1. Introduction
The Korean cigarette price (encompassing all taxes and charges imposed on cigarettes) has remained at 2,500 won per pack after a 200 won hike in 2002 and a 500 won hike in 2005. A proposal for another 500 won increase was announced in July this year, but it was turned down due to the fear of a possible rise in commodity prices. However, it should be kept in mind that a pack of cigarettes costs 13.3 USD in Norway, 9.8 USD in the UK, 5.72 USD in the US, and 2.11 USD in Korea, as of 2010. Furthermore, Korea's Esse brand cigarettes cost 2,500 won per pack, which is the lowest among OECD member countries. On the other hand, the smoking rate of adult males in Korea stands at 41%, significantly higher than the OECD average (26%).
While a cigarette price increase is being proposed to lower the nation's smoking rate, some argue against the proposal on the grounds of the possible rises in commodity prices it may incur. According to the Korea Institute for Health and Social Affairs, the reasonable cigarette price in Korea in 2012 should have been 4,500 won when taking into account the incomes and cigarette prices of 19 European countries. Despite this, the Ministry of Health and Welfare announced that it would be unlikely to raise cigarette prices this year due to the possibility of affecting the low-income bracket.
This report aims to address the pros and cons of cigarette tax increases, examine the impact of a cigarette price increase on public finance, and highlight its implications.
2. Role of Smoking in Driving Up Healthcare Expenses
It has been shown that smoking incurs additional healthcare expenses. As much as 4.6% of healthcare expenses covered by health insurance (for those aged 20 and older) arises from smoking. This figure falls within the range of 3.38%-7% as reported in the preceding report. To be more precise, among the 8.2179 trillion won in healthcare costs related to the treatment of the 20 diseases associated with smoking, a total of 1.8726 trillion won is presumed to be incurred by smoking - equivalent to 4.6% of all healthcare expenses (for those aged 20 and older). For covered expenses, which amount to 6.4978 trillion won, a sum of 1.5265 trillion won (5.0%) is estimated to have been incurred by smoking. However, studies show that even though a cigarette price increase may lead to a decline in smoking rates, the healthcare expenses incurred by smoking do not decrease in proportion. According to the Congressional Budget Office's estimation in 2012, the risk of smoking-associated diseases subsides over an extended period of time and it takes at least two decades of nonsmoking for a smoker to restore his/her life expectancy to 90% of that of a non-smoker and also to reduce healthcare costs to 10% higher than those of a non-smoker.
3. Estimation of Revenue Impacts of the Cigarette Price Increase
It is important to see the effect of a cigarette price increase on demand when estimating the revenue impacts of a cigarette price increase. Based on the estimation of price elasticity of cigarette demand using macroeconomic data, short-term elasticity turned out to be -0.38 and long-term elasticity -0.53. These figures are not much different from the results of past studies, which stand within the range of -0.2 to -0.5.
This report also presents six scenarios. Scenarios I through IV involve cigarette price increases of 500 won, 1,000 won, 1,500 won, and 2,000 won, respectively. Increases in taxes and charges are based on the distribution ratio of 2004 (cigarette consumption tax + local education tax : public health contributions = 5:5). Scenario V proposes a 500 won increase with the introduction of price indexation, while Scenario VI proposes an increase of 2,000 won with a distribution ratio different from Scenario IV.
The results showed that tax revenue increases of 1.4-5.2 trillion won can be expected in 2014 with the cigarette price increases of 500-2,000 won. According to the 500 won increase of Scenario I, taxes and charges associated with cigarettes will rise by 1.4 trillion won in 2014. According to Scenario IV's 2,000 won increase, they will rise by 5.2 trillion won, which is 3.5 times higher than the expected tax revenue increase effect of Scenario I.
4. Connection with Commodity Prices and Cigarette Consumption Patterns Based on Different Income Brackets
As for the impact of cigarette price increases on commodity prices, a 1,000 won increase in the cigarette price (as proposed by Scenario II) is estimated to lead to a 0.33%p increase in the consumer price index of the following period (based on the consumer price index of May 2013). The impact of a cigarette price increase on the consumer price index may last only through the following period, but its influence on expected inflation, etc. also needs to be taken into account.
As for consumption patterns, with a 10% increase in cigarette prices, the difference of the shares of income spent on cigarette consumption between different income groups decreases. The lower the income, the higher the share of income spent on cigarette consumption. Groups with lower incomes also show a bigger decline in demand with a cigarette price hike. This report also looks into elasticity and changes in cigarette consumption patterns from price hikes using household trend survey data. Without a cigarette price increase, the difference between the share of income spent on cigarette consumption of the group earning less than a million won and the group earning six million won or more is 0.78%p. With a price increase, however, the figure went down to 0.50%p.
5. Policy Implications
As Korea's cigarette prices are lower than many advanced countries, with its smoking rates higher, it is time to consider a cigarette price increase as a means of reducing smoking rates. However, in order not to affect commodity prices, it is desirable to consider the implementation of an array of non-price-related policy measures at the same time.
Even in the case that commodity prices are low enough to afford the possible increase incurred by a rise in cigarette price, tax resistance is another significant factor in designing policy. A cigarette tax increase is likely to spark the resistance of the public as it adds to the financial burden of low-income smokers. As explained above, the difference between the shares of income spent on cigarette consumption of different income groups decreases with an increase in cigarette prices. The lower the income, the higher the share of income spent on cigarette consumption. Thus, groups with lower incomes show a bigger decline in demand with a cigarette price hike. However, this decline in demand cannot be said to actually lessen the financial burden of low-income households. In order to minimize tax resistance, it is critical to form a consensus on the need of a price policy for bringing down smoking rates and on the use of its increased revenue.
Shin Youngim, Suh Jaeman
The Korean cigarette price (encompassing all taxes and charges imposed on cigarettes) has remained at 2,500 won per pack after a 200 won hike in 2002 and a 500 won hike in 2005. A proposal for another 500 won increase was announced in July this year, but it was turned down due to the fear of a possible rise in commodity prices. However, it should be kept in mind that a pack of cigarettes costs 13.3 USD in Norway, 9.8 USD in the UK, 5.72 USD in the US, and 2.11 USD in Korea, as of 2010. Furthermore, Korea's Esse brand cigarettes cost 2,500 won per pack, which is the lowest among OECD member countries. On the other hand, the smoking rate of adult males in Korea stands at 41%, significantly higher than the OECD average (26%).
While a cigarette price increase is being proposed to lower the nation's smoking rate, some argue against the proposal on the grounds of the possible rises in commodity prices it may incur. According to the Korea Institute for Health and Social Affairs, the reasonable cigarette price in Korea in 2012 should have been 4,500 won when taking into account the incomes and cigarette prices of 19 European countries. Despite this, the Ministry of Health and Welfare announced that it would be unlikely to raise cigarette prices this year due to the possibility of affecting the low-income bracket.
This report aims to address the pros and cons of cigarette tax increases, examine the impact of a cigarette price increase on public finance, and highlight its implications.
2. Role of Smoking in Driving Up Healthcare Expenses
It has been shown that smoking incurs additional healthcare expenses. As much as 4.6% of healthcare expenses covered by health insurance (for those aged 20 and older) arises from smoking. This figure falls within the range of 3.38%-7% as reported in the preceding report. To be more precise, among the 8.2179 trillion won in healthcare costs related to the treatment of the 20 diseases associated with smoking, a total of 1.8726 trillion won is presumed to be incurred by smoking - equivalent to 4.6% of all healthcare expenses (for those aged 20 and older). For covered expenses, which amount to 6.4978 trillion won, a sum of 1.5265 trillion won (5.0%) is estimated to have been incurred by smoking. However, studies show that even though a cigarette price increase may lead to a decline in smoking rates, the healthcare expenses incurred by smoking do not decrease in proportion. According to the Congressional Budget Office's estimation in 2012, the risk of smoking-associated diseases subsides over an extended period of time and it takes at least two decades of nonsmoking for a smoker to restore his/her life expectancy to 90% of that of a non-smoker and also to reduce healthcare costs to 10% higher than those of a non-smoker.
3. Estimation of Revenue Impacts of the Cigarette Price Increase
It is important to see the effect of a cigarette price increase on demand when estimating the revenue impacts of a cigarette price increase. Based on the estimation of price elasticity of cigarette demand using macroeconomic data, short-term elasticity turned out to be -0.38 and long-term elasticity -0.53. These figures are not much different from the results of past studies, which stand within the range of -0.2 to -0.5.
This report also presents six scenarios. Scenarios I through IV involve cigarette price increases of 500 won, 1,000 won, 1,500 won, and 2,000 won, respectively. Increases in taxes and charges are based on the distribution ratio of 2004 (cigarette consumption tax + local education tax : public health contributions = 5:5). Scenario V proposes a 500 won increase with the introduction of price indexation, while Scenario VI proposes an increase of 2,000 won with a distribution ratio different from Scenario IV.
The results showed that tax revenue increases of 1.4-5.2 trillion won can be expected in 2014 with the cigarette price increases of 500-2,000 won. According to the 500 won increase of Scenario I, taxes and charges associated with cigarettes will rise by 1.4 trillion won in 2014. According to Scenario IV's 2,000 won increase, they will rise by 5.2 trillion won, which is 3.5 times higher than the expected tax revenue increase effect of Scenario I.
4. Connection with Commodity Prices and Cigarette Consumption Patterns Based on Different Income Brackets
As for the impact of cigarette price increases on commodity prices, a 1,000 won increase in the cigarette price (as proposed by Scenario II) is estimated to lead to a 0.33%p increase in the consumer price index of the following period (based on the consumer price index of May 2013). The impact of a cigarette price increase on the consumer price index may last only through the following period, but its influence on expected inflation, etc. also needs to be taken into account.
As for consumption patterns, with a 10% increase in cigarette prices, the difference of the shares of income spent on cigarette consumption between different income groups decreases. The lower the income, the higher the share of income spent on cigarette consumption. Groups with lower incomes also show a bigger decline in demand with a cigarette price hike. This report also looks into elasticity and changes in cigarette consumption patterns from price hikes using household trend survey data. Without a cigarette price increase, the difference between the share of income spent on cigarette consumption of the group earning less than a million won and the group earning six million won or more is 0.78%p. With a price increase, however, the figure went down to 0.50%p.
5. Policy Implications
As Korea's cigarette prices are lower than many advanced countries, with its smoking rates higher, it is time to consider a cigarette price increase as a means of reducing smoking rates. However, in order not to affect commodity prices, it is desirable to consider the implementation of an array of non-price-related policy measures at the same time.
Even in the case that commodity prices are low enough to afford the possible increase incurred by a rise in cigarette price, tax resistance is another significant factor in designing policy. A cigarette tax increase is likely to spark the resistance of the public as it adds to the financial burden of low-income smokers. As explained above, the difference between the shares of income spent on cigarette consumption of different income groups decreases with an increase in cigarette prices. The lower the income, the higher the share of income spent on cigarette consumption. Thus, groups with lower incomes show a bigger decline in demand with a cigarette price hike. However, this decline in demand cannot be said to actually lessen the financial burden of low-income households. In order to minimize tax resistance, it is critical to form a consensus on the need of a price policy for bringing down smoking rates and on the use of its increased revenue.
Shin Youngim, Suh Jaeman