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	Murdoch University Electronic Journal of Law

E LAW - MURDOCH UNIVERSITY ELECTRONIC JOURNAL OF LAW
VOLUME 1 NUMBER 4 (DECEMBER 1994)
Copyright E Law and/or authors

Review of Western Australian State Taxes 1994
Chapter 2 TOBACCO TAXATION

Characterisation of Tobacco Industry
Price Elasticity of Demand for Tobacco
The Legislative Scheme
Tobacco Tax - A Case for Regressive Tax
Vertical Inequity
Horizontal Inequity
Regulation or Revenue?
The Use of Tax as a Regulatory Tool
Does Healthway Achieve its Purpose?
Earmarking for Health Promotion
Conclusion
Bibliography

PART I: CHARACTERISATION OF TOBACCO TAXATION

Statistics indicate that tobacco smoking constitutes the single greatest
cause of preventable disease and premature death in Australia,[1] and is
currently the primary cause of cancer deaths among Australian males.[2] When
tobacco products are used in the manner in which they are designed to be
used, they are potentially dangerous to the health of the smoker, and can
be seen as physically and psychologically addictive. In an effort to reduce
the social costs of smoking, the government may attempt to regulate
consumption through the taxation of tobacco products.

The focus of this chapter will be to discuss the regulation of tobacco
smoking by the earmarking of tobacco taxes for the purpose of health
promotion. It is recognised that a principal aim of tobacco taxation is to
generate revenue for government, however.

Tobacco taxation can be viewed from three perspectives depending upon the
manner in which the purpose of the tax is characterised. Firstly, tobacco
taxation may be viewed in a purely fiscal light where the sole purpose of
the taxation is to generate funds for the general or specific purposes of
government. This perspective conforms with traditional views concerning the
purpose of taxation.

Secondly, it may be viewed as a corrective tax. The purpose of such a tax
is to internalise all possible externalities that may occur as a result of
the consumption of the product which bears the tax.[3] The revenue raised
through tobacco taxation of this type, should equate as nearly as possible
to the total social and economic costs imposed upon the community by the
consumption of tobacco. Finally, and for our purposes, tobacco taxation may
be seen in terms of a regulatory tax. The goal of such a tax is to regulate
the consumption of the particular product upon which it is placed. As such,
a regulatory tax is non-economic in nature (as it is based on moral,
ethical and paternalistic considerations), and in the context of tobacco,
is designed to encourage a reduction in consumption.

Price Elasticity of Demand for Tobacco

Demand for tobacco products has been shown to be price inelastic in
Australia.[4] This means that any increase in the price of tobacco products
will see a less than proportionate decrease in the demand for them. The
price inelasticity of demand associated with tobacco products is basically
attributable to the fact that smoking is an addictive activity, and that
tobacco has no direct substitute.

The price inelasticity of demand for individual smokers does vary depending
upon factors such as price, addiction levels, the age of the smoker, their
socio-economic grouping, and their disposable income.[5]A regulatory tax
works best when imposed upon products that display price elastic demand.
This does not preclude the regulation of a price inelastic good such as
tobacco, although the effectiveness of the tax as a regulatory tool is
reduced.

PART 2: THE LEGISLATIVE SCHEME

"Tobacco taxes" are levied in the form of licence fees exacted against
tobacco wholesalers and retailers by the Business Franchise (Tobacco) Act
1975 (WA) ("BFTA").

The dichotomy between wholesalers and retailers is not significant for the
purposes of the exaction of tax with both groups being subject to a fee of
$20 plus 35% of the value of tobacco that they expect to sell during the
term of the licence.[6] This value is determined by the Commissioner of
Taxation (who is vested with the administration of the BFTA),[7] as a gross
amount by reference to the amount sold during the prescribed period
immediately preceding the term of the licence.[8]"Earmarking" funds raised by
way of taxation means specifically allocating them to a predetermined
target. This allocation generally forms an integral part of the taxation
scheme, and may constitute one of the significant purposes behind the
raising of the taxation. The appropriation of licence fees to an earmarked
recipient is controlled by the Tobacco Control Act 1990 (WA) ("TCA"). The
primary purpose of the TCA is not, however, taxation oriented. In the words
of the preamble, taxation would only be considered as a matter
"incidentalto or connected with" the main objectives of the legislation.
These are listed in section 3 as:

(i) to encourage, particularly young people, not to begin smoking;

(ii) to limit the exposure of young people to smoking;

(iii) to encourage and assist people to quit smoking; and

(iv) to promote good health and the prevention of illness.

In the furtherance of these objectives, the TCA establishes the West
Australian Health Promotion Foundation ("Healthway").[9] Section 22 of the
TCA lists nine objectives of Healthway. In summary they relate to the
furtherance of the objectives of the TCA through sponsorship of health
promotion activities, particularly sports and arts. The power to make
sponsorship grants to suitable bodies is given in section 23.Healthway is
funded by tobacco licence fees pursuant to section 26(2) of the TCA:

"...(2) There shall in respect of the financial year commencing 1 July 1993
and of each subsequent financial year be paid to the Foundation -

(a) an amount equal to 7% of the total amount of fees paid under the
Business Franchise (Tobacco) Act 1975 to the Commissioner of State Taxation
during that financial year; or

(b) $12.9 million,

whichever is the lesser amount, and this section appropriates the
Consolidated Fund accordingly."[10]The use of this money is tightly
controlled by the legislation, and Healthway is closely scrutinised in its
application of the moneys to the achievement of its objectives.[11] Section
26(3) requires that the moneys be appropriated to The West Australian
Health Promotion Fund at Treasury, and, by section 26(8), that the funds be
allocated in each financial year as:(i) not less than 30% to sporting
organisations;(ii) not less than 15% to arts organisations;(iii) not more
than 50% to the same organisation.It is further provided that any funds not
disbursed within four months of the end of the financial year must be
returned to the Consolidated Fund.[12]Finally, Healthway is required to
publish an annual report detailing its expenditures during the financial
year, in relation to the achievements of its purposes.[13] The accountability
of the organisation is further ensured through the report of the Auditor
General, and the pending report of the Health Promotion and Evaluation
Program.

PART 3: TOBACCO TAXES - A CASE FOR A REGRESSIVE TAX?

In considering the traditional taxation notions of "efficiency", "equity"
and "simplicity", it is submitted that efficiency and simplicity are
inappropriate criteria by which to evaluate a tax which has a regulatory
purpose.

Efficiency, in terms of taxation, relates to discouraging a redistribution
which results in a distortion of the market. But the very purpose of this
regulatory tax is to distort the tobacco market.

Simplicity concerns itself with ensuring that the administrative costs of
raising the tax do not cut into its desired revenue raising capabilities;
regulation has no concern with this. Further, in the context of regulation
through earmarking, we are concerned with a later stage of the taxation
process than that of exaction.

Equity is comprised of two components, vertical equity and horizontal
equity. Vertical equity relates to the incidence of a tax burden between
different income brackets. Horizontal equity refers to the incidence of a
tax upon persons within the same income bracket. They have relevance in
examining regulatory taxes as discussed below.

Vertical Inequity

Given the ability of businesses to raise the retail price of cigarettes,
the incidence of such a tax shifts from the distributors or suppliers to
the consumers through higher retail prices. Additionally, econometric
studies[14] indicate that tax increases may be exaggerated by producers or
retailers, resulting in even higher prices.[15]Given that the incidence of
tobacco taxes falls primarily on smokers, it follows that the distribution
of the tax burden in the general population mirrors the distribution of
smokers. As the hazards of smoking have become more widely known, tobacco
consumption has decreased more rapidly in higher socio-economic groups.[16]
Consequently tobacco consumption has become more concentrated in lower
socio-economic groups, such that tax increases, as a proportion of income,
fall most heavily on these groups. The Tobacco Institute of Australia
argues that the effective increase in tobacco taxation is 2.5 times greater
on low income earners than it is on high income earners.[17] As the incidence
of tobacco tax is predominantly on the lower socio economic groups, tobacco
tax is regressive in nature.[18]Although a regressive tax infringes the
principle of vertical equity, the regressive nature of tobacco taxation is
essential where the tax is to achieve a regulatory purpose. The tax
achieves its regulatory aim by falling more heavily upon lower socio
economic groups; that is those who smoke the most.

Horizontal Inequity

According to traditional taxation concepts, a horizontally equitable tax
should have the same incidence upon all individuals within the same income
bracket. To achieve a regulatory aim, however, horizontal inequity should
be promoted, so that the individuals being regulated are hit more heavily.
This will encourage them to quit smoking, and thus reduce the extra tax
burden faced by them in comparison to those who do not smoke in the same
income bracket.

PART 4: REGULATION OR REVENUE?

The final section of this paper considers whether revenue from tobacco tax
should be earmarked for regulation. The issue raised when considering this
is whether the government can, via health promotion, influence the smoking
and health habits of Western Australians. In other words, whether
earmarking will have the desired effect of reducing smoking within the
community, thus achieving the regulatory aims of the tax.

The Use of Tax as a Regulatory Tool

Theoretically, the most inexpensive and direct way of eliminating the
consumption of tobacco would be through prohibition. This measure would
affect all consumers of tobacco products equally, but as a matter of public
policy, it would seem unlikely that such a measure would ever be introduced
given the political ramifications that would accompany such an act.

Admittedly, the alternative of regulation through the imposition of a tax
is a blunt instrument. But the bluntness of the tool is not sufficient to
dismiss its imposition. Furthermore, it is submitted that the earmarking of
tobacco taxes for a general health promotion foundation - such as Healthway
- has the effect of `sharpening' the regulatory tool. Armed with such
funds, Healthway is able to re-channel the moneys into regimes that can
influence the smoking habits of particular socio-economic groups. By way of
example, the American Heart Association[19] recognises that the imposition of
a 10% price increase will result in a 3%-5% decrease in smokers. However,
teenagers[20] and low income earners are more responsive to this increase.
Higher income earners on the other hand, require additional advertising
campaigns to be convinced, since money considerations are not a factor.

Does Healthway Achieve its Purpose?

Healthway can be seen as a manifestation of the regulatory purpose of
tobacco taxation. Although it can be established that Healthway does
sharpen the regulative effect of the tax, a question remains as to how
successful Healthway is in achieving this purpose. Healthway is the
embodiment of "health promotion purposes" in WA. The objectives and scheme
by which Healthway operates (as discussed in Part 2) covers the whole
playing field of health promotion objectives in this State.

Being a relatively new organisation, and because of difficulties in
compiling and assessing information concerning its operations, the overall
success of the organisation in reducing the incidence of smoking within the
community has not yet been fully assessed. The more established Victorian
equivalent, Vic Health, however, has revealed that although there has been
an overall increase in health awareness within the community, there is no
conclusive evidence that the organisation has been responsible for
decreases in smoking participation.[21] In light of this, one must question
whether the function performed by Healthway is a suitable and effective
means of achieving the objective set out in s.3 of the TCA of decreasing
smoking levels.Problems are evident in terms of Healthway acting as a tool
for reducing the incidence of smoking within the community in the long
term. If Healthway is successful, and significantly reduces the consumption
of tobacco products in Western Australia, then the funds available to
Healthway will be reduced. Alchin[22] has established, however, that
anti-smoking promotions only work in the short term. This requires that
promotions be continually funded to be effective in permanently reducing
smoking . Thus, the funding of Healthway will be cyclic, and it can be
argued that this is not in keeping with the goals of the regulation. If we
cannot reach a conclusion on the true worth of Healthway, should we then be
considering other viable alternatives? Firstly, the government could extend
the scope of assistance to people to quit, not just by taxing the
consumption of tobacco, but by subsidising the purchase of products aimed
at assisting people to quit. Assuming that tobacco taxes would fund the
subsidy, this is justifiable, in that it directs the money expended by
smokers back to themselves, rather than to the benefit of the community as
a whole. Again, however, one must ascertain the medical validity of the
products that are subsidised before the approach is undertaken.

A second alternative is to stagger taxes so that products with lower levels
of nicotine are taxed at a lower rate. This encourages smokers to consume
less harmful brands, and eventually to desist with the habit. This
argument, it is submitted, fails on several grounds. Firstly, it encourages
people to believe that lower nicotine levels are less harmful, where as a
matter of public policy, this should be avoided. Secondly, such a system is
contrary to all principles of taxation simplicity, as a higher order of
administration would be required to identify those products with lower
content. Finally, wholesalers may, as a commercial decision, spread the
incidence of tax over the retail price of all brands in their range, thus
defeating the object of a staggered tax.

It thus appears that there is no certain way of eliminating smoking through
regulation. In our opinion, the flexibility of Healthway in its application
of moneys is its advantage. The TCA requires Healthway to expend money in
the furtherance of its objectives, and thus enables it to pursue any method
which prevailing trends suggest is the most successful way of attacking
smoking as a public health issue. The ancillary benefits to the community
cannot be discounted, and are in keeping with the government policy of
reducing budgetary health outlays caused by a variety of unhealthy
practices.

Earmarking for Health Promotion

In returning to our original questions, that is, firstly whether the
government can through taxes and promotions influence the smoking habits of
Western Australians, and secondly if this form of regulation is the most
effective way of doing so, several points emerge. It appears that the
government, through the combined effect of tax and promotions, influence
consumer choices with regard to the purchase of cigarettes. Taxes alone are
a very blunt tool, and it may be seen that the channelling of funds toward
health promotions sharpens the regulatory tool, and broadens the impact of
the tax to socio-economic classes that are unlikely to be influenced by
price increases alone.

PART 5: CONCLUSION

Whether tax revenues are earmarked for health promotion purposes in the end
does not come down to a question of economics (although, it is possible to
balance externalities against revenue generated) but public policy.
Clearly, public policy in modern Australia rests with the reduction of
consumption through regulation and health promotion measures. Whether
Healthway is the best embodiment of this public policy direction is yet to
be seen.

BIBLIOGRAPHY

ALCHIN, T.M., World Tobacco Taxation: A Summary, University of Western
Sydney (Nepean) Department of Economics, Working Paper No. 93/12 December
1993.

ALCHIN T.M., A Survey of Some of The Determinants of Demand for Tobacco
Products. University of Western Sydney (Nepean), Department of Economics,
Working Paper No. WP 93/04, May 1993.

ALCHIN, T.M., The New 75 per cent Tobacco Tax in NSW, University of Western
Sydney, Nepean, Department of Economics, Working Paper No. WP 92/04, August
1992.

ALCHIN, T.M., The Health Promotion Foundations: How Successful are They?,
University of Western Sydney, Nepean, Department of Economics, Working
Paper No. WP92/03, July 1992.

ANDREWS, B. AND ALCHIN T.M., Supply of Tobacco Products. University of
Western Sydney (Nepean), Department of Economics, Working Paper No. WP
93/08, September 1993.

BORREN P., AND SUTTON M., "Are Increases in Cigarette Taxation Regressive?"
Health Economics Vol 1: 245-253 (1992). [Considers economic analysis
whether and how regressive tobacco taxes are within various social
classes.]

COLLINS, D.J. AND LAPSLEY, H.M., Estimating the Economic Costs of Drug
Abuse in Australia. Canberra, Department of Community Services and Health
(1991).

JOHNSON B., "Once an Addict, Seldom an Addict". Contemporary Drug Problems.
Vol 7(1978) at pg.35-53.

SAMMARTINO, F., The Distributional Effects of an Increased in Selected
Federal Excise Taxes, Staff Working Paper, Congressional Budget Office,
Washington, (1987).

SUMNER, D.A. and WAR, R., "Tax Changes and Cigarette Prices", Journal of
Political Economy, Vol 89, 1981: pp.1261-1265.

Notes:

[1] Andrews, B. and Alchin, T.M., Supply of Tobacco Products. University of
Western Sydney (Nepean), Department of Economics, Working Paper No. WP
93/08, September 1993, at pg2.

[2] See, Collins, D.J. and Lapsley, H.M., Estimating the Economic Costs of
Drug Abuse in Australia. Canberra, Department of Community Services and
Health (1991).

[3] Alchin, T.M., World Tobacco Taxation: A Summary. University of Western
Sydney (Nepean) Department of Economics, Working Paper No. 93/12 December
1993, at pg. 2; such externalities include increased health costs to the
community, decreases in employee productivity where the employee smokes.

[4] Mcleod, P.B., "Advertising Bans, Tobacco and Cigarette Consumption".
Economic Letters, Vol. 20 (1986) at pg 391-396.; Johnson, L.W., "Cigarette
Advertising and Public Policy". International Journal of Social Economics
Vol. 15(7) [1988] at pg 76-80; Clements, K.W. (et al), Does Advertising
Affect Drinking and Smoking? Discussion Paper 85.02, University of Western
Australia, 1985; the general conclusion is that the elasticity figure lies
somewhere in the range of -0.2 and -0.51.

[5] Supra note 3.

[6] s.10(2) of the BFTA.

[7] s.3 of the BFTA.

[8] s.10(2) of the BFTA, read together with the Schedule.

[9] See Part 3 of the TCA.

[10] As the money is appropriated through the consolidated fund, the money is
legally appropriated to Healthway. The only limitation on statutory
earmarking of revenue in this way is that it inhibits the government's
flexibility of appropriating revenue.

[11] s.26(9) of the TCA.

[12] s.26(10) of the TCA.

[13] See s.26(9).

[14] Johnson B., "Once an Addict, Seldom an Addict". Contemporary Drug
Problems. Vol 7(1978) at pg.35-53.

[15] Sumner, D.A. and War, R., "Tax Changes and Cigarette Prices", Journal of
Political Economy, Vol 89, (1981) pgs 1261-1265; the authors suggest,
however, that retailers and distributors use the opportunity afforded by an
increase in taxes to incorporate their own increases in costs that accrue
over time.

[16] See, Sammartino, F., The Distributional Effects of an Increased in
Selected Federal Excise Taxes, Staff Working Paper, Congressional Budget
Office, Washington, (1987).

[17] Supra note 3, at pg 29.

[18] Borren, P., and Sutton, M., Are Increases in Cigarette Taxation
Regressive? Health Economics Vol 1: 245-253 (1992).

[19] Steering Committee Coalition on Smoking OR Health "Saving Lives and
Raising Revenue: The Case for Major Increases in State and Federal Taxes",
January 1993, pg 5.

[20] Ibid at page 5.

[21] Alchin, T.M., The Health Promotion Foundations: How Successful are
They?, University of Western Sydney, Nepean, Department of Economics,
Working Paper No. WP92/03, July 1992.

[22] Supra note 4 at pgs13-14.