Tobacco Economics in Indonesia Sarah Barber Sri Moertiningsih Adioetomo University of California, Berkeley Demographic Institute Faculty of Economics, University of Indonesia Abdillah Ahsan Diahhadi Setyonaluri Demographic Institute Demographic Institute Faculty of Economics, University of Indonesia Faculty of Economics, University of Indonesia "Implementing the maximum legally allowable tobacco tax rates could prevent between 1.7 and 4.0 million tobacco-related deaths among smokers and generate additional revenues of US$ 3.2 to 6.5 billion. Doubling the tobacco tax could increase employment by more than one quarter of a million jobs." One of a series of reports on tobacco taxation — a key component of the MPOWER package — funded by the Bloomberg Philanthropies as part of the Bloomberg Initiative to Reduce Tobacco Use. Monitor tobacco use and prevention policies Protect people from tobacco smoke Offer help to quit tobacco use Warn about the dangers of tobacco Enforce bans on tobacco advertising, promotion and sponsorship Raise taxes on tobacco ISBN: 978-2-914365-40-6 International Union Against Tuberculosis and Lung Disease (The Union) 68 boulevard Saint Michel, 75006 Paris - FRANCE Tel : +33-1 44.32.03.60, Fax : +33-1 43.29.90.87 email: [email protected]; web: www.iuatld.org Suggested citation: Barber S, Adioetomo SM, Ahsan A, Setyonaluri D. Tobacco Economics in Indonesia. Paris: International Union Against Tuberculosis and Lung Disease; 2008. Tobacco Economics in Indonesia Executive Summary 1 I. Background of the Study 4 Purpose and Scope of the Study 4 Data Sources 4 Data Gaps and Limitations 5 II. Introduction 6 Smoking Prevalence and Burden of Disease 6 Relationships Between Health and Economic Productivity 8 Market Failures: Inadequate Information About Health Risks and Addiction, and Financial and Physical Costs Imposed on Nonsmokers and Society 10 Generating Government Revenue: Tobacco Price and Tax Measures 13 III. Tobacco Tax, Tariff, and Price Information 17 Tobacco Tax Structure 17 Cigarette Taxes and Prices 19 Affordability of Tobacco Products 23 Note About ad valorem and Specific Tax Systems 24 IV. Demand Studies 27 Studies Using Aggregate Data 27 Studies Using Household Data 29 Impact of an Increase in Tobacco Prices on Low-income Households 30 Impact of an Increase in Tobacco Taxes on Cigarette Consumption and Government Revenue 31 V. Industry Market Structure and Employment 35 Tobacco Farming 35 Market Structure of the Cigarette Industry 37 Tobacco Manufacturing 39 Studies Evaluating the Impact of Taxation on Employment 42 VI. Tobacco Tax Administration 46 Revenue from Tobacco Excise 46 Factors in Determining the Tobacco Tax Rates 46 Industry Responses to the Tobacco Tax System 53 Tax Administration, Counterfeiting, and Smuggling 55 Conclusions and Recommendations 59 Annexes 62 Acknowledgments 85 Bibliography 86 Executive Summary Low real cigarette prices, population growth, More than 97 million non-smokers in rising household incomes, and mechanization of the Indonesia are routinely exposed to kretek industry have contributed to sharp increases in tobacco consumption in Indonesia since the 1970s. secondhand smoke. The majority of tobacco users are smokers, and the vast majority of smokers (88 percent) use kreteks, or trillion per year (US$ 319 million and 1.2 billion). In cigarettes made of tobacco and cloves. Smoking addition, secondhand smoke is carcinogenic. More prevalence is 34 percent, and 63 percent of men than 97 million nonsmokers are regularly exposed to smoke. Per capita adult tobacco consumption secondhand tobacco smoke. Households with smokers increased by 9.2 percent between 2001 and 2004. dedicate 11.5 percent of monthly expenditures on Given the delay of up to 25 years between the time of tobacco, and such high spending has serious welfare smoking uptake and the onset of many chronic implications. The national nutritional surveillance diseases, the negative health effects of increases in system reported that paternal smoking predicts an cigarette consumption are being seen only now. Up to increased probability of short-term and chronic child one-half of today’s 57 million smokers in Indonesia will malnutrition. die of tobacco-related illnesses. The customs law states that excise should be used The vast majority of smokers (88 percent) to reduce consumption of tobacco products and control use kreteks, or cigarettes made of tobacco their distribution because they are unhealthy. In practice, the primary factor taken into consideration and cloves. when setting the tobacco tax rate is the annual revenue target. The system continues to promote gaps in prices between products, tobacco has become more Market failures exist for tobacco, including affordable over time, and smoking prevalence among imperfect information about health risks and the risks of children has increased sharply. Cigarette prices and tax addiction. Some 78 percent of Indonesian smokers rates in Indonesia are low relative to other countries, started before the age of 19 years. Nicotine is highly and real cigarettes prices have remained stable since addictive; among children under 15 years who already the 1980s. The current tax rate (37 percent of sales smoke, 8 out of 10 have tried to quit but were price) is low compared with the global benchmark of unsuccessful. Unlike those who use other highly 70 percent, and the rates are below the maximum addictive but illegal substances, however, smokers are allowable by law. The government “roadmap” intended presented with many opportunities to purchase tobacco to create healthy communities and guide tobacco and are constantly confronted with advertisements that excise policy could result in worse health outcomes by promote tobacco use as socially acceptable. Taxation plays an important role in keeping prices high to prevent uptake among children and adolescents, who did not Up to one-half of the 57 million smokers in intend to start a lifetime addiction. Indonesia today will die of tobacco-related Smoking imposes costs on nonsmokers and illnesses. Some 78 percent of Indonesians society. Health care costs for tobacco-related illnesses started smoking before the age of 19 years. in Indonesia could amount to between Rp 2.9 and 11.0 2 | Tobacco economics in Indonesia From a revenue perspective, tobacco taxation is Six large hand-rolled and machine-made relatively easy to administer given that six large hand- kretek firms contribute some 88 percent of rolled and machine-made kretek firms contribute total tobacco excise revenues. some 88 percent of total revenues. However, the tobacco manufacturing industry has responded to the tiered tax rates by firm production scales in a number encouraging higher consumption. There is no evidence of ways. The tiered rates allow firms to incur lower to indicate that reducing nicotine levels has any effect taxes by reducing their production levels to fall within on health outcomes. lower tax brackets, establishing new small firms, or Demand for tobacco products responds to buying up small firms or contracting production to changes in price. Reaching the global benchmark of 70 them. In effect, the production tiers in the tobacco tax percent through a specific, or primarily specific rather system offer a number of different ways to legally avoid than ad valorem, tax would have the greatest health the highest tax brackets, thereby substantially impact and could avert between 2.5 and 5.9 million reducing the impact of a tax increase on revenue tobacco-related deaths. At the same time, the demand generation and social welfare. In addition, the industry for tobacco products is inelastic, or the percentage has strong lobbying power to influence policy because reduction in demand is less than the percentage 71 percent of market share is held by three companies. increase in price. With a relatively small impact on the In the past, firms have been willing to absorb tax tax base, this increase would contribute Rp 23.8 to 75.8 increases and reduce their margins to maintain or trillion (US$ 2.6 to 8.3 billion) additional revenue, increase market share. It is notable that the 2008 regardless of reduced sales volumes for cigarettes. regulation imposed a large, nearly uniform specific tax for all tobacco products and this represents a major The impact of price and tax measures on health change from the previous tax scales. The impact of this and revenue depends on the structure of the market, change should be monitored closely. industry and consumer responses to tax and price increases, and the implementation of the tax. The Cigarette manufacturing has contributed current tobacco tax structure itself is complex, based less than 1 percent of total national on the type of tobacco product, mode of production (machine or hand-rolled), and industry production employment since the 1970s. scale. It has evolved over time to incorporate multiple and sometimes conflicting goals, including not only Changes in tobacco tax and price would not be revenue generation but also employment and the expected to have a great impact on tobacco and clove promotion of small industries. The policy has largely farming nationally for several reasons. Less than acted to protect small firms by reducing demand for 2 percent of Indonesian farmers are involved in tobacco products from large firms through increases in their cultivation, and most tobacco and clove farmers are retail prices and tax rates. concentrated in specific geographic areas. Both tobacco and clove farmers already have very diverse