Tobacco products are the most heavily taxed consumer goods in the world, with taxes often exceeding half of the retail price, generating more than $200 billion dollars in tax revenues for governments every year.
Governments use tobacco taxes to achieve multiple objectives. Excise taxes and other fiscal measures are used by governments to generate revenue. Fiscal measures can be used to further public health objectives by reducing tobacco consumption. Fiscal policy is, for instance, a central feature of the World Health Organization’s Framework Convention for Tobacco Control (FCTC). Article 6 of the FCTC states, “Price and tax measures are an effective and important means of reducing tobacco consumption by various segments of the population, in particular young persons.”
In general, governments levy three types of tax on tobacco:
- excise tax—a selective consumption tax, usually applied to alcohol, tobacco, and fuels, and in some countries to a wider range of products such as soft drinks, coffee, and tea;
- customs duties, which apply to imported goods only; and
- value added tax (VAT)—a general consumption tax that applies to all goods and services.
Cigarette excise taxes can be structured in different ways. Some countries, such as Australia, South Africa, or Norway, levy a ‘specific’ tax, which is a monetary amount per cigarette. Other countries, such as Thailand, Paraguay, Venezuela, and Bosnia, levy an ‘ad valorem’ tax, which is calculated as a percentage of the price. These tax systems are known as ‘single tier’ systems, because all cigarettes are subject to a single tax rate (either specific or ad valorem).
Many countries have introduced systems that are more complicated. Quite common are the so-called ‘multi-tiered’ systems, which divide cigarettes into a number of categories (for instance based on retail price, the length of the cigarettes, or the packaging type), establishing a different tax rate for each category.
‘Mixed’ tax systems are also common. They combine a specific and an ad valorem component. All European Union countries must adopt mixed tax systems. Countries outside the E.U. with mixed tax systems include Switzerland, Russia, Ukraine, and Mexico. Many countries with ad valorem or mixed structures also apply a ‘minimum excise tax,’ which guarantees a minimum tax amount per cigarette, irrespective of the tax structure adopted.
Minimum Excise Tax
Many countries with ad valorem excise taxes have adopted a minimum excise tax in an effort to protect excise revenues and public health objectives. Minimum excise taxes guarantee a minimum tax income on each pack of cigarettes, regardless of their retail sales price. They also limit the tax advantage that ad valorem excise taxes provide to lower-priced brands, and thus help prevent the proliferation of cheap cigarettes which undermine public health.
As of January 2011, 24 of the 27 European Union countries apply minimum excise taxes, including Germany, Greece, Italy, Netherlands, Poland, Spain, and France. Countries in other parts of the world that have adopted a minimum excise tax include Argentina, Israel, Russia, Switzerland, Turkey, and Ukraine.
Different tax structures can result in large differences in cigarette price levels within each country and between different countries. Under a specific tax system, for instance, all cigarettes in a country pay the same tax amount. With an ad valorem system, on the other hand, low-priced cigarettes pay less excise tax compared to premium (higher quality and priced) cigarettes, which drives larger price differences. The chart below shows the excise tax on low-priced cigarettes as a percentage of the excise tax paid by premium-priced cigarettes in several countries.
Tobacco products other than cigarettes (cigars, cigarillos, fine-cut tobacco for the hand-rolling of cigarettes, pipe tobacco, snus, chewing tobacco, and so on) are subject to excise taxes in most (but not all) countries. However, most countries tax these other tobacco products at much lower tax levels compared to manufactured cigarettes. The following chart compares the tax level on cigarettes and fine-cut tobacco (‘roll-your-own’ tobacco) for some E.U. countries.
Fiscal policy should be used to achieve both revenue generation and public health goals. As recognized by public health experts, fiscal measures, such as tax and price measures, are a key component of a comprehensive tobacco policy.
We do not, however, support excessive tax increases which can have the adverse effect of undermining public health objectives. Governments must strike a balance between maintaining taxes at levels that achieve their policy objectives and not making tobacco products unaffordable for adult smokers. Finding this right balance will depend on many local factors. As the International Monetary Fund has stated, “Ultimately, tobacco excise tax rates must reflect the purchasing power of the local consumers, rates in neighboring countries, and, above all, the ability and willingness of the tax authority to enforce compliance.”
One key factor in deciding on the right tax rate is the potential impact that tax increases have on the development of illicit trade. It is clear that illicit trade is driven by a large number of factors including excessive taxation. Although it is possible to maintain high tax levels without a corresponding high level of smuggling, tax remains a key incentive and therefore an important factor in regard to illicit trade in tobacco products. Moreover, governments must have the capacity, willingness, and ability to enforce the laws and control their borders. Experience shows that adopting a policy of gradual, regular tax increases combined with effective measures to counter illicit trade is the optimal way for governments to meet both revenue and health objectives, while reducing the risk of stimulating and fostering the illegal market.
Governments should not only consider the optimal tax level—it is more important to adopt the right tax structure. The wrong tax structure can merely encourage a shift in demand to lower-taxed cigarettes or other tobacco products. As a guiding principle, we believe that there is no public health basis for a tax system that drives consumers to lower-priced brands when it is well established that there is no safe cigarette. That is why we generally support specific tax structures, minimum excise taxes, and harmonization of taxes for manufactured cigarettes and other lit-end tobacco products such as fine-cut tobacco.
 Curbing the Epidemic, 1999, the World Bank. Appendix A, A view from the International Monetary Fund.