The European Union (EU) has been one of the world’s champions of high cigarette excise taxes. Thanks in part to its Tobacco Tax Directive, the EU is the region with the highest average cigarette prices in the world. As we wrote in a previous blog post, the European Commission is, encouragingly, working on a possible revision of the Directive.
There are few challenges that the Commission faces in the Directive revision process. The first one is the rising anti-European sentiment in Europe. Euroskeptics, who largely oppose any new regulation coming from Brussels, are now prominent in national governments of many EU Member States. In May 2019, the European Union holds its next parliamentary elections, which will inevitably bring power shifts to the European government.
The other challenge to the Commission is the rhetoric spread mainly by the tobacco industry, which states that the only result of higher tobacco tax is that some smokers switch to illicit or other tax-non-paid cigarettes. Instead of lower tobacco consumption and higher government revenue, the higher taxes benefit only those who circumvent them.
New timely evidence that is highly germane to the revision process has just been published in the Tobacco Control journal. The study by American Cancer Society researcher, Michal Stoklosa, uses 2004-2017 official European Commission data and a methodology developed by Nobel prize-winning economist, Gary Becker, to disentangle the effects of higher cigarette prices on cigarette demand in the EU. Specifically, the study examines the effects of cigarette prices on tax-paid sales as well as on cross-border shopping in the EU using econometric modelling of cigarette demand.
The study results suggest that the tobacco industry has part of its story right. The differences in cigarette prices across EU Member States encourage cross-border cigarette purchases. Proximity to countries with lower cigarette prices provides opportunity for legal cross-border shopping and facilitates illegal activities, such as reselling legally-purchased cross-border cigarettes.
But that’s all for the accuracy of the tobacco industry narrative. In reality, there is no reason for alarm. The problem of tax avoidance and evasion resulting from the proximity to countries with lower cigarette prices is small. In an average EU country, only about 1.5% of tax-paid sales is missing due to cross-border purchasing from neighboring countries with lower cigarette prices. In addition, the effect is only significant for EU internal, land borders. The study shows no influence of prices on cross-border purchasing across maritime borders and across borders (of any kind) with non-EU neighbors.
More importantly perhaps, even with some cross-border cigarette purchasing, high cigarette prices are still highly effective in discouraging consumption. The study finds that, on average, a 10% increase in cigarette prices results in a 3.5% to 4.7% decline in cigarette sales. This means that increasing cigarette prices by one euro per pack from its current average across all EU Member States would result in about 40 billion fewer cigarettes smoked each year. The estimated values of price elasticity also suggest that the next tax increases in the EU will bring, on average, additional tax revenue to the treasuries.
The newly-published study provides some useful guidelines for European policymakers. The study shows that the policymakers should ignore the tobacco industry’s alarmist narrative of rising tax avoidance and evasion. The scale of cross-border cigarette purchasing in the EU is small and an upward convergence of cigarette prices across EU Member States would further significantly reduce the problem. As per the cross-border purchasing in the non-EU, neighboring countries, the effects of larger price differences between the EU and its neighbors are statistically not significant in the study. There are likely other factors influencing illicit cigarette trade from countries outside the EU.
Foremost, further cigarette price increases in the EU would improve public health by contributing to decreases in overall cigarette consumption, generating large benefits to the health of EU residents and to the sustainable development of the Union through lower healthcare costs and higher economic productivity from a healthier population. Because the study finds higher income to be associated with higher cigarette sales, future tax increases need to account for the effects of growing income, to make cigarettes less affordable over time.
Read more about illicit trade in tobacco products here.
Download data set used in this study.
Read full article: Stoklosa M. (2018) Prices and cross-border cigarette purchases in the EU: evidence from demand modelling. Tobacco Control Published online first on 14 December 2018. http://dx.doi.org/10.1136/tobaccocontrol-2018-054678