Question

Part (d) Is a tax on cigarettes a regressive tax or a progressive tax? Explain your answer, including a definition of both terms.

Part (e) Australia’s police forces and border forces have warned that rapid rises in the tax on cigarettes have had unintended consequences of encouraging illegal activity such as smuggling, with proceeds funding other criminal activities. Explain why this might be the case. In your answer refer to the role that elasticity of demand plays in making illegal activity more profitable

Answer 1

PART (D)

The cigarette excise tax is regarded as a regressive tax because it targets smokers who are customers of this consumable product and the government assesses tax as a percentage of the value of the asset that a taxpayer purchases or owns.

Regressive Taxes

Low-income individuals pay a higher amount of their incomes in taxes compared to high-income earners under a regressive tax system because the government assesses tax as a percentage of the value of the asset that a taxpayer purchases or owns. This type of tax has no correlation with an individual's earnings or income level.

Regressive taxes include property taxes, sales taxes on goods, and excise taxes on consumables, such as gasoline or airfare. Excise taxes are fixed and they're included in the price of the product or service.

Progressive Taxes

Taxes assessed under a progressive system are based on the taxable amount of an individual's income. They follow an accelerating schedule, so high-income earners pay more than low-income earners. Tax rate, along with tax liability, increases as an individual's wealth increases. The overall outcome is that higher earners pay a higher percentage of taxes and more money in taxes than do lower-income earners.

This sort of system is meant to affect higher-income people more than low- or middle-class earners to reflect the presumption that they can afford to pay more.

PART (E)

Driver of illicit trade

A major driver of the growth in illicit trade is the substantial profits to be made by criminal organizations from selling illegal cigarettes from other countries border.

Excessive taxation and regulation

Taxation and regulation play an important role for governments as part of a public health policy to reduce smoking rates. However, when taken to an extreme, a heavily taxed and regulated market makes the unregulated and untaxed black market attractive for criminals.

Tax increases on cigarettes that go well-beyond inflation rates give smokers the incentive to increasingly seek out less expensive products. Criminals have taken advantage of this trend by offering illegal tobacco products at a significant price discount compared to legal products.

CONSEQUENCES OF ILLICIT TRADE

Everyone loses, except criminals

Among its many destructive consequences, the illicit tobacco trade:

• Robs governments of tax revenues;
• Exposes consumers to unregulated products often manufactured in unsanitary conditions;
• Poses threats to security by providing a major source of illegal income for transnational organized criminal groups;
• Encourages corruption and threatens the rule of law in countries where illicit trade is rampant;
• Reduces the effectiveness of public health policies;
• Makes it easier for minors to access tobacco products; and
• Undermines the legitimate industry's business.

Threats to Security

The increasing threat to security was recently illustrated by the European Commission:

The illicit tobacco trade has long been recognized as a main source of revenue for organized crime, and, in some cases, terrorist groups. The new European Agenda on Security adopted by the European Commission on 28 April 2015 recognizes the importance of fighting cigarette smuggling as a means of cutting off criminal groups from this revenue source.

Illicit cigarette trade as a threat to the national security of the United States:

The past two decades have provided a number of cases demonstrating the direct link between cigarette smuggling and serious organized criminal and terrorist activity in the United States. Illicit cigarette tax stamps helped to fund one of the convicted bombers in the first World Trade Center bombing in 1993, and U.S. government reports have found that illegal cigarette smuggling networks in the U.S. are being used to fund terrorist networks in the Middle East like Hezbollah, Hamas, and al Qaeda.

Security threats in other parts of the world:

At the 2009 International Law Enforcement Intellectual Property Crime Conference, Ronald K. Noble, INTERPOL Secretary General, stated: Paramilitary groups and organized crime rely on counterfeiting – especially of cigarettes – to reap huge profits and even to fund terrorist activities.

Experts have also said illegal cigarette trafficking is a source of funding for terrorist group Islamic State (ISIS). According to Dr. Louise Shelley: Oil is not ISIS’ only source of revenue… Still more funding comes from the sale of counterfeit cigarettes, pharmaceuticals, cell phones, antiquities, and foreign passports.

Christian Eckert, France’s Minister of Budget, also recognized the link between terrorism and illicit trade in an interview in 2015, where he stated the following: What is clearly evolving is to involve Customs in the fight against terrorism. It is demonstrated and known that many jihadists are involved in petty crime (counterfeit, contraband of tobacco, drugs).

Damage to legitimate business

A report conducted by Frontier Economics, a leading European economics consultancy, estimates that between 2 and 2.6 million jobs have been lost globally due to counterfeiting and piracy of a wide range of consumer products, including brand name luxury goods and tobacco.

In the legal tobacco supply chain, manufacturers, suppliers, wholesalers, distributors, and retailers are all affected by illicit trade. Manufacturers suffer considerable financial losses, and long-term damage to their brands, which they have invested time and money to build. Wholesalers, distributors, and retailers lose because reduced demand for legal products leads to fewer sales. Small retailers not only lose cigarette sales, but also the sale of other items adult smokers usually buy when in their shops. To illustrate, in the two Canadian provinces of Ontario and Quebec, 2,300 convenience stores closed down in 2009, largely because they are unable to compete with the low prices of contraband cigarette offerings.

Minors have access to illegal tobacco

Children should not smoke or use products containing nicotine. However criminals who deal in and profit from the illicit trade do not differentiate between consumers on any basis. Independent experts and government authorities agree that the illicit tobacco trade—by operating outside lawful and regulated channels—provides easy access to tobacco products to youth.

Demand Elasticity

"When the price of an illicit drug changes, the quantity consumed by existing users may change and the total number of users may also respond. The percentage change in total consumption resulting from a 1 percent change in price is referred to as the demand elasticity. For cocaine and cigarettes, the elasticity of demand has been estimated at around -0.5, indicating that demand falls by 0.5 percent when price increases by 1 percent. This elasticity is similar to that observed for tobacco and implies that a price increase more than compensates for the reduction in demand and results in higher overall drug revenues. There are fewer studies for heroin, but a reasonable estimate for elasticity appears to be around -0.3. For methamphetamine, a successful Australian government effort to reduce the supply of precursor chemicals led the price of the drug to temporarily triple and the purity to decline from 90 percent to 20 percent. Simultaneously, amphetamine-related hospital admissions dropped by 50 percent, and use among arrestees declined by 55 percent. However, these indicators returned to their previous levels within four months as prices fell and purity increased."

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