Consumption Tax on Unhealthy Goods

Economics of Consumption Tax on Unhealthy Goods.

Introduction:

Unhealthy consumption prevails in the fields of nutrition, energy and transport. Taxing is one a solution to provide a healthier living. With globalization, qualities of goods do fail to meet the international standards. International movements of goods which damage health are increasing with Cross border marketing, promoting unhealthy behaviours of alcohol and tobacco consumption and unhealthy diets. (Richard Smith, 2003). The report narrows down to Daily life consumption of tobacco and alcohol considering the impact of individual's income, price of the produce and the substitutions available briefing on supply and demand. The taxing of unhealthy goods is segmented under consumption taxation rather than on income. For addictive goods, the level of consumption today not only causes harm tomorrow, but also increases the marginal benefit of future consumption. Literally every country charges through some sort of ad valorem tax through value added tax, sales tax or an expenditure tax.

Economic Models to study Demand for Cigarettes:

Studies on demand for cigarettes have applied several types of economic models to different types of data with various estimation techniques. In general, two types of economic models are used: the conventional demand model and the addictive demand model. These models have been applied to two types of data: aggregate level data including time-series data for a single geographical unit and pooled cross-sectional time-series data, and individual level of survey data.

Conventional demand models which use aggregate data normally specify the demand equation in a way that the quantity of cigarettes demanded is a function of cigarette prices, income, tobacco control policies and a variety of socioeconomic and demographic factors. But there are two exceptions (Baltagi and Goel, 1987; Peterson et al., 1992), in which a quasi-experiment approach was used to compare changes in cigarette consumption in states in the United States that have raised cigarette taxes to consumption in states where taxes have not changed. A small but growing number of studies have used data on individuals taken from large-scale surveys (Lewit et al., 1981; Lewit and Coate, 1982; Grossman et al., 1983; Chaloupka and Pacula, 1998; Farrelly et al., 1998). These studies differ from those using aggregated data, in that they normally estimate a two-part model, by estimating firstly the probability that an individual will smoke and, secondly, the level of consumption among smokers. The conventional demand model does not account for the addictive nature of cigarette smoking.

There are several versions of the addictive model that have been used for studying the demand for cigarettes: the imperfectly rational addiction model, myopic addiction model and rational addiction model (Chaloupka and Warner, 1999). The rational addictive model is the most recent model used for modelling demand for cigarettes (Becker and Murphy, 1988; Becker et al., 1991; Pekurinen, 1991; Chaloupka, 1990, 1991, 1992; Keeler et al., 1993). The rationality here simply implies that individuals incorporate the interdependence between past, current, and future consumption into their utility maximization processes. This is in contrast to the assumption, implicit in myopic models of addictive behaviours, that future implications are ignored when making the current decision. Empirically, the demand equation is specified as the quantity of cigarettes demanded in the current period being a function of both past and future consumption as well as those other factors included in the conventional demand model.

Becker and Murphy (1988) and Becker et al. (1991) developed several hypotheses from the basic rational addiction model. First, the quantities of the addictive good consumed in different time periods are complementary. As a result, current consumption of an addictive good is inversely related to not only the current prices of the good, but also to the all past and future prices. Consequently, the long-term effect of a permanent change in prices will exceed the short-term effect. Moreover, the ratio of the long-term to short-term price effect increases as the degree of addition rises. In addition, the model predicts that the impact of an anticipated price change will be greater than that of a comparable un-anticipated price change, while a permanent price change will have a larger impact on demand than a temporary price change. Finally, price responsiveness varies with time preference: addicts with higher discount rates will be more responsive to changes in money prices that those with lower discount rates.

Specific variables included in the demand model of each study vary, depending on the economic model used and the availability and type of the data. Important factors that have been evaluated include costs of cigarette smoking, consumers' income, cigarette advertising and other promotion activities, and health information. The cost of cigarette smoking should be defined broadly, including not only the purchase price of cigarettes, but the time and other costs associated with smoking. Restrictions on smoking in public places and private work sites, for example, impose additional costs on smokers by forcing them outdoors to smoke, by increasing the time and discomfort associated with smoking, or by imposing fines for smoking in restricted areas. Similarly, limits on access to tobacco by youth may increase the time and potential legal costs associated with smoking.

Supply and Demand- Price Elasticities :

Cigarette consumption is found to be negatively related to price. The estimated price elasticity from those studies using aggregated data varies from -0.14 to -1.23, but most fall in the narrower range from -0.3 to -0.5, including the result from the two quasi-experimental studies (Baltagi and Goel, 1987; Peterson et al., 1992). The estimated price elasticities from the studies using individual-level data, in general, are comparable to those estimates from the studies using the aggregate data.

Nearly all of the studies of the price-demand relationship focus on the developed countries. Warner (1990) argued that price responsiveness in less developed countries is likely to be greater than in more developed countries, given the relatively low incomes and relatively lower level of cigarette consumption by smokers in poor countries.

Are young smokers more or less sensitive to prices?

The question of whether youth are more or less responsive to prices than are adults has been examined in a number of studies using individual-level data (Lewit, et al., 1981; Lewit and Coate, 1982; Grossman et al., 1983; Chaloupka, 1998). Findings from those studies are mixed. The earlier studies on this issue found that youth are more sensitive to prices than are adults. This result, however, was challenged by the study done by Wasserman et al. (1991), which found that the price responsiveness of youth was not significantly different from that of adults. Recent studies of youth and young adult smoking (Chaloupka and Grossman, 1996; Farrelly et al., 1998; Tauras and Chaloupka, 1998) generally supported the earlier results that the price sensitivity of cigarette demand was inversely related to age. Those recent studies estimated the price elasticity of demand for cigarettes by youth was between -1.1 and -1.3, very similar to -1.44 estimated Lewit et al. in1981.

The price responsiveness of sub-population groups by income levels has been investigated by a number of researchers (Chaloupka, 1991; Townsend et al., 1994; Farrelly et al., 1998). Results from those studies indicate that cigarette demand is less price elastic for more educated or higher income individuals.

The economics of “sin taxes”:

Economists always draw sharp distinction between private costs and benefits and externalities. Where goods generate externalities when consumed, and where consumers make well informed, rational choices, efficient consumption choices would be made if tax levied at rate equal to marginal external cost.

The 3 main categories of smoking and drinking externalities:

-Direct externalities like Costs of passive smoking, Injury to victims of alcohol-fuelled violence and accidents.

-Costs of collectively-funded medical treatment and care- Treatment of the individual smoker / drinker for tobacco / alcohol -related conditions, other differences in medical treatment and care costs arising from individual consumption.

-Other net public expenditure effects like forgone pensions and revenue effects.

Under perfect competition the supply curve is the marginal cost to the firms in the business. Any costs that are borne by neither the seller nor the buyer must be added to these costs to create the social cost of the good. On the assumption that the only people who benefit from the consumption of the goods are the consumer themselves, the demand curve is the social benefit curve.

So, instead of coming to the market solution of a price-quantity combination P*-Q*, the socially optimal combination is P`-Q`. That is, if there is a market for a good where some of the costs spill over to others, then the market will produce too much of the good and charge too little for it.

Modeling Taxes - Government Intervention

To correct an externality, we can tax the osffending good, we can limit its use, and we can forbid its use. Of these options, taxes are most appealing to economists, as they allow people who are willing to pay all of the costs of their consumption to go ahead and consume. Using taxes in this way has the positive effect of discouraging those people who are not willing to pay the costs from becoming consumers of the undesirable or unhealthy good.

When a tax is imposed on a good, this will have the effect of shifting the supply curve upwards by the amount of the tax. In the case of a specific tax, it will be a parallel shift, since the amount of the tax is the same at all prices. In the case of an advalorem tax, the curve will swing upwards. At a zero price there would be no tax and hence no shifts in the supply curve. As price rises, so the gap between the original and new supply curves will widen, since a given percentage tax will be a larger absolute amount the higher the price.

The curve shift upwards by the amount of the tax because the firm is persuaded to produce the same quantity as before the imposition of the tax(Q1),and they must now receive a price which allows them fully to recoup the tax they have to pay(P1 + tax).

The effect of the tax is to raise price and reduce quantity. Price will not rise by the full amount of the tax, however, because the demand curve is downward sloping. The price rises only to P2. Thus the burden or incidence of such taxes is distributed between consumers and producers. Consumers pay to the extent that price rises. Producers pay to the extent this rise in price is not sufficient to cover the tax.

Discussions

Increase in price of A will Increase the demand for B and vice versa. High taxation should relatively increase the consumption of quality goods. When related with the income of the general public the consumption is high when the income is high and would prefer luxury products over cheaper items. The availability of alternatives impact the consumption behaviour, people move towards cheaper produces. The consumption level is cut-down by stages and level of quitting or rehabilitation stages increase with alcohol than cigarettes with a relative cheaper price tag (diminishing marginal rate of substitution). The alternative of direct consumption of tobacco (oral or nasal stuffs) are taxed less than the branded cigarettes for example, some tax higher tar and nicotine cigarettes at higher rates than lower tar or nicotine cigarettes, while others impose lower taxes on smaller and/or filtered cigarettes than on longer and/or unfiltered cigarettes. The structure of tobacco taxes in most countries is a mix of both specific and ad valorem taxes that varies across tobacco products. (Frank J. Chaloupka et al) The consumption levels are just a trade-off between the available choices. The positive effect of tax is over powered by the illegal substitutes of drugs and addictive consumption. In addition, many suggest that ad valorem taxes are likely to lead to reductions in average product quality as producers and consumers switch to lower cost tobacco products (Barzel, 1976; British American Tobacco, 1994; Sobel and Garrett, 1997). The high market price will catalyze higher criminal activities as it becomes a habit to consume illegal products with the demand being almost constant.

With increase in price the supply tends to increase. But in the addictive market, the supply curve facing issues of quality uncertainty tends to move upward depicting the decrease in supply even if the product is in the thick market. The supply curve literally becomes vertical reflecting on whatever the price market will bear even in the presence of multiple entrants. In the short run, with the demand being highly in-elastic, suppliers would enjoy setting up high price benefit from a high margin of profit after tax. Fluctuating around the firms' marginal cost, higher prices does not bring in extra supply power. Rather excise tax on tobacco and alcohol are highly regressive in a longer-run where it is a loss to the firm making to exit from the industry. A tax increases the cost of selling each unit of a product and therefore usually decreases the willingness of sellers to supply given quantities. (Joseph J. Cordes et al, 2005). The higher the price elasticity of supply of a good or service, the greater the excess burden of a tax on its sale and vice versa.

Conclusion:

One can conclude the inelasticity of the demands for unhealthy goods (tobacco and alcohol) increases the consumption taxation as a whole with increase in revenue for the government. On a long run, chances are high for a shift towards elastic demand with respect to the prices. This allows a room for thinking for the policy makers to improve on the taxation procedure by concentrating on the supply side more than the consumer side of the market.

References:

Becker GS et al. (1991). ‘Rational addiction and the effect of price on consumption'. American Economic Review . Vol. 81 (2),pp. 237-41.

Becker GS, et al (1994). ‘An empirical analysis of cigarette addiction'. American Economic Review. Vol.84(3), pp. 396-418.

Becker & Murphy KM (1988). ‘A theory of rational addiction'. Journal of Political Economy. Vol. 96(4), pp. 675-700

Chaloupka FJ.(1991). ‘Rational addictive behavior and cigarette smoking'. Journal of Political Economy .Vol.99(4),pp.722-42.

Chaloupka FJ.(1998). ‘The Impact of Proposed Cigarette Price Increases'. Policy Analysis No. 9, Health Sciences Analysis Project. Washington: Advocacy Institute.

Chaloupka FJ & Pacula RL. (1998). ‘An Examination of Gender and Race Differences in Youth Smoking Responsiveness to Price and Tobacco Control Policies'. National Bureau of Economic Research Working Paper No. 6541.

Chaloupka FJ, Warner KE .(1999). ‘The economics of smoking'. In: Newhouse JP, Culyer AJ, editors. The Handbook of Health Economics. Ediiton.1, Chapter.29, pp.1539-1627.

Chaloupka FJ, Wechsler H.(1997). ‘Price tobacco control policies and smoking among young adults'. Journal of Health Economics. Vol.16(3), pp.359-73.

Peter Earl, Tim Wakeley (2005).Business Economics: A Contemporary Approach. Berkshire: McGraw - Hill Education.

Frank, R. (2008). ‘The Economic Naturalist: Why Economics Explains Almost Everything'. Virgin Books.

John Sloman (2000). Economics. (Fourth Edition). Essex.: Prentice Hall.

Joseph et al(2005). ‘Encyclopedia of taxation and tax policy'. (Second Edition). Washiington.: Urban Institute Press

Mirrlees, J., (2000). ‘What taxes should there be?'. Paper Presented at the 7th Annual Conference, Toulouse, France. March 24.

Robert C. Guell (2005). ‘Issues in Economics Today' (Second Edition). New York.:Tata Mcgraw Hill -Irwin

Selected case studies: ‘Issues in the global tobacco economy'. Food and Agriculture Organization of the United Nations,Rome, 2003.

Please be aware that the free essay that you were just reading was not written by us. This essay, and all of the others available to view on the website, were provided to us by students in exchange for services that we offer. This relationship helps our students to get an even better deal while also contributing to the biggest free essay resource in the UK!