Buying ‘sins’

ABI’s beer line

Senator Pia Cayetano had a mouthful to say in yesterday’s public hearing on sin tax proposals in the Senate.  She reacted to a lament made by the representative of the Asia Brewery Inc. (ABI), the beer company owned by Lucio Tan, that hefty increases in the tax rates of alcoholic products will raise prices, make the product less accessible to the poor, and reduce sales.  Of course, all this will mean problems for ABI’s income statement.

Senator Pia Cayetano (in red) completing a run

Cayetano, who is a physical fitness and health enthusiast, reminded the ABI official that:

• alcoholic drinks and tobacco products are harmful products; and
• raising taxes on sin products has the expressed intention of reducing their consumption

Her parting shot?  It’s not the government’s responsibility to make sure that firms producing such ‘goods’ will remain profitable.  It is also not the government’s responsibility to find alternatives for these firms if demand for sin products decreases because of price increases.  Finding alternatives is the firms’ responsibility.

The stated rationale for the tax bill is to reduce consumption of so-called ‘sin’ products and collect increased revenues due to the hike in tax rates.  Revenues will be earmarked for health programs for those who got sick because of alcohol and cigarettes.

Let’s deconstruct this proposed bill’s rationale.  Every university student who enlisted in elementary economics knows that when the price of a product iincreases, the demand for the same decreases.  This means that product sales and sales revenue of producing or marketing firms will likewise decline.

However, demand for a product does not depend on its price alone.  Indeed, price increase can dampen demand but other factors can mitigate the impact of the price increase.  For example, a buyer may continue consuming the same amount of beer or cigarettes even if product prices went up.  He may do so because of taste, bull-headedness, habit, or peer pressure.  He may reduce the consumption of other goods so he can finance the purchase the same amount of his favorite ‘sins’.

Experts actually believe that demand for cigarettes is inelastic; meaning demand is not greatly affected by price changes.

Professor Craig Gallet

Nicotine is believed to be addictive and smokers find it very difficult to quit smoking.  In a 2007 article published in the Australian Journal of Agricultural and Resource Economics, Craig Gallet reported that “compared to other alcoholic beverages, beer elasticities tend to be more inelastic.

This means that raising sin tax rates may not go a long way to discourage consumption.  Will the tax bill raise enough money to fund health programs?

Senate President Juan Ponce Enrile

Senate President Juan Ponce Enrile, once Customs Commissioner and Secretary of Finance, bluntly told finance officials the other day they need to temper the revenue collection targets.  He warned that smuggling will eat into projected collections.  Enrile’s warning cannot be dismissed outright.  One, he is fully aware of the shortcomings of our country’s anti-smuggling bureaucracy.  Second, guarding our shorelines (reputedly twice longer than that of the United States) against smugglers.

Finance Secretary Cesar Purisima

While Enrile has a point, some questions need to be raised.  Assuming that the proposed tax rates are adopted and enacted to law (and most likely, they will not and compromises will be reached), how much sin must be smuggled into the country?  Surely, the Senator is not suggesting that the entire or even half of the market will be served by smuggled goods.  What had been argued so far are blanket warnings regarding smuggling but no estimates are offered so we can understand the negative impact of smuggling of potential revenues.

Any idea where the smuggled ‘sins’ will come from?  Where they will come in?  Isn’t it most likely through the so-called Southern back-door?  Won’t this knowledge help us mitigate the adverse effects of smuggling?

While readers of this post may have correctly surmised that I am in favor of sin tax reform, it’s more complicated than simply raising tax rates.  The challenge to policy makers is to design measures that could meet sometime conflicting objectives as well as be compatible with prevailing circumstances.

Sin tax alignments

Department of Finance (DOF) logo

From government’s point of view, the ideal excise tax on sin products is an ad valorem or a percentage tax of the manufacturing price of a pack of cigarettes or a bottle of beer or whiskey.  Failing that, it can accept a specific tax on these products indexed to the inflation rate.  Of course, it goes without saying that government will prefer the highest tax rate, be it specific or ad valorem.

Through  these specifications, government can collect the maximum possible sin tax revenues.

Additionally, the national government believes that high sin tax rates will dampen consumption and consequently have positive effects not only on people’s health.  It could also improve peace and order and reduce crime rates.

Department of Health (DOH) seal

What about the tax preferences of the manufacturers of sin products?  Of course,  they will prefer low rates; specific rather than ad valorem; and unindexed (to inflation) tax rates.  Low tax rates will ultimately lead to lower prices of sin products which will ultimately mean greater demand for the same.  Nonetheless, the demand for sin products is generally inelastic–meaning demand for the same is not very sensitive to changes in product prices except in the long run.  Some tax experts report that beer is the most inelastic among alcoholic beverages while others opine that the nicotine content of cigarettes make demand for tobacco products also inelastic.

Local sin product manufacturers have predictably opposed the government-proposed 1000% increase in specific taxes on beer and alcoholic beverages and tobacco products.  The huge increase is proposed given the relative freezing of specific tax rates since 1996.  The tax law approved at the time did not approve indexation to inflation of the tax rates and provided only for minimal tax increases.

 

San Miguel beer

How will consumers of sin tax react to government’s tax proposals?

Filipino beer drinkers

It does not take one to be a rocket scientist to figure out that consumers will oppose government’s plans.  In his column at the Philippine Daily Inquirer yesterday, Prof. Cielito Habito pointed out that the poor consume sin products in a greater proportion compared to middle income and rich people.  Thus, they will oppose increases in tax rates that translate into higher retail prices.  

Colt 45, one of the beer brands of Asia Brewery Inc.

And higher retail prices for these ‘indispensable’ products means lower real incomes for the poor.

This might not register well with a public already reeling with high prices of oil products and an increase in transport fares.  

What we have here is a case where the interests of sin tax manufacturers and consumers largely coming from the ranks of the poor are aligned and ranged against that of government.

Obama and Noynoy smoking

It is incumbent upon government to gather political support for its tax plans within and without Congress.

 

Will it be a good idea to appeal for support from the wives and children of smokers and drinkers who may be concerned about the health of their relatives?  To those who are worried that  the money  spent for sin products is money that should spent for the dining table and other household necessities?  Or will that be seen as an invasion of privacy and curtailment of individual freedoms? Or will it encourage strife within households?

Will examples from role models help?