Cigarette Tax hike defies economic logic

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By Sam Oldfield, an economics student at Latrobe University and an Associate at Prosper Australia.

The Rudd government’s sudden increase in cigarette taxes completely disregards sound economic practice. Joe Hockey calls it “policy on the run” – he couldn’t be more correct. Making smokers the targets of Kevin Rudd’s war on anything bad for us is par for the course, but the obvious lack of thought here should shock the Australian public.

Of the recommendations of the Australian Medical Association report on tobacco use only one is considered – raising the price. Recommendations of restricting outlets, better support for people trying to quit and changing the culture of smoking are ignored in favour of easy money for a government pretending to manage its budget.

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Chart: The Real Price of the most popular cigarettes in Australia, 1940–2011 (cents per stick)

The lack of a comprehensive, long term plan is only the beginning. Social and economic ramifications are conveniently disregarded. Cigarette taxes are regressive, and on a price-inelastic good to boot. A ten per cent price increase reduces consumption by a paltry four per cent. The Rudd government can tax cigarettes as hard as they like and smokers will keep paying.

The fact that the majority of smokers are from lower income brackets and the economic damage of taxing the poor for the benefit of the rich has evidently escaped the attention of Kevin Rudd and Chris Bowen. It seems nobody has considered how this will affect the wider economy, though the logic is plain: if a ten per cent increase in price leads to a mere four per cent decrease in smoking, then how is the rest of the price increase funded? The answer is obvious, smokers will fund their habit by cutting back elsewhere, and since average smokers are in the income brackets that consume most of their income, the effect of this tax hike on the wider economy will be immediately felt.

Retailers, regardless of how they feel about smoking, should be angered at $5.4 billion disappearing from the pockets of their customers over the next four years. The economic damage this slap-dash policy will have on investment, employment and household financial health should be at the forefront of the conversation.

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Chart: The Consumer Price Index, 1973–2011: Cigarettes and Tobacco Sub-group compared with overall index

Laughably, the Rudd government seems to think this economic chemo-therapy demonstrates its economic management credentials, when in truth it certifies them as economically incompetent.

Smokers can alternatively access the black market. Current market price is 26 cents a stick, so a white market price of $1 leaves plenty of room for both a black market price increase and volume growth. Even current prices offer a tempting $4.5 billion pie to criminals – it would be a tempting pie for anyone.

You may think this is no big deal but you’d be wrong. History has shown that it is through trafficking the high demand, socially acceptable drugs that distribution networks are formed, the contacts and supply lines set up by marijuana traffickers are the perfect conduit for the far less desirable methamphetamines and opiates. A supply chain conveying one type of small-bulk high-value good can easily carry any other small-bulk high-value good, indeed the temptation for otherwise civic minded “chop chop” dealers to increase profits by trading in dangerous drugs may prove too much to resist.

That smokers are expected to pay for the cost of their healthcare is widely accepted even by smokers. Most smokers would not have a problem with paying a bit beyond that, but when the government is making a profit (tax revenue minus healthcare cost due to smoking) of $1,771 per smoker already, which will rise to $2,902 with the tax hike, many will turn to the black market and thus no longer fund their own healthcare.

Money that should go towards treatment of smoking related illness will instead line the pockets of criminals. The free rider effect becomes apparent.

It is the lack of real economic thinking beyond some basic (and potentially spurious) statistics that most marks the failure of this policy. It is a dark condemnation of the current state of the economics profession and the competence of technocrats that this rubbish passes for economic policy. Instead of real reform (or even debate) of our economic policy and tax system, band-aid solutions like this are offered which should anger smokers and non-smokers alike.

You may not like smoking, but this policy shift of the Rudd government does little good and potentially does significant harm to Australia’s future.

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https://prosper.org.au/2013/07/07/cigarette-tax-hike-defies-economic-logic/