COP6 update: An increase in the excise tax does not reduce government revenue

13 Oct 2014

It is also good for government revenue because, even though tobacco consumption decreases, the percentage increase in the excise tax per unit is greater than the percentage decrease in tobacco consumption.

Recently, Philip Morris International hired the American economist Arthur Laffer to advocate against tax increases on the basis that increases in taxes will reduce revenue. His argument was based on a theory that he developed in the 1980s. It gained prominence in the 1980s and 1990s and often forms the basis of (misplaced) arguments by big business to reduce the tax rate, on the grounds that such a reduction would actually increase tax revenues.

Laffer argued that if the tax rate became “too high”, the government would lose revenue by increasing the tax rate further. At low tax rates, an increase in the tax rate would increase tax revenue. There was supposed to be some turning point on the Laffer curve, beyond which an increase in the excise tax would reduce revenue.

Big business did not mind

The trouble is that one cannot know where that turning point is. On the mistaken belief that income and corporate tax rates were on the “wrong” side of the Laffer curve, many countries reduced their corporate tax rates in the late 1980s and early 1990s, only to find that their revenues decreased. Big business did not mind, but it hurt ministries of finance badly.

The tobacco industry argues that many countries are already beyond the turning point of the Laffer curve, in terms of their tobacco taxation. In general, there is no truth in this.

The only countries that have experienced a decrease in their tobacco excise tax revenue are those that have been able to significantly reduce tobacco consumption, often through other means (e.g. legislative interventions such as clean indoor air policies, advertising bans and plain packaging).

Very few countries could not benefit

There are very few countries where the excise tax is so high that an increase in the excise tax would cause government revenue to decrease.

South Africa is a prominent example. Between 1990 and 2012, excise taxes per pack increased by 552 percent in real terms (i.e. adjusting for the effect of inflation). During the same period, real excise tax revenues increased by 283 percent. In contrast, in the 1970s and 1980s real excise revenue decreased quite sharply because the real excise tax per pack of cigarettes decreased.

The industry’s argument that an increase in the excise tax will reduce excise tax revenue in the short term is typical industry scare mongering, and is contradicted by an overwhelming body of empirical evidence.

*This article was first published in the FCA Bulletin at COP6.

Read more Bulletin articles on our COP6 resources page

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