Summary of the Article
The article discusses the importance of price elasticity of demand level in the economy in determining tax imposed on tobacco. A household survey conducted in the UK reveals that a whopping 10.2 million of the population were cigarette consumers in 2007. Policy makers are showing increasing focus on promoting public health and attempting to discourage tobacco consumption by imposing stringent tax on tobacco. Tax on tobacco has been increased considerably in the last decade in order to reduce the number of tobacco consumers in the country. However, the effectiveness of higher tax on tobacco will be determined by price elasticity of demand level in the country. The following sections describe the efforts made by the government to impose heavy taxes on tobacco, price elasticity of tobacco demand and importance of price elasticity of demand level in tax imposition on tobacco.
Tobacco Taxes in the UK
Efforts are being made to increase tax on tobacco to curtail demand. An analysis of data gathered from tobacco manufacturers association suggests that tax per 20 cigarettes has increased by more than 250 per cent from 1990 to 2009. In spite of the steady increase, the taxes appear to have adjusted only against the rate of inflation. Hence, visible impact of tax increase on decrease in tobacco consumption has not been experienced. Reduced tobacco consumption is a key to improve public health. It is, thus, imperative to understand price elasticity of demand when imposing tax on tobacco to achieve the desired results.
Price Elasticity of Demand
Price elasticity can be defined as decrease in quantity demanded of an economic good with a one per cent increase in its price, all other things being constant. Similarly, price elasticity of tobacco demand refers to decrease in tobacco demand with price increases. The imposition of tax increases price of tobacco for the consumer, ultimately decreasing its demand. To ensure that the tax imposed is effective, it is important to understand the amount of decrease in demand with every unit increase in price.
A report by the World Bank concludes that demand for tobacco is less sensitive to price in developed nations than developing nations. The report shows that price elasticity of demand in developed nations is only 0.4, which means a price increase by ten per cent reduces demand only by four per cent. In developing countries, price elasticity of tobacco demand is 0.8. Research conducted by the World Bank on price elasticity of tobacco demand on youth shows that demand for tobacco declines by ten per cent when price is increased by ten per cent. Youths are more sensitive to price changes and taxes are a bigger deterrent for them.
Importance of Price Elasticity in Determining Tax on Tobacco
Determining price elasticity of demand level is important to understand the impact of tax on tobacco on the overall economy. Broadly, higher tax on tobacco can affect the economy in three ways. Firstly, it may hurt the poor customers. It is evident from the World Bank report that the price elasticity of demand for tobacco is relatively inelastic for the population as a whole, which means that demand will reduce by a lesser degree than increase in price. The demand is even more price inelastic for developed nations. Hence, it is quite possible that instead of reducing demand, the increase in tax on may financially affect the poor customers. With increasing prices, a bigger chunk of customer’s income will be spent on cigarettes and hurt them.
Secondly, tax revenues will reduce with decline in tobacco demand. With increase in tax on tobacco, tobacco demand and sales will decline. Hence, tax revenue collected from value added tobacco products, corporate tax for firms selling tobacco products and income tax for employees of such firms will decrease. This decrease is proportionately higher as compared to the increase in tax revenue from higher tax levied on tobacco.
Thirdly, unemployment will increase with reduction in tobacco demand. The decline in demand will require less staff for manufacturers, distributors and suppliers. This will reduce the per capita income of the economy. This situation can, however, be avoided if consumers spent the extra penny saved, by quitting smoking, to purchase other goods and services. Hence, information of price elasticity of demand is essential to ensure effectiveness of taxes imposed on tobacco. Also, the tax imposed should be fair and not unnecessarily burden the poor.
Analysis of the Article
This section of the paper will discuss the various aspects of increasing tax on tobacco and price elasticity of demand as discussed in the article and its impact on economy.
Adverse Impact of Tax on Poor Tobacco Consumers
The first aspect of price elasticity of demand is based on the premise that the demand for tobacco is relatively inelastic. The same is supported by the World Bank report that shows that price elasticity for tobacco demand is 0.4 for developed nations. It is important to mention here that demand is of three types: need or essential, comfort and luxury. The demand for essential goods or services is less sensitive to price and is inelastic. Tobacco is not an essential commodity and its absence will not threaten life. With increase in prices, demand for tobacco will drastically fall for occasional consumers and youth. But, addiction to tobacco makes its demand relatively inelastic. Those who are addicted to tobacco find it difficult to survive without it. The withdrawal symptoms of quitting smoking are very unpleasant and even those with less disposable income would not be affected much by increases in cigarette prices. These poor consumers will end up paying more taxes and carrying a heavy financial burden on their shoulders.
However, it is important to note that the objective of the policy makers is to improve public health. In that sense, tax on tobacco cannot be unjust and unfair. For an addicted consumer, the present unpleasantness due to withdrawal symptoms overshadows the rational calculation of future adverse financial and health effects of smoking. Until and unless the cost of smoking increases significantly, the realisation may not happen in a consumer. It is, therefore, important to increase prices substantially. Along with this, providing extensive health care support to individuals to cope against the withdrawal symptoms is essential.
Adverse Impact of Decreased Tax Revenue
The decline in demand from increase in tax will reduce the tax revenue for the government. As the tax revenue will decrease, the willingness of government to increase tax on tobacco will also decrease. Thus, the decision of the policy makers to impose additional tax on tobacco is also sensitive to price of tobacco products. The effect of reduction in tax revenue can be countered by promoting health care clinics with extensive support to quit smoking. Advanced clinical research to launch medicines that can more effectively take care of the withdrawal symptoms will be well received by tobacco addicts. These sectors can be profitable in the long run and earn tax revenue for the government. It will also reduce government’s future spending on public health to treat tobacco related diseases. Stringent penalties for public smoking and appropriate checks to ensure the same will increase revenue.
Increase in Unemployment Rate
Unemployment rates increase with decrease in tobacco demand. However, the alternate occupations that will increase the tax revenue in the previous section will also reduce unemployment. Investment in information dissemination about ill effects of smoking will also lead to employment generation.
Conclusion
Price elasticity of demand plays an important role in determining the amount of tax imposed on tobacco. Different groups of people have different levels of price elasticity to tobacco demand and respond differently to rise in tobacco prices. The youth are sensitive to price changes and show a desirable decrease in demand with increase in prices. Occasional smokers also respond well to tobacco price increases. However, the addicted consumers are relatively inelastic to changes in tobacco prices. A unilateral approach of increasing tax will not affect their tobacco consumption behaviour. Also, government in sensitive to price increases as it reduces tobacco demand and tax revenue, and increases unemployment. It is, thus, imperative that the policy makers focus on investment in healthcare, information dissemination and alternate employment generation to cope with the resistance on increasing tax on tobacco.
Works Cited
Brown, Catherine. “Price Elasticity of Demand and Tax on Tobacco”. Articlesalley.com. Web. 7 May 2012.
