Sound taxation and sin taxes

“It is better to tax bad things than good things,” asserts Nobel prize-winning economist Joseph Stiglitz. Pollution, he thus argues, should be taxed more than work. The rationale is simple: anything you tax will be done less. If you tax a bad practice like pollution, less of it will be done—and that would make all of us better off. On the other hand, taxing labor income (which most governments do) induces people to work less, thus produce less—and we all end up worse off, with less of the goods and services we enjoy.

It is a good idea, then, to tax tobacco products and alcoholic beverages—the so-called “sin products”—because this will reduce smoking and excessive alcohol consumption and their attendant ill effects. And we all know what these ill effects are.  In the Philippines, seven out of the 10 leading causes of death are smoking-related. Department of Health data indicate that 515 to 827 Filipinos contract smoking-related lung cancer and other lung and heart diseases every day. It is also estimated that 240 Filipinos die daily from these diseases. Drinking alcohol similarly leads to a host of social problems and economic costs, such as violence, crime, abuse of women and children, vehicle accidents, accidental falls, drowning, suicides, fires, productivity losses and health care expenditures.

The worst effects of smoking and drinking fall on the young and the poor. Studies have shown that the health effects of smoking and drinking are worst for those who begin smoking and drinking at a young age. It is also a fact that the poor smoke and drink more than the rich, and yet are least able to get needed health care when these vices lead to illness. As a former health undersecretary once lamented, the Philippines has gained a reputation for having the highest-priced medicines and cheapest cigarettes in Asia. The sad reality is that the poorest households spend more for tobacco and alcohol than they do for education or health care, a fact borne out by official data on family expenditures.

What’s particularly disturbing is that the Philippines has one of the highest percentages of young smokers across Asia, as found by the Global Youth Tobacco Survey of the World Health Organization (WHO) in 2007. About 30 percent of Filipino adolescents in urban areas were found to be smokers, whereas the corresponding figures for other Asian countries are much lower (12.6 percent for Indonesia and 11.7 percent for Thailand, for example). And in Southeast Asia alone, the Philippines reportedly has the second highest number of smokers, comprising more than a third of all Filipinos. WHO attributes all these to the relative cheapness of cigarettes in the country, where cigarettes are taxed an average of 42 percent, much lower than the now international norm of 70 percent.

Compounding our problem is the fact that over the last decade, real prices (that is, prices adjusted for overall inflation) of cigarettes in the country have actually gone down by anywhere from 9 to 18 percent. This means that prices of cigarettes have risen more slowly than that of other goods consumed by the average Filipino family, by that much. A study by Filomeno Sta. Ana and Jo-Ann Latuja found, for example, that using prices prevailing in 2000, the price of the most popular medium-priced cigarette brand had effectively gone down from P16.95 a pack to P13.87 over the past decade, a drop of 18 percent. The reason for this is that our sin taxes, once inflation is accounted for, have actually become lighter as a result of flaws in our current sin tax law. And so, whereas tobacco excise taxes made up 4 percent of government’s total tax revenues in 2001-2002, this share is now down to 2.5 percent.

What urgent changes are needed on the sin tax law? As pointed out above, the law fails to ensure that the level of tax keeps pace with inflation. Government spending requirements do not decline over time—and yet the current sin tax law has the government effectively getting less and less from that source as years go on. This situation has arisen because, among other things, different cigarette brands are taxed differently according to a price classification scheme pegged on prices that prevailed back in 1996. Old brands—which make up 90 percent of the market—thus enjoy a distinct advantage over newer ones, as their prices, for tax classification purposes, have been effectively frozen for the past 16 years! While the law provides for defined upward adjustments in the excise tax every two years since 2005 until 2011, these have not been enough to offset the inflation effect. The net effect, then, has been for the share of tax in the gross price paid by smokers for cigarettes to fall over time. And because the automatic adjustments—inadequate as they are—ended in 2011, Congress must definitely pass a new sin tax law now.

What should the new law provide, then? Three things must change. One, the 1996 price classification freeze must go, to remove the undue advantage of old brands. Two, the multi-rate structure must give way to a single rate for ease of administration and to level the playing field. Three, the tax rates must automatically adjust yearly to inflation, to avoid the erosion of government’s tax take over time. The sin tax bill filed by Rep. Joseph Emilio Abaya, endorsed by Malacañang and the Department of Finance, addresses all of these. The reformed sin tax law would thus attain attributes of a good tax as postulated by Stiglitz: It would be economically efficient (i.e., in this case, it discourages harmful activities), easy to administer, politically accountable and fair.

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