Question

Cigarettes in Australia have long been subject to excise tax – a per cigarette tax levied on the suppliers of cigarettes. (The tax applies to all tobacco products, however for the purposes of this question assume cigarette and tobacco consumption are the same thing). In 2016 the federal government announced that the excise tax rate for cigarettes would rise by 12.5% a year for the next 4 years. Over this period tax revenue collected from the sale of cigarettes has increased considerably. Legal cigarette consumption has fallen to an all-time low in Australia due to a combination of the tax on cigarettes, and public health initiatives such as plain packaging, health warnings and banning advertisements.

Part (a) Consider the following two policies aimed at reducing cigarette smoking:

(i) A tax on the suppliers of cigarettes, and

(ii) The public health campaign initiatives.

Illustrate both of these policies separately using a fully labelled and explained demand and supply diagram for each of parts (i) and (ii). Do not use actual numbers; this is intended as a theoretical exercise.

Compare and contrast the impact on equilibrium price and quantity of cigarettes of each of these policies, explaining your answer with reference to the diagrams.

Consider the impact of each policy on government revenue. Explain your answer. Can the impact on government revenue be illustrated on either of your diagrams? If so, indicate and explain the area on the diagram/s that represents government revenue.

Part (b) Consider the following quotation:

“When a tax is levied on a good, a share of it is paid by both the consumer and producer. In the case of cigarettes however much more of the burden of the tax is paid by consumers, even though the tax is levied on the suppliers of cigarettes.”

Why might this be the case? In your answer explain both parts (sentences) of this statement.

If the price of a packet of cigarettes increased by 10%, and in light of your explanation of the quotation, would you expect the quantity of cigarettes consumed to increase or decrease, and by more or less than 10%? Explain your answer.

Part (c) Taxation of cigarettes is often justified on the grounds that cigarette smoking creates externalities. What is meant by the term “externalities” in this context? Give two examples of externalities created by cigarette smoking and explain how a tax on cigarettes could potentially address both of these. Using a fully labelled and explained diagram explain how a tax can increase efficiency in the cigarette market. What size tax should be levied to maximise efficiency in this market? (Indicate the efficient tax size on your diagram – no actual number required).

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

The federal government has imposed excise duty on Australian-made and customs duty on imported tobacco products since the passage in 1901 of the Excise Act5 and the Customs Act.6 Prior to federation, the colonies imposed their own tariffs.7-9

Until 1999, federal excise and customs duty was calculated on the basis of the weight of tobacco products. The Excise Regulations, 1925,10 specified precisely how manufacturers needed to label, calculate and declare excise duty. These also specified how the weight of tobacco products (and the volume of alcohol and petroleum products) was to be calculated. For cigarettes, this included the weight of filter and paper, but not the weight of the packaging.

In the early years of last century, manufactured tobacco was charged at a rate of one shilling per pound (of product weight) and cigars were taxed at one shilling and sixpence per pound. Since 1920, the rate of the duty has been set out in (frequently amended) schedules to the Excise Tariff Act passed in 1921.11 Historically, duty on tobacco in cigarettes was levied at a higher rate than duty on non-cigarette tobacco ). In November 1983, the then federal treasurer, the Hon. Paul Keating, changed customs and excise policy in several ways. First, the rate of federal excise and customs duty was linked with the Australian Consumer Price Index (CPI),12 meaning that since that time, excise and customs duty have automatically increased twice each year. Between February 1984 and August 2013 these increases have been in line with changes in the CPI for the six months to the previous December and June. Since March 2014 increases have been in line with changes each six months between February and November in Average Weekly Earnings. Second, the rate of duty for cigars was immediately made equal to that of cigarettes. Third, the rate for non-cigarette tobacco was increased by $5 a kilo. In subsequent budgets the rate for smoking tobacco was increased further (by another $5 a kilo in the 1984 and 1985 budgets ii , and then by $1.90 in the 1986 budget).

compares the excise duty on cigarettes with that on cigars and smoking tobacco in selected years since 1965. As can be seen in rates for smoking tobacco became equal to that for cigarettes in 1986.

Rates of federal excise duty

Year $ per kg cigarettes* $ per kg cigars* $ per kg smoking tobacco

1965 9.26. 7.39 4.94

1970 10.36 8.49 5.38

1975 19.36 16.56 9.88

1982 29.70 25.34 15.10

1983 30.98 30.98 20.10

1984 32.25 32.25 25.92

1985 34.35 34.35 32.60

1986 37.26 37.26 35.36, 37.26

1987 40.73 40.73 40.73

Source: Australian Tobacco Marketing Advisory Committee. Annual Report 1994: year ended 31 December 1994 regarding the operation of the Tobacco Marketing Act 1965. Canberra: Australian Tobacco Marketing Advisory Committee, 1995.

* Current dollars: the price in the applicable year; no adjustment has been made for inflation

Historically, tobacco products produced in Australia were subject to a lower rate of duty than that applicable to imported tobacco products. Customs duty was brought into line with excise duty following the publication in June 1994 of a report of an inquiry by the Industry Commission into tobacco growing and manufacturing industries in Australia.13 Coinciding with the end of the Tobacco Stabilisation Plan (see Chapter 10, Section 10.8.2), the harmonisation of customs and excise duty was in line with government policy to reduce a range of direct and indirect subsidies in an attempt to improve international competitiveness of Australian exports. compares rates of excise and customs duty (per kilo of tobacco weight) from 1987 to 1999.

As can be seen in excise duty became equal to customs duty in 1995.

Rates of federal duty* per kilo of weight, all tobacco products, as at June 1987 to 1999–excise and customs, Australia

Year Excise rate Customs rate

1987 39.35 41.79

1988 41.75 44.19

1989 44.94 47.38

1990 48.42 50.86

1991 51.72 54.16

1992 52.50 54.94

1993 57.67 60.11

1994 63.56 66.00

1995 79.02 79.02

1996 83.02 83.02

1997 84.27 84.27

1999 88.03 88.03

* Current rate: the rate in the applicable year; no adjustment has been made for inflation

1987 to 1989: Australian Tobacco Marketing Advisory Committee.

1990 to 1999: Scollo M and Lal A. The very latest tobacco taxes, prices, production, expenditure, reported consumption and revenue in Australia.

Throughout the 1990s, health groups lobbied for increases in federal excise duty.14 ,15 In addition to the six-monthly CPI increases, the government increased the rate of federal excise applicable to cigarettes and other tobacco products on several occasions. These included a $5 per kilo increase in 199216 and increases announced in the 1993 budget17 of 3% in August 1993 and 5% in February and August 1994 and February 1995.18 iii The final increment rise of 5% planned for August 1995 was brought forward and increased to an immediate 10% rise in the Federal Budget handed down on 10 May 1995.19

shows the rate of the federal excise duty on cigarettes over the period since 1958. The figure is expressed in constant 1989–90 dollars to take into account rising prices over that time. iv

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

$0.00

$20.00

$40.00

$60.00

$80.00

Automatic indexation

Automatic indexation

Excise duty rate ($AUD)

Year Excise duty rate

1958 55.86

1959 55.43

1960 54.59

1961 52.6

1962 50.74

1963 51.1

1964 51.1

1965 58.23

1966 63.28

1967 61.24

1968 59.69

1969 57.88

1970 55.18

1971 58.99

1972 61.18

1973 57.52

1974 62.26

1975 61.35

1976 65.28

1977 57.35

1978 52.36

1979 61.88

1980 53.98

1981 49.65

1982 44.82

1983 48.4

1984 50.54

1985 48.66

1986 48.58

1987 48.83

1988 48.35

1989 48.39

1990 48.42

1991 50.01

1992 50.15

1993 54.08

1994 58.59

1995 63.37

1996 71.03

1997 71.86

1998 73.63

1999 73.78

Figure 13.2.1

Excise duty rate per kilo of tobacco, Australia 1958 to 1999

Note: Excise duty rate expressed in constant 1989–90 dollars

Sources: Australian Tobacco Marketing Advisory Committee. Annual Report 1994: year ended 31 December 1994 regarding the operation of the Tobacco Marketing Act 1965. Canberra: Australian Tobacco Marketing Advisory Committee, 1995.

Federal Budget papers 1996 to 1999: Willis R. 1995-96 Commonwealth Budget. Canberra: The Parliament of the Commonwealth of Australia, House of Representatives, 1995; Costello P. Budget 1998-99. Budget paper no. 2. Health and Family Services Budget measures. Canberra: Australian Government, 1998; Costello P and Fahey J. Budget 1998-99. Final budget outcome 1998-99. Table 8, Revenue replacement payments to the States. Canberra: Australian Government, 1999. Available from: http://www.finance.gov.au/publications/final-budget-outcomes/docs/Fbo9899.pdf .

Data adjusted by the Consumer Price Index: Australian Bureau of Statistics. 6401.0 Consumer Price Index, Australia Table 11. CPI: group, sub-group and expenditure class, index numbers by capital city. Canberra: ABS, 2011. Viewed: 30 December 2011. Available from: http://www.abs.gov.au/AUSSTATS/[email protected]/DetailsPage/6401.0Sep%202011?OpenDocument

It is evident from Figure 13.2.1 that, once its value was restored by the increase and introduction of indexation in the 1983 budget, federal duty on cigarettes remained fairly steady in real terms over the late 1980s and early 1990s, increasing significantly only in the late 1990s. The level of federal duty on cigarettes in 1998 was about 50% higher in real terms than it was at its lowest point in the early 1960s.

In 1999, after extensive lobbying by health groups, 14 the government moved from levying excise and customs duty on cigarettes on the basis of weight to a system based on the number of cigarettes (see Section 13.3.1.2 for full details). Excise and customs rates on cigarettes and other tobacco products applicable since 1999 are set out in Table 13.2.3.

Excise and customs duty applicable to cigarettes and other tobacco products since November 1999, Australia

Year Dollars per cigarette or cigar weighing less than 0.8 g* Dollars per kg of smoking tobacco, or cigarettes or cigars weighing greater than 0.8 g*

November 1999 0.18872 235.90

February 2000 0.19155 239.44

August 2000 0.19481 243.51

February 2001 0.20260 253.25

August 2001 0.20645 258.06

February 2002 0.20893 261.16

August 2002 0.21227 265.34

February 2003 0.21524 269.05

August 2003 0.21804 272.55

February 2004 0.22044 275.55

August 2004 0.22353 279.41

February 2005 0.22621 282.76

August 2005 0.22915 286.44

February 2006 0.23259 290.74

August 2006 0.23840 298.01

February 2007 0.24031 300.39

August 2007 0.24343 304.30

February 2008 0.24757 309.47

August 2008 0.25450 318.14

February 2009 0.25679 321.00

August 2009 0.25833 322.93

February 2010 0.26220 327.77

April 29 2010 0.32775 409.71

August 2010 0.33267 415.86

February 2011 0.33633 420.43

August 2011 0.34474 430.94

February 2012 0.34681 433.53

August 2012 0.34889 436.13

February 2013 0.35447 443.11

August 2013 0.35731 446.65

December 2013 0.40197 502.48

March 2014 0.40639 508.01

September 2014 0.46268 578.37

March 2015 0.47008 587.62

September 2015 0.53096 663.70

March 2016 0.53733 671.68

September 2016 0.61054 763.20

March 2017 0.61726 771.60

September 2017 0.69858 ^901.39

March 2018 0.71046 916.72

September 2018 0.80726 1,076.35

March 2019 0.81775 1090.33

September 2019 0.93653 1291.77

March 2020 0.94964 1309.85

September 2020 1.10360 1576.57

Between 1999 and 2010 there were no increases in tobacco excise and customs duty on tobacco products apart from adjustments for CPI. Excise and customs duty was increased by 25% on 30 April 2010, and 12.5% annually from 2013 to 2017 (Figure 13.2.2). Four annual 12.5% excise and customs duty increases were scheduled from 2013–17,20,21 followed by a further four 12.5% annual increases to the year 2020.22,23

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

$0.00

$0.20

$0.40

$0.60

$0.80

$1.00

Excise and customs duty per stick ($2012)

Year Excise and customs duty

2000 0.281

2001 0.280

2002 0.280

2003 0.280

2004 0.280

2005 0.280

2006 0.282

2007 0.280

2008 0.283

2009 0.279

2010 0.351

2011 0.353

2012 0.349

2013 0.349

2014 0.440

2015 0.497

2016 0.564

2017 0.634

2018 0.715

2019 0.820

2020 0.954

Figure 13.2.2

Value of excise and customs duty on tobacco (per cigarette stick weighing less than 0.8 grams): 2000 to 2020, Australia

Note: Rate expressed in 2012 dollars. Rates at August of each year to 2013, then rates at September for 2014 onwards.

Excise and customs duty for smoking tobacco (and cigars and cigarettes weighing greater than 0.8 grams of tobacco per stick) is set at a per kilogram rate that is equivalent to factory-made cigarette sticks assuming 0.8 grams of tobacco is used per cigarette. However, smokers generally use less tobacco per cigarette than this, so that in practical terms RYO tobacco attracts less tax per stick than FM cigarettes. In 2017, the Australian Government determined that the customs duty and excise on RYO tobacco (and cigars and cigarettes weighing greater than 0.8 grams of tobacco per stick) would be harmonised with FM cigarettes over a period of four years beginning September 2017. The changes were announced in the May 2017 Federal Budget.24 The customs duty and excise rate of smoking tobacco would be increased so that it assumes that 0.775 grams is used in each stick in 2017, reducing to 0.75 grams in 2018, then 0.725 grams in 2019, and reaching 0.7 grams in 2020.25,26

By reducing the quantity of smoking tobacco assumed per cigarette, this measure is expected to increase the duty on and consequently the price of roll-your-own tobacco relative to factory-made cigarettes,27,28 curbing the growing disparity in prices of these types tobacco products—see also Section 13.3.1.2.

By reducing the quantity of smoking tobacco assumed per cigarette, this measure is intended to increase the duty on and consequently the price of roll-your-own tobacco relative to factory-made cigarettes,27,28 curbing the growing disparity in prices of these types tobacco products—see also Section 13.3.1.2. At September 2020, the excise on a 0.7 gram roll-your-own cigarette was equivalent to a typical factory-made cigarette. However, given RYO smokers tend to roll cigarettes using much less tobacco than this—0.5 grams on average29—a typical RYO smoker pays around 40% less excise per cigarette than a FMC smoker in 2020.