E LAW - MURDOCH UNIVERSITY ELECTRONIC JOURNAL OF LAW VOLUME 1 NUMBER 4 (DECEMBER 1994) Copyright E Law and/or authors Review of Western Australian State Taxes 1994 Chapter 2 TOBACCO TAXATION Characterisation of Tobacco Industry Price Elasticity of Demand for Tobacco The Legislative Scheme Tobacco Tax - A Case for Regressive Tax Vertical Inequity Horizontal Inequity Regulation or Revenue? The Use of Tax as a Regulatory Tool Does Healthway Achieve its Purpose? Earmarking for Health Promotion Conclusion Bibliography PART I: CHARACTERISATION OF TOBACCO TAXATION Statistics indicate that tobacco smoking constitutes the single greatest cause of preventable disease and premature death in Australia,[1] and is currently the primary cause of cancer deaths among Australian males.[2] When tobacco products are used in the manner in which they are designed to be used, they are potentially dangerous to the health of the smoker, and can be seen as physically and psychologically addictive. In an effort to reduce the social costs of smoking, the government may attempt to regulate consumption through the taxation of tobacco products. The focus of this chapter will be to discuss the regulation of tobacco smoking by the earmarking of tobacco taxes for the purpose of health promotion. It is recognised that a principal aim of tobacco taxation is to generate revenue for government, however. Tobacco taxation can be viewed from three perspectives depending upon the manner in which the purpose of the tax is characterised. Firstly, tobacco taxation may be viewed in a purely fiscal light where the sole purpose of the taxation is to generate funds for the general or specific purposes of government. This perspective conforms with traditional views concerning the purpose of taxation. Secondly, it may be viewed as a corrective tax. The purpose of such a tax is to internalise all possible externalities that may occur as a result of the consumption of the product which bears the tax.[3] The revenue raised through tobacco taxation of this type, should equate as nearly as possible to the total social and economic costs imposed upon the community by the consumption of tobacco. Finally, and for our purposes, tobacco taxation may be seen in terms of a regulatory tax. The goal of such a tax is to regulate the consumption of the particular product upon which it is placed. As such, a regulatory tax is non-economic in nature (as it is based on moral, ethical and paternalistic considerations), and in the context of tobacco, is designed to encourage a reduction in consumption. Price Elasticity of Demand for Tobacco Demand for tobacco products has been shown to be price inelastic in Australia.[4] This means that any increase in the price of tobacco products will see a less than proportionate decrease in the demand for them. The price inelasticity of demand associated with tobacco products is basically attributable to the fact that smoking is an addictive activity, and that tobacco has no direct substitute. The price inelasticity of demand for individual smokers does vary depending upon factors such as price, addiction levels, the age of the smoker, their socio-economic grouping, and their disposable income.[5]A regulatory tax works best when imposed upon products that display price elastic demand. This does not preclude the regulation of a price inelastic good such as tobacco, although the effectiveness of the tax as a regulatory tool is reduced. PART 2: THE LEGISLATIVE SCHEME "Tobacco taxes" are levied in the form of licence fees exacted against tobacco wholesalers and retailers by the Business Franchise (Tobacco) Act 1975 (WA) ("BFTA"). The dichotomy between wholesalers and retailers is not significant for the purposes of the exaction of tax with both groups being subject to a fee of $20 plus 35% of the value of tobacco that they expect to sell during the term of the licence.[6] This value is determined by the Commissioner of Taxation (who is vested with the administration of the BFTA),[7] as a gross amount by reference to the amount sold during the prescribed period immediately preceding the term of the licence.[8]"Earmarking" funds raised by way of taxation means specifically allocating them to a predetermined target. This allocation generally forms an integral part of the taxation scheme, and may constitute one of the significant purposes behind the raising of the taxation. The appropriation of licence fees to an earmarked recipient is controlled by the Tobacco Control Act 1990 (WA) ("TCA"). The primary purpose of the TCA is not, however, taxation oriented. In the words of the preamble, taxation would only be considered as a matter "incidentalto or connected with" the main objectives of the legislation. These are listed in section 3 as: (i) to encourage, particularly young people, not to begin smoking; (ii) to limit the exposure of young people to smoking; (iii) to encourage and assist people to quit smoking; and (iv) to promote good health and the prevention of illness. In the furtherance of these objectives, the TCA establishes the West Australian Health Promotion Foundation ("Healthway").[9] Section 22 of the TCA lists nine objectives of Healthway. In summary they relate to the furtherance of the objectives of the TCA through sponsorship of health promotion activities, particularly sports and arts. The power to make sponsorship grants to suitable bodies is given in section 23.Healthway is funded by tobacco licence fees pursuant to section 26(2) of the TCA: "...(2) There shall in respect of the financial year commencing 1 July 1993 and of each subsequent financial year be paid to the Foundation - (a) an amount equal to 7% of the total amount of fees paid under the Business Franchise (Tobacco) Act 1975 to the Commissioner of State Taxation during that financial year; or (b) $12.9 million, whichever is the lesser amount, and this section appropriates the Consolidated Fund accordingly."[10]The use of this money is tightly controlled by the legislation, and Healthway is closely scrutinised in its application of the moneys to the achievement of its objectives.[11] Section 26(3) requires that the moneys be appropriated to The West Australian Health Promotion Fund at Treasury, and, by section 26(8), that the funds be allocated in each financial year as:(i) not less than 30% to sporting organisations;(ii) not less than 15% to arts organisations;(iii) not more than 50% to the same organisation.It is further provided that any funds not disbursed within four months of the end of the financial year must be returned to the Consolidated Fund.[12]Finally, Healthway is required to publish an annual report detailing its expenditures during the financial year, in relation to the achievements of its purposes.[13] The accountability of the organisation is further ensured through the report of the Auditor General, and the pending report of the Health Promotion and Evaluation Program. PART 3: TOBACCO TAXES - A CASE FOR A REGRESSIVE TAX? In considering the traditional taxation notions of "efficiency", "equity" and "simplicity", it is submitted that efficiency and simplicity are inappropriate criteria by which to evaluate a tax which has a regulatory purpose. Efficiency, in terms of taxation, relates to discouraging a redistribution which results in a distortion of the market. But the very purpose of this regulatory tax is to distort the tobacco market. Simplicity concerns itself with ensuring that the administrative costs of raising the tax do not cut into its desired revenue raising capabilities; regulation has no concern with this. Further, in the context of regulation through earmarking, we are concerned with a later stage of the taxation process than that of exaction. Equity is comprised of two components, vertical equity and horizontal equity. Vertical equity relates to the incidence of a tax burden between different income brackets. Horizontal equity refers to the incidence of a tax upon persons within the same income bracket. They have relevance in examining regulatory taxes as discussed below. Vertical Inequity Given the ability of businesses to raise the retail price of cigarettes, the incidence of such a tax shifts from the distributors or suppliers to the consumers through higher retail prices. Additionally, econometric studies[14] indicate that tax increases may be exaggerated by producers or retailers, resulting in even higher prices.[15]Given that the incidence of tobacco taxes falls primarily on smokers, it follows that the distribution of the tax burden in the general population mirrors the distribution of smokers. As the hazards of smoking have become more widely known, tobacco consumption has decreased more rapidly in higher socio-economic groups.[16] Consequently tobacco consumption has become more concentrated in lower socio-economic groups, such that tax increases, as a proportion of income, fall most heavily on these groups. The Tobacco Institute of Australia argues that the effective increase in tobacco taxation is 2.5 times greater on low income earners than it is on high income earners.[17] As the incidence of tobacco tax is predominantly on the lower socio economic groups, tobacco tax is regressive in nature.[18]Although a regressive tax infringes the principle of vertical equity, the regressive nature of tobacco taxation is essential where the tax is to achieve a regulatory purpose. The tax achieves its regulatory aim by falling more heavily upon lower socio economic groups; that is those who smoke the most. Horizontal Inequity According to traditional taxation concepts, a horizontally equitable tax should have the same incidence upon all individuals within the same income bracket. To achieve a regulatory aim, however, horizontal inequity should be promoted, so that the individuals being regulated are hit more heavily. This will encourage them to quit smoking, and thus reduce the extra tax burden faced by them in comparison to those who do not smoke in the same income bracket. PART 4: REGULATION OR REVENUE? The final section of this paper considers whether revenue from tobacco tax should be earmarked for regulation. The issue raised when considering this is whether the government can, via health promotion, influence the smoking and health habits of Western Australians. In other words, whether earmarking will have the desired effect of reducing smoking within the community, thus achieving the regulatory aims of the tax. The Use of Tax as a Regulatory Tool Theoretically, the most inexpensive and direct way of eliminating the consumption of tobacco would be through prohibition. This measure would affect all consumers of tobacco products equally, but as a matter of public policy, it would seem unlikely that such a measure would ever be introduced given the political ramifications that would accompany such an act. Admittedly, the alternative of regulation through the imposition of a tax is a blunt instrument. But the bluntness of the tool is not sufficient to dismiss its imposition. Furthermore, it is submitted that the earmarking of tobacco taxes for a general health promotion foundation - such as Healthway - has the effect of `sharpening' the regulatory tool. Armed with such funds, Healthway is able to re-channel the moneys into regimes that can influence the smoking habits of particular socio-economic groups. By way of example, the American Heart Association[19] recognises that the imposition of a 10% price increase will result in a 3%-5% decrease in smokers. However, teenagers[20] and low income earners are more responsive to this increase. Higher income earners on the other hand, require additional advertising campaigns to be convinced, since money considerations are not a factor. Does Healthway Achieve its Purpose? Healthway can be seen as a manifestation of the regulatory purpose of tobacco taxation. Although it can be established that Healthway does sharpen the regulative effect of the tax, a question remains as to how successful Healthway is in achieving this purpose. Healthway is the embodiment of "health promotion purposes" in WA. The objectives and scheme by which Healthway operates (as discussed in Part 2) covers the whole playing field of health promotion objectives in this State. Being a relatively new organisation, and because of difficulties in compiling and assessing information concerning its operations, the overall success of the organisation in reducing the incidence of smoking within the community has not yet been fully assessed. The more established Victorian equivalent, Vic Health, however, has revealed that although there has been an overall increase in health awareness within the community, there is no conclusive evidence that the organisation has been responsible for decreases in smoking participation.[21] In light of this, one must question whether the function performed by Healthway is a suitable and effective means of achieving the objective set out in s.3 of the TCA of decreasing smoking levels.Problems are evident in terms of Healthway acting as a tool for reducing the incidence of smoking within the community in the long term. If Healthway is successful, and significantly reduces the consumption of tobacco products in Western Australia, then the funds available to Healthway will be reduced. Alchin[22] has established, however, that anti-smoking promotions only work in the short term. This requires that promotions be continually funded to be effective in permanently reducing smoking . Thus, the funding of Healthway will be cyclic, and it can be argued that this is not in keeping with the goals of the regulation. If we cannot reach a conclusion on the true worth of Healthway, should we then be considering other viable alternatives? Firstly, the government could extend the scope of assistance to people to quit, not just by taxing the consumption of tobacco, but by subsidising the purchase of products aimed at assisting people to quit. Assuming that tobacco taxes would fund the subsidy, this is justifiable, in that it directs the money expended by smokers back to themselves, rather than to the benefit of the community as a whole. Again, however, one must ascertain the medical validity of the products that are subsidised before the approach is undertaken. A second alternative is to stagger taxes so that products with lower levels of nicotine are taxed at a lower rate. This encourages smokers to consume less harmful brands, and eventually to desist with the habit. This argument, it is submitted, fails on several grounds. Firstly, it encourages people to believe that lower nicotine levels are less harmful, where as a matter of public policy, this should be avoided. Secondly, such a system is contrary to all principles of taxation simplicity, as a higher order of administration would be required to identify those products with lower content. Finally, wholesalers may, as a commercial decision, spread the incidence of tax over the retail price of all brands in their range, thus defeating the object of a staggered tax. It thus appears that there is no certain way of eliminating smoking through regulation. In our opinion, the flexibility of Healthway in its application of moneys is its advantage. The TCA requires Healthway to expend money in the furtherance of its objectives, and thus enables it to pursue any method which prevailing trends suggest is the most successful way of attacking smoking as a public health issue. The ancillary benefits to the community cannot be discounted, and are in keeping with the government policy of reducing budgetary health outlays caused by a variety of unhealthy practices. Earmarking for Health Promotion In returning to our original questions, that is, firstly whether the government can through taxes and promotions influence the smoking habits of Western Australians, and secondly if this form of regulation is the most effective way of doing so, several points emerge. It appears that the government, through the combined effect of tax and promotions, influence consumer choices with regard to the purchase of cigarettes. Taxes alone are a very blunt tool, and it may be seen that the channelling of funds toward health promotions sharpens the regulatory tool, and broadens the impact of the tax to socio-economic classes that are unlikely to be influenced by price increases alone. PART 5: CONCLUSION Whether tax revenues are earmarked for health promotion purposes in the end does not come down to a question of economics (although, it is possible to balance externalities against revenue generated) but public policy. Clearly, public policy in modern Australia rests with the reduction of consumption through regulation and health promotion measures. Whether Healthway is the best embodiment of this public policy direction is yet to be seen. BIBLIOGRAPHY ALCHIN, T.M., World Tobacco Taxation: A Summary, University of Western Sydney (Nepean) Department of Economics, Working Paper No. 93/12 December 1993. ALCHIN T.M., A Survey of Some of The Determinants of Demand for Tobacco Products. University of Western Sydney (Nepean), Department of Economics, Working Paper No. WP 93/04, May 1993. ALCHIN, T.M., The New 75 per cent Tobacco Tax in NSW, University of Western Sydney, Nepean, Department of Economics, Working Paper No. WP 92/04, August 1992. ALCHIN, T.M., The Health Promotion Foundations: How Successful are They?, University of Western Sydney, Nepean, Department of Economics, Working Paper No. WP92/03, July 1992. ANDREWS, B. AND ALCHIN T.M., Supply of Tobacco Products. University of Western Sydney (Nepean), Department of Economics, Working Paper No. WP 93/08, September 1993. BORREN P., AND SUTTON M., "Are Increases in Cigarette Taxation Regressive?" Health Economics Vol 1: 245-253 (1992). [Considers economic analysis whether and how regressive tobacco taxes are within various social classes.] COLLINS, D.J. AND LAPSLEY, H.M., Estimating the Economic Costs of Drug Abuse in Australia. Canberra, Department of Community Services and Health (1991). JOHNSON B., "Once an Addict, Seldom an Addict". Contemporary Drug Problems. Vol 7(1978) at pg.35-53. SAMMARTINO, F., The Distributional Effects of an Increased in Selected Federal Excise Taxes, Staff Working Paper, Congressional Budget Office, Washington, (1987). SUMNER, D.A. and WAR, R., "Tax Changes and Cigarette Prices", Journal of Political Economy, Vol 89, 1981: pp.1261-1265. Notes: [1] Andrews, B. and Alchin, T.M., Supply of Tobacco Products. University of Western Sydney (Nepean), Department of Economics, Working Paper No. WP 93/08, September 1993, at pg2. [2] See, Collins, D.J. and Lapsley, H.M., Estimating the Economic Costs of Drug Abuse in Australia. Canberra, Department of Community Services and Health (1991). [3] Alchin, T.M., World Tobacco Taxation: A Summary. University of Western Sydney (Nepean) Department of Economics, Working Paper No. 93/12 December 1993, at pg. 2; such externalities include increased health costs to the community, decreases in employee productivity where the employee smokes. [4] Mcleod, P.B., "Advertising Bans, Tobacco and Cigarette Consumption". Economic Letters, Vol. 20 (1986) at pg 391-396.; Johnson, L.W., "Cigarette Advertising and Public Policy". International Journal of Social Economics Vol. 15(7) [1988] at pg 76-80; Clements, K.W. (et al), Does Advertising Affect Drinking and Smoking? Discussion Paper 85.02, University of Western Australia, 1985; the general conclusion is that the elasticity figure lies somewhere in the range of -0.2 and -0.51. [5] Supra note 3. [6] s.10(2) of the BFTA. [7] s.3 of the BFTA. [8] s.10(2) of the BFTA, read together with the Schedule. [9] See Part 3 of the TCA. [10] As the money is appropriated through the consolidated fund, the money is legally appropriated to Healthway. The only limitation on statutory earmarking of revenue in this way is that it inhibits the government's flexibility of appropriating revenue. [11] s.26(9) of the TCA. [12] s.26(10) of the TCA. [13] See s.26(9). [14] Johnson B., "Once an Addict, Seldom an Addict". Contemporary Drug Problems. Vol 7(1978) at pg.35-53. [15] Sumner, D.A. and War, R., "Tax Changes and Cigarette Prices", Journal of Political Economy, Vol 89, (1981) pgs 1261-1265; the authors suggest, however, that retailers and distributors use the opportunity afforded by an increase in taxes to incorporate their own increases in costs that accrue over time. [16] See, Sammartino, F., The Distributional Effects of an Increased in Selected Federal Excise Taxes, Staff Working Paper, Congressional Budget Office, Washington, (1987). [17] Supra note 3, at pg 29. [18] Borren, P., and Sutton, M., Are Increases in Cigarette Taxation Regressive? Health Economics Vol 1: 245-253 (1992). [19] Steering Committee Coalition on Smoking OR Health "Saving Lives and Raising Revenue: The Case for Major Increases in State and Federal Taxes", January 1993, pg 5. [20] Ibid at page 5. [21] Alchin, T.M., The Health Promotion Foundations: How Successful are They?, University of Western Sydney, Nepean, Department of Economics, Working Paper No. WP92/03, July 1992. [22] Supra note 4 at pgs13-14.