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Duterte approves higher excise tax for tobacco products

Under the new law, excise tax on cigarettes will go up to P45 from P35 starting
January 1, 2020, to be followed by more increases in succeeding years

Published 6:47 PM, July 25, 2019

MANILA, Philippines – President Rodrigo Duterte signed into law the bill raising
excise tax for tobacco products, a measure he certified as urgent last May.

"To address the urgent need to protect the right to health of the Filipino people and to
maintain a broader fiscal space to support the implementation of the Universal Health
Care Act, the President has signed into law HB (House Bill) No. 8677 or SB (Senate
Bill) No. 2233 increasing the excise tax on tobacco products," said Executive
Secretary Salvador Medialdea on Thursday, July 25.

The law, Republic Act No. 11346, raises cigarette tax from the current P35 to P45 for
the first year of implementation. This will be followed by 5-peso increases every year
until the rate reaches P60 in 2023.

Starting 2024, a 5% increase would be imposed annually.

Here is the schedule:

 January 1, 2020 - P45/pack
 January 1, 2021 - P50/pack
 January 1, 2022 - P55/pack
 January 1, 2023 - P60/pack
 January 1, 2024 onwards - 5% indexation

The measure is expected to generate P15 billion in revenue in 2020 and P140 billion
until 2023. – Rappler.com
MICROECONOMICS COMMENTARY
By: JOSH VIR

The article talks about a raise in excise taxes on cigarettes in the Philippines. It is an
effort by the government to reduce cigarette consumption, which is a demerit good.
The excise tax is being increase from its current peso 35/pack to peso 60/pack in
2023 with subsequent 5% increase every year after that. Note, an excise tax is any
levy on manufactured goods, which is levied at the moment of manufacture, rather
than at sale.

Cigarettes are demerit goods that are over-provided by the market and whose
consumption is harmful to not just the people addicted to consuming it but also to the
passive smokers around them. They thus produce a negative externality where the
costs (represented as negative benefits) lead to marginal social benefits being lower
than the marginal private benefits.

Smoking in the short run provides private benefit to the consumer since given its
addiction it gives him relief from experiencing withdrawal symptoms. However in the
long run continued consumption of cigarettes causes major health issues for the
consumer leading to increase in healthcare spending, as well as lower workplace
productivity.

As you can see clearly illustrated in the Fig.1. attached below there is a problem with
the over-allocation of resources as Qm (or Market Quantity) exceeds Qopt (or Optimum
Quantity). This overconsumption leads to market failure and external costs. Welfare
loss (as seen in the figure below) is the negative externality that is resulting from the
overconsumption of cigarettes.

Fig.1: Negative Consumption Externalities (for Cigarettes)

The PED of cigarettes also comes into play as cigarettes are inelastic products given
their addictive nature to smokers and as such the increase in prices of the additional
excise tax may not have the desired effect since even if price increases quantity
demanded may decrease by only very little in the short run.

The Philippine government has seen the ill effects of smoking on their general
population. It is not just the smokers that are affected by adding to their overall
healthcare costs but also the passive smokers who add to the external costs. Seeing
these negative external costs as a result of overconsumption of cigarettes, the
Philippines government has decided to put an excise tax on each pack of cigarette
sold. The excise tax will almost be doubled in the span of 4 years. The net impact on
the price increase for the consumer per pack of cigarettes will be around 30%. The
government hopes that in doing so they may discourage people from buying
cigarettes.

A common argument against cigarette taxation is on socio-economic grounds.

Typically lower income groups smoke far more than people falling within the higher
income categories. And as such this raises a concern that that any further tax will be
excessively burdensome for those within the lower income brackets. This certainly
brings to light the regressive nature of taxes on cigarettes. The lower income groups
are extremely price sensitive and this very argument of a price increase can act as
an effective self-control device because it will have more of the desired effect of
reducing their smoking.

Fig. 3: The Effect of imposing an excise tax on cigarettes

Fig-3 above is a better representation of the effect of an indirect tax (such as excise
tax) on the marginal private cost of the production of cigarettes. The increase in
excise tax reduces the overall Supply (the Supply curve moves to the left), and in
doing so also raises the marginal private cost (to MPC + tax), which is now higher
than the marginal social cost.

For the consumers, the tax increases the price to Pc – the price that consumers have
to now pay to buy the reduced quantities at Qopt. The suppliers of cigarettes
meanwhile collect Qopt at Price Popt – reflecting an overall decrease in overall sales as
a portion of it is paid to the government in taxes. The government meanwhile collects
the difference between Consumer Price and Supplier price at the reduced quantities
(Pc less Popt) x Qopt.

There are many disadvantages of the excise tax being added by the Philippine’s
government. The first one being that income inequality may increase due to the fact
that taxes such as excise tax are often regressive due to the fact that the rich and the
poor have to pay the same amount per pack of cigarettes. This leads to the poor
shelling out far more as a share of their incomes than the rich. This can also lead to
lower living standards as more of the disposable income of the poor consumers will
be taken and many of those who smoke are from the lower income categories.

Another disadvantage could be that the reduction of cigarette consumption would be

low in the short run. This is due to the fact that price elasticity of demand is inelastic
for cigarettes due to their addictive nature. And so, the government may not achieve
its objective, which is to discourage the people from the use of cigarettes.

It may also increase unemployment as producers will earn lower revenues leading
them to have to cut costs to make the same level of profits and since many of those
who work in the cigarette industry are from a manufacturing level whom can easily be
replaced as they are unskilled labor. It will be hard for them to find other jobs since
their skills are focused in only one industry. The government will also now have to
contend with greater unemployment and connected social consequences.
However, there are also advantages of raising the excise tax by the Philippine
government. One is that because PED is inelastic the government will be able to
raise greater revenue, as the demand will remain almost the same given the
addictive nature of cigarettes. And the government can reinvest this excess money
into other social projects like healthcare or infrastructure.

There will also be a greater reduction of smoking in the long run. As seen in the
article tax rates will continue to rise over the subsequent years making cigarettes
more expensive to those low-income consumers. There will come a price threshold at
which some would not be able to afford cigarettes. This will lead to a reduction in the
number of smokers, thus reducing the external costs.

In conclusion, while the consumption of cigarettes may not decrease in the short run
because of its addictive nature. In the long run the price thresholds and the continual
increase of the tax rates will deter potential customers to start consuming cigarettes
and the old customers from lower income groups will have to think twice before
buying more cigarettes. Thus, in the long run it will achieve the government’s goal of
reducing cigarette consumption in the Philippines.