Author: Giovanni Andrulli
Though Italian situation is better than global average, a significative rise of the excise duties on Tobacco could imply, beyond a reduction in consumption, a rise in Italian tax revenues, too.
*Note on terminology: for the sake of simplicity, by "taxes" I will mean at large all forms of taxes in force, and I will explain their specific nature only when necessary.
Some recent data
According to the most recent estimates, from Goodchild et al. (2017) [1], tobacco-related diseases had a direct impact on healthcare costs of about $ 422 bln (5.7% of total healthcare expenditures) and implied a wider loss of productivity of about $ 1.436 bln (1.8% of global GDP), in 2012.
Assuming a homogeneous distribution of healthcare expenditures due to tobacco-related disease, it is possible to estimate [2] that Italy spent around € 6.5 bln through the NHS in 2012. Just for comparison, Italy spent € 5.2 bln for “Childhood and family policies” and € 7.4 bln for financing public universities, in 2018 [3].
According to the same linear estimates, Italy lost around € 34.7 bln including indirect costs of tobacco, an amount similar to the revenues collected in 2019 by Esselunga, Luxottica, Pirelli and PosteItaliane, all together.
There is still a poor debate in Italy, though some awareness is emerging, prompted by non-governmental initiatives such as the ones lead by Umberto Veronesi Foundation [4].
Why tobacco is a particular commodity
According to economic theory, an increase in taxes causes a net loss in efficiency, despite the improvement in fairness, since public spending is typically a redistributive instrument. There is a trade-off.
Tobacco is often considered a luxury good, because of its non-necessity as commonly understood. It is, however, a "necessary" good in economic theory, since its price elasticity is between 0 and 1.
The case of tobacco thus presents two contrasting features: it is not a necessary good, and so not worthy of legal protection, but its demand is typically rigid. According to the Ramsey rule, taxation is most effective on rigid demand goods, such as bread, sugar or milk. However, there are no ethical problems here, and, at the same time, its rigid demand ensures an increase in revenue.
Moreover, as a source of negative externalities, 'Pigouvian' taxation does not imply a net loss in market efficiency. In the case of tobacco, therefore, there is no trade-off.
About Tax Increase: efficiency.
Figure 2
The variation of tax revenues when the rate changes can be described by the famous Laffer Curve, and in the case of a rigid demand good, we are in the first part of the curve (the one in blue, Figure 2): the arithmetic effect of price on revenues prevails over the economic one of reduced quantity.
Estimating the price elasticity of demand for tobacco is not easy, mainly because of the low availability of longitudinal data. Nevertheless, cross-referencing the data on price increases published by the AGCM (Italian competition authority) with the data on inflation and tobacco consumption published by ISTAT, yields an average price elasticity of demand of 14.3% over the period 2015-2017, confirming the assumptions about the economic 'necessity' of the good at stake [5].
On the other hand, many other estimates show a wide variation, with peaks above the unity in the long run. Unfortunately, it is common that their funders suffer from deep conflicts of interest with the results to be published.
About Tax Increase: fairness.
In economics, negative externalities occur when the parties of a transaction do not bear the whole burden of the costs they generate [6].
In the case of tobacco, it is possible to estimate such externalities observing some surrogate markets, such as the National Health System and the labour market.
The economic costs attributable to smoking can be divided into:
- direct costs: for prevention and medical expenses;
- indirect costs: related to morbidity and mortality, therefore calculable as lost future earnings.
As said at the beginning, global direct costs in 2012 are estimated at $422 billion (5.7% of global health expenditure). Italy spent approximately €149,500 million on healthcare in 2016, with an average per capita expenditure of €2.466 [7]. The average expenditure for smoking-related healthcare costs is therefore around €140 per capita per year. And that is only the direct externality that every Italian citizen pays every year.
State intervention, moreover, is particularly desirable when there are major information asymmetries, such as those typically related to health risks.
The current debate
There are several clarifications that need to be kept in mind for an increase in tobacco excise duty to be effective:
Figure 3
- The substitution effect with poor quality cigarettes can be discouraged by taxing the number of packages and not their value. In other words, it is necessary to increase the weight of the specific rate relative to the ad valorem rate, which in Italy is among the lowest in Europe (in figure 3);
- Tobacco substitutes should be taxed proportionally to induce a similar decrease in consumption until there is not enough evidence on their effects on health. This legislative delay is unavoidable, it can only be reduced through information campaigns on the effects of such products, as happened after 2010 for rolling tobacco, and a few years later for electronic cigarettes;
- Regarding smuggled tobacco, high taxation is not sufficient to create an illegal market for a good: the coexistence of other characteristics is indispensable, such as cultural heritage, level of corruption and legal certainty [8]. In Italy, in particular, the problem seems insignificant despite the fact that it has been increasing lately;
- Finally, at least in Italy, tax revenues from tobacco do not have a direct link to health financing related to treatment and prevention of smoking-related diseases.
Yet, it could be argued that the State, by influencing citizens' choice through taxation, would not take individual preferences sufficiently into account, acting in the name of a short-sighted paternalism. As Richard Thaler points out, however, many people pay for help to quit smoking, whereas no one would pay for help to start [9].
Figure 4
I argue that the analysis reported above is largely sufficient to support a sharp increase in taxes (mainly specific taxes) on tobacco products. In Italy, as in Europe (Figure 4), there is a wide margin for such adjustments, and the reasons why they do not occur suggest that they are mainly political in nature.
Giovanni Andrulli
References
[2] The whole set of assumptions and estimates is available upon request
[3] https://www.agi.it/economia/copernicani_conti_pubblici_spesa_debito_manovra-4605150/news/2018-11-10/
[4] https://www.fondazioneveronesi.it/magazine/articoli/fumo/quanto-ci-costa-il-fumo [5] Calculations are available upon request or at http://www.tesionline.it/default/tesi.asp?idt=54923
[6] Hall, J. (2013). Homer Economicus. Turin, Bruno Leoni Institute, pp. 137-157
[7] “Spesa sanitaria. In cinque anni (2012-2016) aumenta solo del +0,7% l'anno. L'Istat presenta il rapporto sul sistema dei conti in sanità”. Quotidiano sanità. https://www.quotidianosanita.it/studi-e-analisi/articolo.php?articolo_id=52308
[8] Laffer, A. B. (2014). Handbook of tobacco taxation: theory and practice. San Francisco, The Laffer center
[9] R. Thaler, C. Sunstein (2009). La spinta gentile. Yale University Press
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