By Indroneel Das
For a long time, sin taxes have been an effective tool for the government to deploy price-based regulation and to deter people from smoking. The term, ‘sin tax’, essentially refers to any abnormally high tax rate applied to intoxicants. It is applicable on goods whose consumption is generally regarded as being harmful to the immediate consumer, as well as the society as a whole.
Evaluating the impact of sin tax
Sin taxes aim to perpetuate ideal behaviour and goodwill governance, but irrespective of whether they succeed, they work spectacularly well for governments. When the consumers treat their consumption not as discretionary, but almost like a staple good, a certain increase or decrease in taxes will have only the most minor effect on demand. Thus, since cigarettes are more of an addiction, it is difficult to observe any solid rationale behind the recent single day 15% drop in ITC shares, based on the GST Council’s decision to raise the cess on cigarettes.
ITC has almost a monopoly in cigarettes, with a major chunk of its revenue coming from cigarettes. When the GST structure was finalised for implementation, it carried a huge loophole — it did not apply any incremental sin tax on cigarettes. When this news went public, shares of cigarette companies soared and investors in cigarette companies, as well as cigarette manufacturers, rejoiced. However, on July 18, the GST Council intervened and raised the cess on cigarettes as per the GST structure, hitting ITC very hard. Again, sin taxes may or may not work to achieve the end goal, depending on their actual execution under the tax regime.
Are current sin taxes any good?
The Indian government has been applying a tax rate of somewhere between 38% to 40% on cigarettes. The World Health Organisation (WHO) survey numbers indicate that almost 35% of the adult Indian population smokes cigarettes. Also, the Indian government makes about Rs. 30,000 crores annually from tax revenues on their sale. For sin taxes to achieve the desired effect on consumer behaviour, the WHO recommends a tax of around 70% internationally. In India, almost half of the recommended tax rate is applied on cigarettes. One could argue that there is a significant conflict of interest with respect to the government for discouraging smoking, yet, earning from its sales.
The government does bear a heavy cost when the citizens do not give up smoking. The government needs to shell out about Rs. 30,000 crore annually, purely on account of smoking and tobacco related illnesses. From a monetary perspective, the sin tax is revenue neutral. However, a pure revenue and cost perspective does not do justice to the ideology on which the sin tax is based. Although the government does not effectively earn anything out of sin taxing, it is still not fruitful if it does not work accordingly.
Lifting the veil: What is escaping the tax?
Despite the staggering numbers, cigarettes make up only about 15% of the total tobacco products commonly used. Beedi and chewable tobacco consumption is exceeds that of cigarettes, but attracts a significantly lower and more lacklustre tax. The taxes applicable to cigarettes are largely dependent on the length of the cigarette stick. In India, cigarette variants include: less than 65 mm, 65-70 mm, 70-75 mm, 75-80 mm, 80-85 mm, and more than 85 mm. The shorter the length of a cigarette stick, the lesser is the tax rate on it. Cigarette manufacturers in the past have resorted to cutting down on the length of cigarettes or introducing a new range of smaller cigarettes to cater to the price sensitive market segment. Thus, depending on their willingness to pay, cigarette makers have a product for any smoker, thereby destroying the fabric of any operational sin tax.
Furthermore, tobacco is cheap in the country, with tobacco farming being rampant. The cost of tobacco will almost never be a constraint for the manufacturers. It is not possible for the government to apply any restrictions on tobacco farming, owing to the tremendously negative impact it will have economically, as well as from a populist, vote-bank point of view. Hence, the supply of raw materials would not be an issue. Moreover, the cigarette companies have figured out the consumer behaviour and demand perspectives.
Increasing affordability despite rising taxes
In India, looking at the hitherto applicable system of taxes, the data on cigarette prices from 1996 (when sin taxing on cigarettes first became potent) to the current year shows an increase of more than 1600% in taxes (data for shortest, non-filter cigarettes). Hence, it could be deduced that the government has been trying to make cigarettes less and less affordable. However, affordability depends on two things, the amount of money being paid to procure something, and the real value of that amount of money. For cigarettes to actually become more expensive, the prices of cigarettes need to rise upward, faster than the real income. Real income is nominal income adjusted for inflation, which is the true value of the money you hold.
Comparing the WHO’s data of the uptrend of the average real income of Indians and the rise in average taxes on cigarettes, we can see that cigarettes have become almost 200% more affordable currently, as opposed to 1990. Thus, despite the steep rise in cigarette taxation, it has, in fact, become easier on the pocket of the average Indian to smoke a cigarette.
Beedi: an alternative way of ‘sinning’
The demand for cigarettes is more price inelastic in India than in most countries of the world. Price inelasticity means that the demand for a good is rather unresponsive to any price changes. This is due to the availability of a home-grown substitute: the beedi. Beedis are at the bottom-end of the value chain of tobacco products. Being infinitely cheaper and much more abundantly consumed than the cigarette, it distorts the entire sin tax system in place. Beedis are hardly taxed, either due to their lack of compliance or the beedi makers’ ability to evade taxes, through tax loopholes.
Need for a unifying tax
Currently, the peak GST rate of 28 per cent and a cess of 5 per cent would remain. However, specific cess on the basis of the length of cigarettes has been raised. In spite of the recent decision of the GST Council to raise the cess on cigarettes under the GST regime, much more needs to be done. There is an urgent need for a steep, unifying tax on all tobacco products, if not a complete ban. This would ensure that nobody could escape the tax net and chewable tobacco, beedis and cigarette makers and consumers alike, would be bearing the brunt. Only such a step can guarantee that a sin tax actually taxes ‘sinning’.
Featured Image Source: Pexels
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