Monday, July 21, 2014

Critical understanding of the Indian budget 2014-15: The Case of Excise on Cigarettes

Does a tax on cigarettes serve any purpose? For a layman seeing the budget figures of a very high excise rate on cigarettes would mean that it indeed makes the stick costlier and would lead to a reduction in its usage. However, there are some crucial figures on smoking and the usage of tobacco which could paint a picture more nuanced than a layman’s observation. This picture also allows us to critically understand policy measures of the federal government. Here the federal budget 2014-15 provides us with this platform.

Does an excise increase matter? Costs, benefits and the illegal.

An excise taxes on the stick is likely to have little or no implications in terms of revenue generation (at least to sponsor health expenditure or to provide a source for funding big-budget expenditure) save for the cost burden passed on to the consumers of cigarettes. If that discourages them from smoking then well and good. The reason is simple and has often been cited. The Public Health Foundation of India estimated the economic cost of smoking at several lakh crores of Rupees and the direct cost to be approximately Rupees 16,000 crore. The expected tax gains of approximately Rupees 4,000 crore, from the excise hike, is nothing compared to the budget expenditure of approximately Rupees 18 lakh crores nor sufficient to cover the direct economic cost of smoking. The huge unregistered market for tobacco and intoxicants would just feel relieved following these hikes since it is more likely that people (not all, but at least a few) would shift to these substitutes. The above tax affects the registered legal part of the industry. But what about the unregistered sector and of course the no-smoke versions of tobacco? Unregistered cultivation of tobacco is prevalent in India. Tobacco Atlas by the World Lung Foundation in 2012 showed that out of the 35 per cent (approximately 275 million) adult population in India who uses tobacco a large number of users (164 million) use smokeless tobacco. Beedi and smokeless tobacco constitute 81 per cent of the total consumption. And of course there is a huge risk factor in consuming tobacco. The expected deaths by the year 2030 is 8 million. [1] But strictly speaking majority of this consumption falls outside the new excise structure.

How could the state be responsible?

To make the federal state accountable and responsible for these taxes it should be accompanied by a suitable reform to implement a well-defined objective (say for instance to promote health). The question is how much of these taxes reduce consumption and encourage a healthier life. For one thing, such a reason (to promote health) by increasing the tax rates is highly debatable. The argument is that any excise duty change is likely to influence only the dominant industries in the market; majority of the consumers would resort to other options and the federal and state governments does not yet have a catastrophic situation facing them due to smoking. This would then go on to suggest that the state should not remain a passive observer after the tariff hike; rather it should actively get involved in drafting and implementing a policy and a regulatory apparatus on handling the large illegal market for tobacco in India.  Now the market response to this hike in the budget and post-budget sessions were different. Major tobacco producer Indian Tobacco Company (ITC) found that the hike helped them compete much with the other industry players.[2] The Cigarette industry in India is an oligopoly dominated by ITC, Godfrey Phillips India (GPI) and Vazir Sultan Tobacco Company (VST). VST in which production is dominated by micro filters is likely to be most influenced most by these taxes. Foreign firms have a significant presence in these industries and their responses would depend on their shares. Continuous price rise following excise hikes in each budgets and additional Value Added Tax (VAT) by the federal states have promised a bleak picture for the industry. But not for the people, nor for the state. But yet nobody is interested in banning cigarettes; the reason might be that the externalities of smoke affect only people within a specific radius. Very few people would get irritated or concerned seeing a person smoke half a mile away (until of course you are allergic to the sight of smoke); and very few cares whether that person would die of smoking. And some others would say that this is much better than the soot filled smokes from our public transport vehicles. But a tax on smoking is likely to tickle one of our nerves awake and make us think and respond like a good citizen. A non-smoker would feel proud of the fact that the federal state is aware and concerned of our health; and it would be much appreciable that a health expenditure etc. of the citizens are kept in check. But here again no one knows for sure how much of the total budgeted expenditure on health goes to help the smokers and victims of passive smoking.     

If a tax should matter

If for one thing the excise has to matter it should makes the role of the state more prominent in producing the intended results. However, as mentioned these intentions are not clear. India has a policy of promoting exports of tobacco and we are the third largest producers of leaf tobacco in the world. There is substantial institutional infrastructure on research and development for tobacco. On the other hand this is also a product whose cultivation is influenced by the availability of a large amount of pesticides and child labour. So reducing consumption of tobacco should be preceded by certain institutional reforms and changes. But we don’t see any hurry in any of these requirements. India has already banned smoking in public places. The federal and state governments implemented the Cigarettes and Other Tobacco Products (Prohibition of Advertisement and Regulation of Trade and Commerce, Production, Supply and Distribution) Act, 2003 (COTPA) to control smoking in public.  However, the policy has not been efficiently implemented since a complete monitoring would involve tracking each and every smoker constantly. There are obvious challenges if reduction in consumption is an intended result. If the state aims to reduce consumption it would mean that the existing regulatory apparatus should strive hard to bring the approximately 81 per cent of the looming unregistered market (of beedi or smokeless tobacco) within legal limits.  This is a daunting task considering the fact that smoke (or no smoke tobacco) need not come from the organized industrial units alone. On the other hand, the incentives for the state on a complete ban of cigarettes is negligible. 

A Critical Reminder on the Budget

The case of tobacco has significant lessons for the manner in which a budget document is often read or misread. Budgets as a policy statement has more life to it than merely being an accounting fact to understand the difficulty at the implementation level. Annual budgets for most laymen are interesting for the different numbers that they toss in front of us. Some appears interesting; but very few are understood in depth to reveal their underlying implications. But each of these figures are dynamic and has spread effects which goes in various depths with the various linkages that it has in the economy. For cigarettes at least, we see that the story runs deep; imagine what the case would be for the myriad commodities which have been included in the list. So does not the budget make a difference? It is worth thinking about.

Rahul V Kumar

[2] The increase in share value of ITC need not be restricted to its response to excise on cigarettes alone. ITC offers a range of products and the market value of ITC shares could also have been significantly influenced by how these products were dealt with in the budget.  

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