobacco expenditures,tobacco the (equation reduction A.5). in medical Subsequently, expenditures, the income and the lost gain is in estimated working years. as the average income per household in decile . Overall, the model𝑖𝑖 anticipates that income will increase as the number of ∆ household= ( in decile . -Overall,1) the model𝑖𝑖 anticipates that income(A.4) will increase as the number of years lost because of premature deaths from tobacco consumption declines. B. Tobaccoyears Price lost Elasticity, because by of Decile premature`DNa:Kb deaths cHFNVA∗ fromCDEFG dIJHKL:EMNHtobacco consumptionA declines. 𝑖𝑖 : ; Income !1 + ε ∗ ∆P𝑖𝑖) ∗ CDEFG HIJHKL:EMNHA Let be ∆defined as =the ( average quantity-1) of cigarettes smoked per day by individual(A.4)(A.5) in income ∆ = ( `DNa:Kb cHFNV-A∗1)CDEFG dIJHKL:EMNHA (A.4) decile d; the average price# per cigarette# (unit value of tobacco`DNa:Kb# use); cHFNVA∗CDEFGthe# consumption dIJHKL:EMNHA decile of #{ 𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊Income𝑊𝑊𝑊𝑊𝑊𝑊: 𝑌𝑌𝑌𝑌𝑌𝑌1𝑌𝑌𝑌𝑌+ ε=; ∗(𝑌𝑌𝑌𝑌𝑌𝑌∆P ∗ ∗𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎 𝑜𝑜CDEFG𝑜𝑜 𝑆𝑆𝑆𝑆 HIJHKL:EMNH𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 )/𝑃𝑃A𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 Theindividual 𝑄𝑄total income ; and gains the in! individual each income characteristics.): group are; estimated Then, the by smoking addingCDEFG HIJHKL:EMNHtheintensity results equationA of the 𝑖𝑖increase is written in The total income gains in eachIncome income! group1 + ε ∗are∆P estimated) ∗ by adding# the results(A.5) of the astobacco follows: ex𝑃𝑃 penditures, the reduction in medical expenditures, and the 𝐷𝐷gain in working years. (A.5) #{ increase in𝑖𝑖 tobacco 𝑋𝑋 expenditures,# the# reduction in medical# expenditures,# and the gain in The total income𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 gains𝑊𝑊𝑊𝑊𝑊𝑊 𝑌𝑌𝑌𝑌𝑌𝑌 in each𝑌𝑌𝑌𝑌 = income(𝑌𝑌𝑌𝑌𝑌𝑌 ∗group𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎# are 𝑜𝑜𝑜𝑜 estimated 𝑆𝑆𝑆𝑆#𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 by)/ adding𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 the𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 results# of the increase# in B. TobaccoThe Price total Elasticity, income𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 bygains𝑊𝑊𝑊𝑊𝑊𝑊 Decile 𝑌𝑌𝑌𝑌𝑌𝑌 in each𝑌𝑌 𝑌𝑌 = income(𝑌𝑌𝑌𝑌𝑌𝑌 ∗group𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎 are 𝑜𝑜𝑜𝑜 estimated 𝑆𝑆𝑆𝑆 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆(A.6) by)/ adding𝑃𝑃 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 the𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 results of the increase in workingtobacco ex years.penditures, the reduction in medical expenditures, and the gain in working years. tobacco expenditures, the reduction in medical expenditures, and the gain in working years. #{ &  # Ä #{ #{ TheLet empirical be defined analysis lnas 𝑄𝑄 theof equation =average𝛽𝛽 + 𝛽𝛽 (A.6)quantity𝑙𝑙𝑙𝑙𝑙𝑙 assumes∗ 𝐷𝐷 of+ cigarettes𝛽𝛽 a𝑋𝑋 log-+log 𝜇𝜇smoked relationship per day among by individual smoking intensity, in income B. Tobacco Price Elasticity, by Decile price,decile andd; income. the average B. priceTobacco is observed per cigarettePrice if Elasticity,and (unit only value if by the Decile of individual tobacco inuse); a giventhe decile consumption is a current decile of B. Tobacco𝑄𝑄#{ Price Elasticity, by Decile 𝑖𝑖 smoker.individual ; and the individual characteristics. Then, the smoking intensity equation is written Let bebe𝑃𝑃 defined as𝑙𝑙𝑙𝑙 as 𝑄𝑄the #{the average average quantity quantity of cigarettesof cigarettes smoked smoked per day per𝐷𝐷# byday individual by 𝑑𝑑individual in income i as follows: Let be defined as the average quantity of cigarettes smoked per day by individual in income decile d; 𝑖𝑖the average𝑋𝑋#{ price per cigarette (unit value of tobacco use); the consumption decile of Several#{ models have been tested to determine the best fit for each country. in income𝑄𝑄 deciledecile d; P thed; average the average price price per per cigarette cigarette (unit (unit value value of of tobacco tobacco use);use); D𝑖𝑖i the consumption decile of individual ; and 𝑄𝑄 the#{ individual characteristics. Then, the smoking intensity(A.6) equation is written 𝑖𝑖 𝑃𝑃 individual ; and the individual characteristics. Then, 𝐷𝐷# the smoking intensity equation is written as follows: # as#{ follows:#{𝑃𝑃 &  # Ä #{ #{ 𝐷𝐷 𝑖𝑖 𝑋𝑋 ln 𝑄𝑄 = 𝛽𝛽 + 𝛽𝛽#{𝑙𝑙𝑙𝑙𝑙𝑙 ∗ 𝐷𝐷 + 𝛽𝛽 𝑋𝑋 + 𝜇𝜇 The empirical analysis of equation𝑖𝑖 𝑋𝑋 (A.6) assumes a log-log relationship among smoking intensity, 56 // Annex A (A.6) price, and income. is observed if and only if the individual in a given decile is a current(A.6) smoker. #{ &  # Ä #{ #{ The empirical analysisln𝑙𝑙𝑙𝑙𝑄𝑄 of equation= 𝛽𝛽 + 𝛽𝛽 (A.6)𝑙𝑙𝑙𝑙𝑙𝑙 #{assumes∗ 𝐷𝐷 +& 𝛽𝛽 a𝑋𝑋 log -+log𝜇𝜇 relationship# Ä #{ among#{ smoking𝑑𝑑 intensity, The empirical analysisln 𝑄𝑄 of equation= 𝛽𝛽 + 𝛽𝛽 (A.6)𝑙𝑙𝑙𝑙𝑙𝑙 assumes∗ 𝐷𝐷 + 𝛽𝛽 a𝑋𝑋 log-+log𝜇𝜇 relationship among smoking intensity, price, and income. is observed if and only if the individual in a given decile is a current Several models haveprice, been and income.tested to determine is observed the best if a fitnd for only each if the country. individual in a given decile is a current smoker. smoker.#{ 𝑙𝑙𝑙𝑙𝑄𝑄 #{ 𝑑𝑑 𝑙𝑙𝑙𝑙𝑄𝑄 𝑑𝑑 Several models have been tested to determine the best fit for each country. Several models have been tested to determine the best fit for each country. Page 41

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∆ = ( -1) (A.3) UDVE CNHFE.CDXFYYDZ[HGFEHL \:VHFVHVA ∆ = ( -1) (A.3) ∆ Medical expenditure= ( :,; 1-+1)ε; ∗ ∆P ∗ CDEFG HIJHKL:EMNH B, (A.3) ! UDVE CNHFE) .CDXFYYDZ[HGFEHL \:VHFVHVUDVE CNHFEA .CDXFYYDZ[HGFEHL \:VHFVHVA A reduction in tobacco consumption in the:,; long run; would be strongly related to a reduction in :,; Medical; expenditure CDEFG1 + HIJHKL:EMNHε ∗ ∆P B,∗ CDEFG HIJHKL:EMNHB, Medicaltobacco expenditure-related diseases. !1 + εThe∗ ∆modelP) ∗ assumes! that the health) effects of tobacco-related diseases A reduction in tobacco consumptionA reduction inin tobaccothe long consumption run would be in strongly the long related run would to a bereduction strongly in related to a reduction in will immediately diminish with the reduction in tobacco consumption. Even though this assumption tobacco-related diseases.tobacco The model-related assumes diseases. that The the modelhealth assumeseffects of that tobacco the health-related effects diseases of tobacco -related diseases is implausible in the short term because changes in the effects of tobacco-related diseases take time will immediately diminishwill with immediately the reduction diminish in tobacco with theconsumption. reduction inEven tobacco though consumption. this assumption Even though this assumption to materialize, it provides an upper-bound estimate of the effects of tax increases. is implausible in the shortis term implausible because in changes the short in termthe effects because of tobaccochanges- relain theted effects diseases of tobaccotake time-rela ted diseases take time to materialize, it providesto an materialize, upper-bound it provides estimate an of upper the effects-bound of estimate tax increases. of the effects of tax increases. The increase in working life years The increase in working lifeThe years increase in working life years The model estimates the impact on income arising from the increase in working years (equation

A.4). To estimate the increase in working years, the years of life lost, YLL, from tobacco-related The model estimates theThe impact model on estimatesincome arising the impact from theon incomeincrease arising in working from yearsthe increase (equation in working years (equation diseases are distributed across deciles proportionally to the number of households that consume A.4). To estimate the increaseA.4). To in estimate working theyears, increase the years in working of life lost,years, YLL the, from years tobacco of life- relatedlost, YLL , from tobacco-related tobacco (equation A.5). Subsequently, the income lost is estimated as the average income per diseases are distributed acrossdiseases deciles are distributed proportionally across to deciles the number proportionally of households to the that number consume of households that consume household in decile . Overall, the model𝑖𝑖 anticipates that income will increase as the number of tobacco (equation A.5). tobacco Subsequently, (equation the A.5).income Subsequently, lost is estimated the income as the lost average is estimated income per as the average income per years lost because of premature deaths from tobacco consumption declines. household in decile . Overall,household the modelin decile𝑖𝑖 anticipates . Overall, that the income model𝑖𝑖 anticipateswill increase that as theincome number will increaseof as the number of 𝑖𝑖 years lost because of prematureyears lost deaths because from of tobacco premature consumption deaths from declines. tobacco consumption declines. 𝑖𝑖 ∆ = ( 𝑖𝑖 -1) (A.4) `DNa:Kb cHFNVA∗CDEFG dIJHKL:EMNHA ∆ = ( -1) (A.4) ∆ = (Income: 1-+1)ε; ∗ ∆P ∗ CDEFG HIJHKL:EMNH A (A.4) ! `DNa:Kb) cHFNVA∗CDEFG dIJHKL:EMNH`DNa:KbA cHFNVA∗CDEFG dIJHKL:EMNHA : ; (A.5) : ; Income 1 + ε ∗ ∆P A ∗ CDEFG HIJHKL:EMNHA Income !1 + ε ∗ ∆P) ∗ CDEFG! HIJHKL:EMNH) # # # (A.5)# (A.5) The total income𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 gains𝑊𝑊𝑊𝑊𝑊𝑊 𝑌𝑌𝑌𝑌𝑌𝑌 in each𝑌𝑌𝑌𝑌 = income(𝑌𝑌𝑌𝑌𝑌𝑌 ∗group𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎 are 𝑜𝑜𝑜𝑜 estimated 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 by)/ adding𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 the𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 results of the increase in

tobacco expenditures,# the𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 #reduction𝑊𝑊𝑊𝑊𝑊𝑊 𝑌𝑌𝑌𝑌𝑌𝑌 in medical𝑌𝑌𝑌𝑌# = ( 𝑌𝑌𝑌𝑌𝑌𝑌expenditures,# # ∗ 𝑆𝑆ℎ𝑎𝑎𝑎𝑎𝑎𝑎 𝑜𝑜 and𝑜𝑜 #𝑆𝑆𝑆𝑆 the𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 gain# in)/ 𝑃𝑃working𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 𝑃𝑃𝑃𝑃𝑃𝑃years.# The total income𝑊𝑊𝑊𝑊𝑊𝑊𝑊𝑊 gains𝑊𝑊𝑊𝑊𝑊𝑊 𝑌𝑌𝑌𝑌𝑌𝑌 inThe each𝑌𝑌𝑌𝑌 total= income(𝑌𝑌𝑌𝑌𝑌𝑌 income ∗group𝑆𝑆ℎ gains𝑎𝑎𝑎𝑎𝑎𝑎 are 𝑜𝑜 in𝑜𝑜 estimated each𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 income by)/ adding𝑃𝑃 group𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 theare𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 estimatedresults of the by addingincrease the in results of the increase in tobacco expenditures, thetobacco reduction expenditures, in medical theexpenditures, reduction inand medical the gain expenditures, in working years. and the gain in working years. B. Tobacco Price Elasticity, by Decile B. Tobacco Price Elasticity,B. Tobaccoby Decile Price Elasticity, by Decile Let be defined as the average quantity of cigarettes smoked per day by individual in income

decile d; the average price per cigarette (unit value of tobacco use); the consumption decile of Let be defined#{ as theLet average be quantity defined ofas cigarettesthe average smoked quantity per of day cigarettes by individual smoked in per income day by individual in income individual𝑄𝑄 ; and the individual characteristics. Then, the smoking intensity equation𝑖𝑖 is written decile d; the average pricedecile per d ;cigarette the average (unit value price ofper tobacco cigarette use); (unit valuethe consumption of tobacco# use); decile ofthe consumption decile of #{ as follows:𝑃𝑃 𝑄𝑄#{ 𝐷𝐷 𝑖𝑖 consumptionindividual𝑄𝑄 ; and decile theof individual individualindividual#{ icharacteristics.;; andand X_ the the individualindividual Then, the characteristics.characteristics. smoking intensity T Then,hen, equation the the smoking 𝑖𝑖smoking is written intensity equation is written 𝑖𝑖 𝑋𝑋 # # as follows:𝑃𝑃 as follows:𝑃𝑃 𝐷𝐷 𝐷𝐷 intensity equation#{ is written as follows: #{ (A.6) 𝑖𝑖 𝑋𝑋 𝑖𝑖 𝑋𝑋

#{ &  # Ä #{ #{ (A.6) (A.6) The empiricalThe analysis empirical of analysis equationln 𝑄𝑄 of equation(A.6)= 𝛽𝛽 assumes+ 𝛽𝛽 (A.6)𝑙𝑙𝑙𝑙𝑙𝑙 assumes ∗a 𝐷𝐷log-log+ 𝛽𝛽 a𝑋𝑋 logrelationship-+log𝜇𝜇 relationship among among smoking smoking intensity,

price, and income.#{ &  is observed# if#{Ä and#{ only& #{ if the individual# Ä in#{ a given#{ decile is a current intensity,The empirical price, analysis andln income.𝑄𝑄 of Theequation= 𝛽𝛽 empiricallnQ_+ 𝛽𝛽 (A.6) is𝑙𝑙𝑙𝑙𝑙𝑙 observed analysis assumes∗ 𝐷𝐷ln+𝑄𝑄 of𝛽𝛽 aif equation𝑋𝑋 log=and𝛽𝛽-+log only+𝜇𝜇 relationship𝛽𝛽 (A.6) if𝑙𝑙𝑙𝑙𝑙𝑙 the assumes∗ individual𝐷𝐷 +among𝛽𝛽 a𝑋𝑋 log smokingin-+log a𝜇𝜇 givenrelationship intensity, decile among d smoking intensity, smoker. isprice, a current and income. smoker. price,is observed and#{ income. if and only if theis observed individual if ainnd a onlygiven if decile the individual is a current in a given decile is a current 𝑙𝑙𝑙𝑙𝑄𝑄 𝑑𝑑 smoker. smoker. Several models#{ have been tested 𝑙𝑙𝑙𝑙to𝑄𝑄 determine#{ the best fit for each country. 𝑑𝑑 Several models have𝑙𝑙𝑙𝑙𝑄𝑄 been tested to determine the best fit for each country.𝑑𝑑

Several models have beenSeveral tested models to determine have been the besttested fit tofor determine each country. the best fit for each country.

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