By an IPS research team

The Sri Lankan economy is at a critical juncture where urgent measures are needed to improve the country’s fiscal situation. The Sri Lanka Institute of Policy Studies (IPS) has argued that increasing tobacco taxation has clear health and tax benefits. In this context, policy solutions, such as tobacco taxation, which can be used to increase government revenue without threatening economic growth, are essential. This blog argues that the 2023 budget should introduce an indexation model that automatically links tobacco tax increases to the size of the economy and inflation. This would generate substantial additional revenue through excise tax on cigarettes.

The right time to raise taxes

The current economic crisis and intense pressure on the healthcare system means there is no better time to raise tobacco taxes in Sri Lanka. Among the benefits of increased tobacco taxes are the generation of additional revenue for the government, widespread public support for an increase in tobacco taxes, and a reduction in the burden on the ailing health system in the United States. Sri Lanka.

A tax targeting a “product of sin” like tobacco will contribute to the government’s ongoing efforts to help raise revenues without increasing the costs of essential goods at a critical time for the economy. According to a poll conducted by the Alcohol and Drug Information Center (ADIC) in September 2021, 91.5% of respondents said they would support an increase in tobacco taxation to increase government revenue. As a result, it is a fiscal measure that the government can introduce that will enjoy near universal public approval. In addition, bringing down tobacco consumption by raising prices, especially of the most harmful cigarettes, will reduce tobacco-caused diseases and ease the strain on the health system as Sri Lanka’s health system faces serious medical shortages due to the economic crisis.

A complex tobacco tax system

Taxation is internationally recognized as the most cost-effective way to reduce tobacco consumption, given the revenue generated by tobacco taxation. The World Health Organization Framework Convention on Tobacco Control (WHO FCTC) recommends simple, inflation-adjusted taxes to reduce tobacco use and prevalence. In the past, in line with these global best practices, Sri Lanka has taken several positive steps to combat smoking including tax increases resulting in significant increase in government revenue as public health benefits to the people .

Sri Lanka, however, has complex tobacco taxation practices in place. Cigarettes in Sri Lanka are taxed at five different excise duty rates depending on the length of the cigarette. Additionally, in Sri Lanka, tobacco taxation has not kept pace with inflation and per capita income, which has made cigarettes more affordable. This had adverse health effects and deprived the government of considerable revenue, which could have been invested in key priorities.

Introduce a single tax on cigarettes

To help alleviate the current budgetary difficulties, an ongoing IPS study recommends the introduction of a single tax for cigarettes of all lengths (accompanied by regulations limiting the length of cigarettes to 84 mm, the cigarette the longest currently sold on the market), which is adjusted annually for inflation and GDP growth the introduction of a single tax on cigarettes, regardless of their length, will make cigarettes less affordable to the young and the poor (see Figure 1 for more information). For example, if a single tax was implemented in 2021, all cigarettes would have cost at least LKR 57, which would reduce the affordability of all cigarettes. Thus, the formula would ensure that taxes are increased consistently and that cigarettes remain unaffordable for the most vulnerable, namely the young and the poor.

The risk of beedi substitution is a commonly used argument against increasing cigarette taxes. An ongoing IPS study, however, provides a counter-argument through cross-price elasticity analysis, which finds that if cigarette prices rise, tobacco smokers are unlikely to replace cigarettes by beedi.

Benefits of introducing a tax formula for cigarettes

Revenue gains: IPS estimates that the government could have gained almost LKR 23.6 billion in additional excise duty revenue if a single excise tax for cigarettes of all lengths had been introduced under the formula in 2021.

Health Benefits: Raising taxes is the most effective way to reduce tobacco consumption. This will help reduce the adverse health effects of tobacco use, alleviate pressures on the health care system, reduce health costs associated with tobacco use, and reduce the adverse effects of tobacco use on income Household. IPS estimates that if a single tax for all cigarettes had been in place since 2018, the number of cigarettes sold would have decreased by nearly 157 million sticks. In addition, the current price is very affordable and could encourage young people to start smoking, which would lead to additional burdens on the health system. As such, the introduction of regulations to limit the length of cigarettes to 84mm would ensure that cigarettes remain unaffordable.

Public support: A tax increase targeting a “product of sin” can generate revenue without increasing the cost of essential goods. As such, this tax increase is likely to enjoy broad public support.

Go forward

Given the current economic crisis and given that cigarette taxes have not been systematically reviewed over time, the government could use this opportunity to introduce a simple formula to increase taxes to double benefit of improved health and fiscal outcomes.

Link to original blog: https://www.ips.lk/talkingeconomics/2022/11/10/taxing-tobacco-why-the-2023-budget-should-increase-tobacco-taxes/