Australia's Future Tax System

Final Report: Detailed Analysis

Chapter E: Enhancing social and market outcomes

E6. Tobacco taxation

E6–1 Why tax tobacco?

The benefits that smokers get from smoking may include immediate pleasure, control of stress, improved self-image and the avoidance of withdrawal symptoms. The costs borne by smokers are primarily the cost of buying tobacco products and, in some cases, serious illness and premature death. Tobacco is a major cause of heart disease (including heart attack), lung cancer, chronic obstructive pulmonary disease (including emphysema) and stroke. Smoking is estimated to have accounted for around 15,000 deaths in Australia in 2003 (Begg et al. 2007). Giving up smoking considerably reduces the chances of serious disease. One study suggests that 4 per cent of quitters will avoid a heart attack, lung cancer, chronic obstructive pulmonary disease or stroke that they would have suffered had they continued to smoke for the next ten years (Hurley & Matthews 2007).

Smokers suffer self-control problems

Tobacco differs from most goods in that its consumption poses self-control problems for most consumers and causes very substantial harm to many consumers. These problems do not by themselves mean that consumers are unable to make decisions about tobacco consumption that give them the most satisfaction over time. Even if a prospective smoker takes into account the chances of becoming addicted, the costs of addiction and the risky costs of consumption, choosing to consume may still be consistent with deriving the greatest available satisfaction over time (Stigler & Becker 1977).

However, there is strong evidence that this 'rational addiction' model does not accurately represent most smokers' choices. First, not only do most smokers become addicted but most addicted smokers display time-inconsistent preferences. That is, they weigh consumption in the present heavily and costs and benefits in the future less heavily. As each day arrives, their preferences shift to give a heavier weight to costs and benefits on that particular day — that is, their preferences change over time (Gruber & Köszegi 2001). A consumer with such preferences may be able to see that their lifetime satisfaction would be increased by giving up smoking and decide to give up smoking at some time in the future, but when the time to give up arrives, they may find themselves unwilling to put their plan into action. Smokers set up commitment mechanisms to help them overcome their inconsistent preferences — betting with others, advertising their decision to friends and relatives or joining a support group — but these are often ineffective. Between 2000 and 2005, about two-thirds of smokers in Victoria attempted to quit but only 30 per cent of these were successful (Brennan et al. 2007).

Second, the decision to start smoking is usually taken by young people. In Australia in 2004, the average age of initiation among those who had ever smoked was 16 (AIHW 2005). In the US, around three quarters of smokers begin smoking before the age of 19 (Gruber 2002). There is also evidence that young people are well informed about the health risks associated with smoking but underestimate how addictive it is. In research from the United States, 60 per cent of adolescents and 48 per cent of adults agreed with the statement 'I could smoke for a few years and then quit if I wanted to' (Arnett 2000).

Third, many daily cigarette smokers support an increase in cigarette taxes, under certain conditions. A Victorian survey in 2008 found that 61 per cent of current smokers supported an increase in tobacco taxes, provided that some of the money was used to fund services to help smokers quit (McCarthy 2009). Evidence from the US and Canada suggests that smokers in jurisdictions with high tobacco taxes are happier than those in low tax jurisdictions (Gruber & Mullainathan 2002). It is unusual for consumers to support higher taxes on a product that they consume themselves, or to be happier in the presence of higher taxes on such a product, and this provides further support for the view that some smokers see higher prices as an incentive to implement their plans to give up smoking.

Individual consumers are usually the best judges of how to spend their money on goods and services of any type ('consumer sovereignty'). But as smoking is addictive, accompanied by inconsistent consumer preferences and predominantly taken up by minors, the government has a legitimate role in mitigating the costs that smoking imposes on smokers themselves.

An important consequence is that tobacco taxes should be set to reduce the costs that smokers impose on themselves and others, not to raise as much revenue as possible. Tobacco taxes can raise significant amounts of revenue but this is only a by-product of their primary purpose.

Principles

Consumer sovereignty is an important principle that underlies much tax policy design.

Several factors justify government intervention to reduce tobacco consumption. First, tobacco is strongly addictive. Second, its consumption is accompanied by inconsistent preferences — smokers place a heavier weight on the current day's costs and benefits than on any other day's. As a result, preferences shift from day to day. Third, smoking is extremely harmful to many long term smokers. Fourth, most people who become addicted do so before the age of 18.

Smokers also impose costs on others

Smokers sometimes impose costs on others. The costs of passive smoking include the costs of disease and premature death caused by passive smoking, as well as the difficult-to-measure discomfort of those exposed to others' smoke. The US Surgeon General has concluded that 'exposure of adults to second-hand smoke has immediate adverse effects on the cardiovascular system and causes coronary heart disease and lung cancer' (US Department of Health and Human Services 2006). A recent assessment by Collins and Lapsley (2008b) concluded that second-hand smoke caused the deaths of 149 Australians in 2004–05.

Babies born to smokers weigh on average about 200 grams less than babies born to non-smokers (US Department of Health and Human Services 2004). Babies with low birth weight have poorer average health outcomes than other babies. Babies of Australian women who smoke during pregnancy are twice as likely as other babies to have low birth weight (less than 2.5 kilos) and are more likely to require special care (Laws et al. 2006).

Which costs are private and which are external will be affected by funding arrangements in the health sector. Given Australia's current health care funding arrangements, only a small proportion — around 17 per cent of all health care costs — is met by individuals themselves. The remainder is met by taxpayers through the public health system, by health fund members and by employers through workers' compensation premiums (AIHW 2008b). In any given year, a smoker's healthcare is likely to cost more on average than that of a non-smoker of the same age and sex. However, because smokers tend to die earlier than non-smokers, the lifetime healthcare costs of smokers and non-smokers in high-income countries may be fairly similar. Quantitative studies have reached conflicting conclusions (World Bank 1999).

Taxation is one method of addressing spillover costs but is not necessarily the best instrument available. For example, recent restrictions on smoking in restaurants, shops, workplaces, bars and other public places have reduced non-smokers' exposure to second-hand smoke, though non-smokers may still be exposed to significant levels of smoke in the home.

Principles

The costs that smoking imposes on non-smokers further support the case for government intervention.

Taxation may be an appropriate policy choice where it is an effective way for the government to achieve its objectives in a market for specific goods and services and where the costs and benefits of taxation compare favourably with available alternatives.