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The Economics of Tobacco and Tobacco Taxation

In India


Submitted By:
Group No. : 9


Ques 1: Interpret table 3.1 and 3.5. Your team is asked to evaluate the future prospects of
ITCs tobacco products in the rural areas based on the numbers in these two tables. Write
a brief report explaining ITCs rural market potential based on the numbers in the case.
Table 3.1 shows the structure of central government excise duties on tobacco products in India
Basic excise duties are levied for manufacturing of these products. The national calamity
contingency duty is a levy for providing calamity relief. Apart from these two health cess and
special excise duty is also charged.
Ciggerates and bidis of various lengths and filter types are taxed at different specific rates.
Tobacco products other than bidis are taxes at an ad valorem basis.
While specific taxes are used to raise revenue, ad valorem taxes are used to reduce consumption.
Table:3.5 (Excise duty as a percentage of retail price for individual tobacco product)
Unfiltered cigarettes, bidis and chewing tobacco face relatively lower tax rates compared to
filtered ones.
Longer cigarettes do not always bear higher tax(as in case of Navy Cut70-75 mm and Wills
Flake <=70 mm).For same length of filtered cigarettes, excise duty for cheaper cigarette is more
than costlier ones.
Tax burden per gram of tobacco in unfiltered cigarettes and bidis is much lower than that in
filtered cigarettes. So bidis and unfiltered cigarettes are substantially under taxed relative to
filtered cigarettes.
Future prospects of ITC:
Based on the numbers in table 3.1 and 3.5,it is obvious that bidis and other smokeless version of
tobaccos are less taxed and cheaper as compared to the cigarettes. Majority of rural population
consume bidis and gutka than cigarettes and hence ITC, with heavy tax and low demand will be
in a disadvantageous position in rural areas.
ITCs rural market potential based on the case:
Expenditure Elasticity of Tobacco Products: As per table 4.1 it is more than for cigarettes and
less than 1 for leaf tobacco and bidis. Hence cigarettes are luxury goods both in rural and urban
areas where as bidis and leaf tobaccos are not. ITC has to be cautious about the spending power
of rural mass before entering into rural market.
Own and Cross Price Elasticity: From Table 4.2 it is clear that cigarette demand is relatively
inelastic. That means a hike in price of cigarettes will have minimum impact on its consumption
as compare to bidis which is a not a good sign for ITC.
The ve signs on cross elasticity implies that bidis and cigarettes are compliments in rural India.
An increase in price of bidi will have greater impact on cigarettes. So if in any case bidi price
goes up, the cigarette consumption will go down. So this is not a good sign for ITC.
Again since bidis and cigarettes have quite different markets, so ITC will find it difficult to
displace the bidi demand with cigarette demand.
Considering the above points, we would like to believe that ITCs rural market potential does not
look good.
Ques 2: Based on the price elasticity estimates in table 4.2, explain own and cross price
elasticities for the tobacco products (bidi, cigarette and leaf tobacco). Assume a hike of
5% on bidis and 15% on cigarettes, how would the young consumer react?
Table 4.2 reports own- and cross-price elasticity estimates for bidis, cigarettes and leaf tobacco
using only tobacco consuming households. Both symmetry-constrained and -unconstrained
estimates are presented here and the results are reported for both rural and urban households. The
elasticity in row & column estimates the effect of a change in the price of good on the quantity
demanded of good.
As we can observe, own-price elasticity estimates for rural and urban households are
approximately the same, except for cigarettes which are relatively more inelastic in urban India
than in rural India. Elasticity for cigarettes is lower than 0.5, which is in consensus with the
conservative estimates available for cigarettes, whether from developing or developed countries.
The present exercise indicates that consumption of tobacco products in India does respond to
changes in prices, though the proportionate increases in price lead to slightly less than
proportionate reductions in consumption in the case of bidis and leaf tobacco, while leading to
much less proportionate reductions in consumption in the case of cigarettes.
Examination of cross-price elasticity from the symmetry-constrained estimates indicates that
bidis are complementary to cigarettes and leaf tobacco in rural India, and to cigarettes in urban
India, though many of the other cross-elasticity coefficients are not statistically significant.
Below table shows the data of the of the assumption of 5% and 15% of hike in price of bidis and
cigarette respectively
Rural Urban Pooled Sample
5% hike in Bidi -0.46 -0.425 -0.455
15% hike in Cigarette -0.507 -0.294 -0.522

Below table shows the reaction of youngster to the price change of cigarette and bidi by 15% and
5% respectively.
5% hike in Bidi -0.585
15% hike in Cigarette -0.255

A hike of 5% in bidi will reduce the consumption of bidi reduces to 5.85%. But 15% increase in
the price of the cigarette reduces consumption to 2.85% only. Though cigarette price is increased
by 15% its consumption is not much affected. This is because most of the youngsters prefer
luxury products.
Ques 3: Raising taxes on tobacco products saves lives and increases government revenue.
What are the pros and cons of such a view point?
Pros and Cons:
Pros of this view point:
Regarding Health And Social Aspects:
1) When the taxes on tobacco products will be hiked , then there will be decrease in the
consumption and that will lead to reduction in the number of immature death
2) Youths will not enter into smoking and the adult smokers will quit. This will lead to
reductions in the health and economic burden caused by tobacco use.
3) When smokers quit, their families benefit in two ways: through improved health and
through improved finances money previously spent on tobacco products can be spent
on food, education and other necessities
4) Some part of the tax collected will be dedicated for tobacco control and other social and
public health programs.
Regarding The Revenue Aspects:

1) Specific taxes provide more predictable revenue and make it harder for the tobacco
industry to influence retail prices.
2) Ad valorem taxes help tobacco prices maintain pace with inflation.
3) .The overall tax structure will be simple and easy for countries to implement. Excise
taxes will be levied at the manufacturer level, rather than at the distributor or retail level.
This helps increase effectiveness by centralizing revenue collections and minimizing
record keeping burdens on small businesses.

Cons of this view point:

1) Tax avoidance and tax evasion activities: it may make tobacco products more affordable
and more widely accessible and available.
2) Smuggling: it would lead people to illegal ways of acquiring low cost tobacco products.
3) Inflation: this would lead to tremendous increase in the cost of tobacco products.
4) Employment : it would affect employment of people who are in unorganized sector
5) Public health vs. increased revenues. What are the opportunity costs of this trade off?
If the status quo continues, 38.4 million current bidi smokers and 13.2 million
Cigarette smokers are likely to die prematurely.
Tobacco consumption is the single most important avoidable factor in the growth of non-
communicable diseases in developing countries, particularly in India.
Tobacco use is an increasingly important contributor to premature death and ill-health in
the developing world.
Raising bidi taxes to Rs 98 per 1000 sticks would add Rs 36.9 billion to tax revenues
and prevent 15.5 million current and future smokers dying prematurely; increasing
cigarette taxes to Rs 3691 per 1000 sticks would further add Rs 146.3 billion to tax
revenues and prevent 3.4 million premature deaths.
Tobacco is a labor-intensive crop in India. Growing, harvesting and processing tobacco represent
the means of livelihood of a large number of agricultural laborers.
Poverty and health have a two-way relationship. Tobacco-use shows a clear and continual
increase with decreasing wealth quintiles. Poor smokers, who are at a greater risk of illness, are
also at a greater risk of not being treated or of falling into greater poverty if they seek treatment.
Poor people spend money on tobacco that could be spent on food, shelter, education, and
healthcare. These decisions can entrench families in an ongoing cycle of poverty and ill-health.
The direct and indirect costs of tobacco-use are immense for national economy. This has
positioned control of tobacco relevant in India's per suite to achieve the goals of poverty
eradication and health for all. For the poor, tobacco-use has a very high opportunity cost, in that
it diverts spending from basic needs. A number of studies have indicated that poor people spend
money on tobacco that could, in theory, be spent on other goods, such as food, shelter, education,
and healthcare. Shah and Vaite reported that, of 400 street-children in Mumbai, most of whom
earned less than US$ 2 a day, half smoked cigarettes or other locally-made tobacco products.
They spent up to 21% of their income on tobacco products, far more than they spent on food,
education, clothing, or savings.