Article:

https://www.theguardian.com/australia-news/2016/may/03/smokers-to-pay-more-than-45-for-a-p
acket-of-cigarettes-from-2020

Australian smokers to pay more than $45 for

a packet of cigarettes from 2020
Treasurer Scott Morrison says increasing tobacco excise in the budget by 12.5%
each year from 2017-20 will raise $4.7bn

Budget 2016 documents say increasing excise has helped reduce the number of smokers from
25% of the population in 1993 to less than 15% in 2013. Photograph: Dan Peled/AAP

The average price of a packet of cigarettes in Australia is now likely to climb to more than $45
from September 2020.
The government will increase the excise on tobacco products by 12.5% each year from 2017 to
2020, at which point it will make up 69% of the price of a pack of cigarettes.

Treasury is billing the increase as a health measure, saying the World Health Organisation
recommends a tax rate of 70% of the price of a cigarette, but the revenue gain is significant.
“The net impact of the tobacco measures will raise $4.7bn over the next four years,” the
treasurer, Scott Morrison, said in his speech to parliament.

The 2017-20 rise replicates four years of increases legislated by Labor – and referred to as “a tax
on workers” by the then opposition leader, Tony Abbott.

Budget documents say increasing excise has helped reduce the number of smokers, saying rates
have fallen from close to 25% of the population in 1993 to less than 15% in 2013.

The revenue windfall is offset slightly by an allocation of $7.7m over two years to the Australian
Border Force to police the illegal importation of tobacco products. Existing penalties will be
strengthened and new offences introduced for tobacco smuggling, which is considered to be at
risk of increasing as prices rise.

The duty-free allowance for tobacco products will be cut from 50 cigarettes (two packs) to 25
(one pack).

The government is partly counting on the steeply rising price of tobacco products to lift the
inflation rate to 2.25% by the June quarter of 2018 from an unusually low 1.25% in 2016.
The budget also allocates an undisclosed amount to ongoing legal action to defend Australia’s
plain packaging laws – the Tobacco Plain Packaging Act 2011.

“The act is currently the subject of dispute settlement proceedings involving four countries
through the World Trade Organisation and an international legal challenge,” the budget papers
say.
“The funding will support work undertaken by the Department of Health, the
Attorney-General’s Department and the Department of Foreign Affairs and Trade to defend the
legislation.”
The amount set aside for these defences is not disclosed “to protect the Australian government’s
position in any litigation”.
IA:

Over Consumption of demerit goods is a type of market failure. Demerit goods such as
cigarettes causes negative externalities of consumption, meaning there is an external price
being paid by a third party such as an employer for example when their employee is ill they are
taking time off of work which then affects the output of that business and that is the external
price being paid. This article is concerned with fixing a market failure in the Australian economy
as cigarettes are being over consumed.The government will be increasing the excise tax on
cigarettes every year by 12.5%, this will cause the price of cigarettes to increase to 45$ per
pack after 2020. An excise tax is a tax that is imposed upon expenditure. This is an attempt to
solve the negative externalities of cigarettes and also to raise government revenue.

Diagram 1: Negative Externalities of consumption in the Australian tobacco market

Diagram 1 portrays negative externalities of consumption of cigarettes in the Australian market.

In diagram 1 the MPB curve falls above the MSB curve, this shows that consumers only taking
into consideration their private benefit and disregard the effect on society. The market is
currently operating at E1 which is where MSB which represents the private benefit of
consumption for the smoker interacts with the marginal social cost to society, this means that
the market is in the state of failure as the smoker is only acknowledging his private benefit of
smoking and is disregarding the external cost on society. Q1 - Q* portrays the over consumption
of cigarettes, this created the welfare loss. At E2 MSC intersects with MSB meaning that the
market is at social optimum level of consumption of cigarettes and that the consumer is paying
the full price of cigarettes.
Diagram 2: Implementation of 12.5% tax on cigarettes in Australia where PED<PES

Diagram 2 portrays first year of taxation. In this diagram a tax of 12.5% is placed on the price of
each unit sold. When the tax is implemented the supply curve shifts from s1 to s2, resulting the
price to rise to Ps which is the price if the whole tax is passed onto the consumers. This results
in excess supply meaning that there will be a fall in prices and it will result in a new equilibrium
price at Pc. Qt is demanded and supplied. Therefore the tax burden is mostly paid for by the
consumer and this makes the market price higher. Price elasticity demand and price elasticity of
supply is the reactivity of demand and supply to changes in price. As PES>PED meaning that
with a change in price, the supply will have a proportionately greater change in supply than
demand. In the case of cigarettes PED is inelastic yet PES is elastic. This means that as costs
increase, producers are likely to halt production and that is why a greater burden of the tax is
passed onto consumers as they react less to changes in price.

This is a regressive tax as it takes up a higher proportion of income from low-income earners,
targeting them more. This tax will make cigarettes too expensive for younger smokers as their
demand is more elastic to a change in price as it takes up a greater proportion of their income.
As cigarettes are Price inelastic, a change in price will lead to a proportionately smaller change
in the quantity demanded. This means that to tackle this problem there has to be a hefty tax to
affect the quantity demanded. Although the heavy tax implemented will cause demand to fall it
will also cause the producers to suffer as now demand has fallen they have to release workers
as their revenue is decreasing because the tax causes their production costs to increase.

The net impact of the tax will raise $4.75bn from 2017 to 2020. As cigarettes get more
expensive, the black market will arise as an illegal source of supply. Black market cigarettes are
smuggled from outside the country and sold for lower prices as no tax has been paid. The
government is tackling this issue by allocating $7.7m out of the tax revenue towards border
force so that they could monitor the illegal importation of cigarettes. The government is also
strengthening existing penalties related with this issue and also introducing new offences for
tobacco smuggling.

To conclude an excise tax is necessary. By implement their taxation plan alongside their other
means of deterrents it would reduce the negative externalities of smoking and it will also help
raise their inflation rate to an optimum level of 2%.

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