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The tobacco tax disaster

#Tax

Writing in The Age, Shane Wright brings our attention to the “social, economic and legal disaster” that is Australia’s tobacco tax:

“Not only have ever-more expensive cigarettes created market opportunities for organised crime, but they’ve also provided smokers with products that could be worse for their health than legal products.

That’s the human side of ever-increasing excise rates being used to tax smoking out of existence. There’s also the economic side.

Treasurer Jim Chalmers is dealing with what is now a $43 billion hole in tobacco excise since 2020 that affects the provision of services, welfare and infrastructure to the entire community.

That’s due to governments of both political persuasions overestimating just how much revenue their assault on tobacco would reap for the budget bottom line. And, as revenue has fallen, governments have spent more money on trying to make up for the cash shortfall.”

When you set tax rates too high, you create incentives for alternative markets to emerge—the profit motive is a powerful predictor of human behaviour!

Then, because those markets tend to be what economists call informal rather than formal, the government paradoxically collects fewer tax dollars despite higher tax rates as more exchanges are driven underground, or people substitute tobacco entirely for other products like booze or vapes.

There are at least two possible solutions to the disaster:

  • One, cut the tobacco excise tax back to a rate that’s low enough to make a black market unprofitable, but high enough to still be a “sin tax”—i.e. to generate revenue to fund the social cost of smoking.
  • Two, keep the excise taxes high and ban or heavily regulate substitutes like vapes and ramp up enforcement efforts—i.e., a “war on tobacco”.

I’ll leave it to you to guess which of the two is my preferred option!

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