Smoking is down but it’s still bringing in big bucks for the government

When I see someone smoking, I tend to scowl as I pass through the putrid cloud they’re creating. But next time I might offer to shake their hand. Because smokers are almost single-handedly propping up our nation’s fiscal situation.

When smokers hand over $23 a packet for their death sticks they share a great deal of that expenditure with the rest of us. The excise on tobacco in Australia is $1076 a kilogram, or 80.7 cents per cigarette. And it is rising, again, by a whopping 12.5% in September this year.

Smoking is in major decline in Australia, at 16% for men and 12% for women. We are leaders in plain packaging and we have some of the lowest smoking rates in the world. So checking the tobacco numbers in the latest  budget was a serious surprise.

Tobacco excise revenue is extremely high this financial year, at $12.8 billion a year. That’s more than double the $6 billion in excise revenue from petrol, even though petrol is used by a much larger group of people. It is also almost triple the amount of excise raised on beer and spirits ($4.8 billion). In fact, smokers pay 13.7% as much tax as companies, which seems amazing.

But next financial year it will be even higher. Tobacco excise revenue in 2019-20 lifts to $17.4 billion. That’s an extra $4.6 billion in revenue — the majority part of Treasurer Josh Frydenberg’s $7.1 billion surplus. Without this extra contribution from smokers his surplus would be what the commentators like to call “razor thin”.

So where is it coming from? How can you get a 36% rise in tobacco excise revenue while Australians continue to give up the darts? The answer involves organised crime.

Chop-chop

Australia is awash in illegal tobacco. This is the side-effect of taxing legitimate tobacco so heavily — if cigarettes can be bought in China for $3 a pack and sold in Australia for $23 a pack, it is worth shipping them here on the sly.

Two years ago, the government set up an investigation into Australia’s so-called “black economy” and it made many recommendations. One of the big ones was to point out how huge was the market in black market cigarettes and “chop-chop” (rough illegal tobacco).

The government began a crackdown and it is next financial year that the windfall of that crackdown is expected to arrive. One of the changes is technical but meaningful — tobacco will now be taxed when it comes into the country rather than when it leaves the warehouse. That prevents imported tobacco from going wandering from the warehouse, undermining the legitimate market in tobacco. These rules come into effect in 2019-20 and they are an absolute boon for the nation’s finances.

Can tobacco tax be too high?

Have you read The Great Gatsby? The novel is set during Prohibition — the era in which the United States banned alcohol. Gatsby hosts parties where illegal booze flows like water — and the money that flows from illegal booze disrupts society. This is part of a pattern. Prohibitions of all sorts are beginning to be seen as costly. The war on drugs, for example, is increasingly seen as a failure.

Cracking down on anything too hard has costs and consequences that are finally being recognised. Using the law to ban things or tax things is, unfortunately, not a free kick.

For a great example we need only look at molasses tobacco — the kind of tobacco used in a shisha pipe. In 2012 the government moved to tax it by weight instead of tobacco content. Because it is moist it is very heavy and the tax became sky high. Legal molasses tobacco promptly became impossible to find while the illegal kind boomed. According to one estimate published by the Australian Government’s Black Economy Task Force, just one legal tonne of the stuff is imported for every 1000 tonnes consumed.

What this means is we can’t expect to lean on ever-higher taxes to eradicate smoking. There is a level above which they do more to create an illegal market than to encourage health. Carving out lucrative markets for organised crime — especially cushy ones where the legal downsides are so much smaller than for drug importation — is totally counterproductive.

There is a “right” level of smoking taxes, which means that, like it or not, there is probably a “right” level of smoking.

Substitution effect and income effect

The right level of tobacco taxes should not only take into account organised crime. It should also be set so it doesn’t make an addict’s life impoverished.

When tobacco excise rises, it does two things. It makes some people smoke less, which is good and the intention of the policy. This is called the substitution effect. Anyone who doesn’t cut back, however, simply gets poorer. This is called the income effect and it is the disappointing downside of the policy.

From a non-smoking, middle-class viewpoint it is easy to cheer the receding tide of smoking and cry for it to be chased over the horizon with ever higher taxes. But we need to think about the income effect when we increase tobacco taxes. With smoking rates already driven so low, the remaining percentage of those who smoke include a lot of disadvantaged people. If this group will not give up, raising excise just soaks them and leaves them with less money for food, rent, medical care and petrol.

Australia regularly runs a brilliant household expenditure survey that finds out who is spending what. In it, tobacco stands out in flashing neon. Not only does the lowest income quintile spend more on tobacco than the highest income quintile as a proportion of their income, but they also spend more in absolute terms. In no other category is that true. (For alcohol, by contrast, the top quintile spends five times as much as the bottom quintile.)

Taxing tobacco is unquestionably an effective public health intervention. But it is also a big tax on the poor. And we should remember that when we see the Treasurer smiling about his surpluses.