Background
Particularly since Taiwan joined the WTO in 2002, the government has been taking serious measures to gain greater control over tobacco usage. The cost of cigarettes to Taiwan consumers has historically been considerably less than that to people in other countries [
1,
2]. On average, 77 minutes of working time is required to purchase one pack of cigarettes in India, 62 minutes in Indonesia, and 56 minutes in China; contrast this with Taiwan where a pack can be bought after only 7 to 10 minutes of work. In 2002, 4.5 million adults in Taiwan were considered smokers, or one in three [
3]. Smoking-related health insurance expenses totaled around NT$20 billion per year, and an additional smoking-related loss in productivity was valued at US$1.032 billion [
4]. As significant an economic burden as this had been, it was obviously worthy of policy attention. Thus, on January 1, 2002, a new tax scheme was enacted in Taiwan.
Taxation on cigarette products is universally recognized as an effective way to reduce tobacco use. In 1999, the World Bank concluded that a 10 percent increase in tobacco price would reduce tobacco use by 4 percent in developed countries and by about 8 percent in developing countries (World Bank, 1999; Chaloupka
et al., 2000) [
5,
6]. Several studies have demonstrated that increased taxes have been particularly effective in reducing tobacco use among youth and young adults [
7‐
10]. The greater effect of higher prices on youth may be a result of lower income, greater peer pressure, less concern about long-term health effects and future health costs, as well as less likelihood of being addicted. Chaloupka and Grossman (1996) used data on over 110,000 eighth-, tenth- and twelfth-grade students to examine the effect price and a variety of tobacco control policies had on youth smoking consumption. They estimated that the overall price elasticity of demand for teenage smokers was -1.31 and concluded that just over one-half of the effect elevated prices had was on the prevalence of smoking among youth. Given that tobacco use among youth is considerably more responsive to price and that most smokers take up smoking before the age of 20, significant increases in tobacco taxes should be effective in producing long-run reductions in smoking among youth.
In most countries, differential taxation rates are applied depending on filter type, cigarette length, size of the relevant factory size, or retail price. A tax incidence can be as low as 8–10 percent of the retail price of domestic hand-rolled
kretek in Indonesia and
cheroots in Myanmar, or as high as 85 percent for imported tobacco in Sri Lanka [
11]. In Taiwan, the new tax scheme, enacted on January 1, 2002, levied a NT$16.8 (where US$1 = NT$34.6) tax excise on each packet. Under this tax scheme, cigarette tax revenues account for 40 percent of the average retail price, approximately NT$42.2 per pack. Added onto the previous NT$11.8 tax on a 20-cigarette pack was an additional NT$5 earmarked as a "Health and Welfare Tax" and 5 percent sales tax. True that a 40 percent increase would be considered high for most other products, but for cigarettes, it is still lower than the 66 percent or more in high-income countries, such as the United States [
6].
In that raising cigarette tax has been proven to be highly effective in reducing cigarette consumption, a cigarette tax increase has become a preferred policy for tobacco control in many countries [
12‐
17]. In the debate on cigarette tax policy, nevertheless, one economic counterargument is that because of the expected reduced consumption, such a tax would eventually lead to a reduction in not only tobacco production but also in tax revenues. In turn, reduced tobacco production would contribute to significant reductions in employment in the tobacco sector, including farming and manufacturing, and other related fields, such as general wholesaling and retailing. Consequently, opponents to cigarette tax increases contend that the adverse impact on the macro-economy should be considered above all else.
Once the new tax was in effect in Taiwan, cigarette consumption plunged almost 25 percent, from 46.3 billion pieces in 2001 to 34.7 billion in 2002. At the same time, the former government tobacco monopoly started to incrementally phase out tobacco production. When the Taiwan market is adjusted to meet WTO conditions, it can be expected that Taiwan tobacco leaf production will continue to fall. One market scenario is that, eventually, low-quality, low-priced tobacco will be imported from non-U.S. sources to compensate for the decreased Taiwan production [
18].
An increase in cigarette taxes can be justified on several grounds. It is a relatively efficient tool for generating tax revenues, an effective approach to improving the overall state of health of the public and reducing health care costs, and an appropriate way to enhance the economic efficiency [
6]. Despite the relatively low price elasticity of demand for tobacco products and the fact that taxes account for a significant share of tobacco price, even a modest tax increase would effectively increase tax revenues. Estimates suggest that in the short-run, a 10 percent increase in cigarette tax would lead to an average increase of nearly 7 percent in cigarette tax revenues [
6].
As a rule, a change in the tax rate levied upon a commodity can lead to smaller, a commensurate, or a greater increase in the retail price of that commodity. In response to increased cigarette taxation, cigarette prices have, in some cases, been found to increase even more than the amount of the tax increase itself [
19]. Recent studies have found, in fact, that prices in Taiwan and South Africa increased by much more than the amount of the increase in tax [
20,
21].
Price elasticity is a particularly important indicator since it measures the effects of a cigarette tax increase on cigarette consumption and government tax revenues. The effect of a price increase on demand depends on cigarette price elasticity – the larger the elasticity is, the greater is the reduction in consumption. Therefore, an estimation of price elasticity is a very important indicator of the extent to which a "Tobacco Health and Welfare Tax" affects cigarette consumption. Used as critical information to adjust the "Tobacco Health and Welfare Tax", price elasticity could help ensure actual policy matches explicit goals.
Using aggregate annual time-series data collected by the Taiwan Wine and Tobacco Bureau, Hsieh
et al. (1999) found the price elasticity of demand was -0.6 for domestic cigarettes and -1.1, for imported ones. This strongly suggests that a tax increase would be more effective in reducing smoking in Taiwan than it would be in most high income countries [
22]. Based on data from a national personal interview survey in 2000 specifically designed to evaluate the effect of the new tax, Tsai
et al. (2002) obtained an average price elasticity of -0.3 for all cigarettes. This was smaller than expected since Taiwan is a highly developed country [
2]. Recently, Lee
et al. (2005) have estimated the demand for cigarettes in Taiwan by using annual time-series data and found a highly significant but negative price effect [
23]. With the estimated price elasticity for domestic and imported cigarettes of -0.644 and -0.822, respectively, those authors have concluded that the tax scheme was able to significantly reduce cigarette consumption. At the same time, they claim, it can be expected that the scheme should generate additional tax revenues. There is little question that with accurate, up- to-date elasticity estimates, the effect of an increase in cigarette tax on cigarette consumption and government tax revenues can be estimated.
The counterargument that a tax increase would lead to reduced employment in many relevant sectors is easily refuted. If resources were not committed to the tobacco sector, they would readily be transferred to other productive economic activities which would in turn generate employment and tax revenues [
6]. Such a shift could actually improve the economy in countries that reallocate the money spent on tobacco in order to increase the production of indigenous goods and services. Consequently, notwithstanding the immediate negligible negative impact on the macro-economy, the long-run impact would likely be positive [
24].
With its aim to devise the most effective policy strategies, the government must take into account the importance of both public health and economic development. Hence, this study investigates the long-term effects of the new cigarette tax scheme in Taiwan on: (1) cigarette consumption and tax revenue; (2) tobacco-related industrial sectors; (3) macroeconomic structure and consumer welfare; and (4) health benefits.
Consumption and tax revenues after the new tax scheme
Before January 1, 2002, the government-run manufacturer, the Taiwan Tobacco and Wine Bureau, was the sole provider of Taiwan's domestic cigarettes. From 1987 to 2002, domestic cigarettes were taxed at NT$10–11 per pack [
25], whereas imported cigarettes were taxed at NT$16.6 per pack. They both were subject to an in-kind tax, i.e., a monopolistic profit, and this explained nearly 47 percent of the retail price [
23]. After Taiwan's entry into the WTO in 2002, the new cigarette tax law imposed an additional tobacco tax of NT$11.8 per pack on both local and imported cigarettes. Thus, the price of local and imported cigarettes rose to NT$35.1 and NT$50.4 per pack, respectively, which represents a total increase of NT$10 for local cigarettes and NT$6 for imported ones.
As for the allocation of funds from the "Tobacco Health and Welfare Tax", there should be none 70 percent goes into a reserve fund for the national health insurance system, while the remaining 30 percent goes to the central government for tobacco hazard prevention and social welfare programs. Using tobacco tax revenues in this way not only discourages smoking, but also provides additional resources to help cover the shortage of funding in the national health insurance system.
To determine the most likely impact of "Tobacco Health and Welfare Tax" increase on the decrease in cigarette consumption and increase in total government tax revenues, in this study, we used 2001 data on price and sales figures. The average annual cigarette consumption of domestic and imported cigarettes in Taiwan was 59.3 and 67.22 packs per capita per year, respectively, for a total of 126.52 packs per capita per year in 2001 [
23]. As a result, prices for local and imported cigarettes rose to NT$35.1 and NT$50.4 per pack, respectively [
23]. This is a rise of NT$10 for local and NT$6 for imported cigarettes. Lee
et al. (2005) estimated price-elasticity for domestic and imported cigarettes at -0.644 and -0.822, respectively [
23]. When these values are extrapolated, authors found an increase of NT$10 for domestic and NT$6 for imported cigarettes resulted in a reduced consumption of 15.21 and 7.51 packs per year per capita, respectively, for an overall average annual reduction of 22.72 packs per person; this represents a total of 1.836 billion packs per year. Lee
et al. (2005) also reported that the government tax revenues would increase to NT$30.849 billion from NT$22.3 billion the year before. Thus, the NT$5 increase in cigarette tax would bring in an extra NT$8.5 billion in tax revenue.
Discussion
Model adequacy
The impact of a tobacco taxation policy is usually based on the adjustment and transmission process via industry and market. In this study, the CGE model was implemented to evaluate the inter-industry relationships within the tobacco market, factors market and intermediate input and income inflow distribution from economic institutes after the tobacco taxation policy. It seems convincing that the tax scheme would influence the structure of the tobacco industry, resource allocation and the redistribution of household income. More importantly, we utilized the CGE model to effectively calculate the causal relation and feedback information system.
Overall, applying the CGE model to quantify the impact of the new tobacco taxation policy on the tobacco industry has four advantages. First, both the macro and micro economic variables in our model estimate the influence of inter-sectors on macro and micro economies, while simultaneously appraising substantial changes in the whole tobacco industry and then predicting further possible developments. Second, our model precisely computes the spillover effects induced by the implementation of the tobacco taxation scheme through the inter-industry relationships from the empirical model. Third, our model includes the interaction between cigarette prices and quantity variables that influence industry resource reallocation after the tobacco taxation increase. It is not necessary to make the design and simulation of the tobacco taxation policy mechanisms difficult. Fourth, by combining the public sector's budget with CGE estimations, government authorities can better comprehend changes brought about by tobacco taxation policy and the causal feedback from cash flows resulting from household consumption, savings and income.
However, our CGE model has some limitations as well. First, the model fails to acknowledge the finite resource base in a real economy. It is not clear the extent to which tobacco industry resources transfer to other industry sectors and contribute to unemployment, how much land there is that is changed for other uses, how much smaller the labor force is, and how much less capital there is that is underinvested after a particular tobacco taxation policy. This could result from the effects of introducing to new cigarette taxation and its influence on inter-industry relationships.
Another weakness of our model lies in its failure to identify the absence of an explicit budgetary constraint for private households. This is because there is no linkage between the sources and uses of income. Thus, if factor returns fall, it is not reflected in reduced consumer expenditures. This limitation is most severe when the shock from the introduction of a tobacco taxation policy is substantial, resulting in income transfers between households with very different consumption patterns. The larger and more complex our model is, the greater the probability will be that inconsistencies exist.
Data quality
In that the data we used to perform our estimations were gathered from official statistical publications, we feel justified to conclude that they adequately manifest their quality. Although the industry relationship tables and capital accumulation matrixes in 1999 are far fewer than those for the base year 2000, they are in agreement with the real economical conditions after repeated collaboration in our model. Our results also attest to the ideal quality of the official statistical data. The replication check and recalibration procedures were conducted repeatedly in order to maintain the validity of the CGE model applied in this paper. Although the results from the CGE model cannot be tested by some specific statistical indicators, we performed some simulation work that showed the validity of the estimated results from our CGE model.
Nevertheless, a problem could possibly exist with the 160 classified sectors in the industry relationship tables for 1999. Some of the sectors had been combined and calculated by government officials. It was impossible to rearrange them to their original form. This could have resulted in some biased empirical results. For example, the degree of impact that the introduction of the tobacco taxation scheme had on the tobacco sector is exhibited as insignificant because its value had been summed into the other special purpose crops. Consequently, the effect of the new taxation scheme on the tobacco sector could have been cancelled out or possibly mixed with the effects on other sectors. Based on the interactions among the different sectors, the more complex the sector classifications are, the closer the empirical results are to the real economy.
Summary
In terms of low price elasticity of cigarette demand and low inter-industry linkages, a rise in cigarette prices caused by the tobacco control policy should only have a negligible negative effect on the domestic macroeconomic structure. Moreover, positive economic benefits have been greatly gained from the enhancement on overall consumer welfare due to the decreased cigarette consumption after the implement of a "Tobacco Health and Welfare Tax". Equally important, the increased tax should reduce the extremely high incidence of death from smoking-related illnesses and increase the overall health benefits to society. Consequently, the strong incentives on the part of the government to implement the cigarette tax scheme as a policy tool for tobacco control seem fully justified.
Conclusion
The main purpose of this study was to analyze the new tobacco tax scheme, introduced in 2002, in terms of the effects it has on the economy and the health benefits it provides in Taiwan by using a CGE model. Based on the results from this model, it is evident that the 2002 tax increase immediately contributes to a NT$8.5 billion increase in government tax revenue but a NT$599 million reduction in factor income from the two tobacco sectors. These sectors could be economically motivated to diversify into other product sectors by being offered short-term, cross-subsidy incentives from the additional tax revenue. No significant impact should result in the transport service, warehousing, retail trade, or advertising services sectors.
In our simulation, the cigarette price increase had only a negligible impact on the overall economic structure. A reduction in cigarette consumption should lead to a slight decrease of around 0.013 percent in GDP. Based on the results, it can be expected that the tax increase should reduce cigarette consumption by 1.836 billion packs in the first year; it should also result in 28,125 to 56,250 lives being saved from tobacco-related illnesses, and total health insurance savings should amount to NT$1.222 to NT$2.445 billion. In all, these health benefits exceed the decrease in GDP. These benefits aside, the rise in cigarette prices should also lead to an NT$13.098 billion increase in household welfare. This could be interpreted as an impressive tenfold counter-effect against the decrease in GDP (about NT$1.275 billion).
Competing interests
The author(s) declare that they have no competing interests.
Authors' contributions
CYY and JML have contributed to designating the study, acquiring the data, conducting the statistical analysis, interpreting the empirical analysis and preparing the manuscript. SHC has contributed to preparing the manuscript and interpreting the empirical analysis. All authors have read and approved the final manuscript.