Should tax policy play a role in reducing the harm of tobacco?

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Following the release of the House Democrats’ Build Back Better Act, federal tobacco and nicotine taxation has been a hot topic in the United States. In an effort to raise about $ 100 billion, the House proposal would double taxes on cigarettes and increase all other taxes on tobacco and nicotine to comparable rates, a strategy with serious unintended consequences.

Since the federal excise tax should seek to internalize the externalities associated with the consumption of these products, the tax rate should correspond (or at least respect) different levels of harm, because less harm means lower social costs. . A tax system that ignores this principle risks having a negative impact on public health by reversing the tendency of smokers to turn to less harmful (and often cheaper) alternatives such as smokeless tobacco and herbal products. steam.

Harm reduction and its impact on tax policy is not an isolated debate in the United States. Earlier this year, Professors Illoong Kwon and Sun-ku Hahn published an article recommending inflation-indexed excise taxes on tobacco products. The study focuses on South Korea and the possibility of introducing differential adjustments for different categories of tobacco products. The journal is looking for ways to maximize revenue while respecting the risk continuum.

The idea suggested in the document is quite simple. When a jurisdiction levies specific excise taxes (quantity-based taxes) on tobacco and nicotine products, the rate, due to inflation, will decrease in real terms over time. This effect has a negative impact on sales. One way to take this into account is to index the rate so that it automatically increases at the same rate as inflation. While inflation adjustments may seem like a simple fix, it only makes sense in situations where the tax rate is at an appropriate level. Too often, tobacco and nicotine taxes are much higher than justifiable as a means to recover costs associated with consumption, and inflation adjustments in these situations would maintain an inappropriate high rate.

In South Korea, the total rates are 3,323 KRW (US $ 2.80) for 20 cigarettes, 3,004 KRW ($ 2.53) for 20 heat sticks, and 2,232 KRW ($ 1.88) per milliliter of vape liquid. The three categories of products are subject to seven different levies and taxes. In the United States, cigarettes and heating sticks are taxed at combined rates more than 35% higher than in South Korea. As a result, in the United States, the combined tax burden on cigarettes goes beyond the internalisation of externalities.

When a rate is appropriate, at a level approaching societal costs, indexation to inflation has the advantage of keeping the real value of the tax constant. The authors argue, however, that governments should go further. Instead of keeping the ratio between products constant by simply adjusting the rate for inflation, a differential adjustment should be implemented. Since vapor-based products are more elastic, a measure of changes in demand resulting from price changes, than cigarettes, the claim is that the rate for cigarettes could be adjusted to a higher rate. (inflation plus 1 percent).

According to the model developed for the study, differential indexation to inflation results in a higher return, since the tax on cigarettes, an inelastic product, grows faster than inflation. Over time, it also increases the difference in tax rates between the more harmful products, cigarettes, and the less harmful nicotine products.

Differential inflation indexation increases the tax difference between cigarettes and vapor products Example of calculating 10-year inflation-adjusted taxes at 2% inflation
Politics Year 1 tax Report 10 year tax Report
Cigarettes Steam product Cigarettes Steam products
No indexation to inflation 3,323 KRW 2 232 KRW 149% 3,323 KRW 2 232 KRW 149%
Inflation-Indexation 3,323 KRW 2 232 KRW 149% 3,971 KRW KRW2,667 149%
Differential inflation index (+1 pp for cigarettes) 3,323 KRW 2 232 KRW 149% KRW4 336 KRW2,667 163%

Note: Annual inflation is assumed to be 2%.

Source: author’s calculations.

While it makes sense to differentiate tax rates between different methods of delivering nicotine, it should not be necessary to over-adjust the rate on cigarettes. It would be simpler and more neutral to lower the rate on less harmful products and to adjust all categories according to inflation. In addition, revenue should not be the primary incentive to tax tobacco and nicotine products, although revenue should obviously always be one of the reasons for levying a tax. Lawmakers should avoid the temptation to overtax products to generate additional income for general spending. The job of excise duty on these products is to internalize externalities, and consumption costs do not increase faster than inflation.

To answer the question posed in the title of this article: yes, tax policy should play a role in reducing the harm of tobacco, but inadvertently. The tax code should remain as neutral as possible, and it should not pick winners and losers. That being said, the nature of excise taxes is such that a well-designed tax system should encourage consumers to stay away from cigarettes. Since the harm associated with consuming other nicotine products (steam products, nicotine sachets) is much lower, the tax rate should be much lower. Since lower rates translate into lower retail prices, it helps consumers navigate the market and helps them switch to less harmful products.

The study presents a very interesting proposition for achieving the dual objective of tobacco taxation: generating income and improving public health. However, the solution overly complicates the problem. The consensus is that nicotine products are less harmful, so rather than waiting for a differential inflation adjustment to achieve the desired ratio between tax rates, governments should simply impose rates that match the profile. danger of products.

Adjusting for differential inflation, however, is a much better proposition than the Build Back Better Act. This proposal would tax nicotine products at higher rates than cigarettes, a strategy to maximize the harm for the 34 million American smokers.

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