Section: A

Date of Submission: July 7, 2013

THE ECONOMICS OF
TOBACCO AND
TOBACCO TAXATION IN
INDIA

Team 3

1. Bitan Banerjee (13A1HP018)
2. Bhalerao Tejal Waman (13A3HP046)
3. Prasoon Agarwal (13A1HP003)
4. Prakhar Maheshwari (13A3HP009)
5. Sandarbh Goswami (13A3HP041)
6. Saptorshi Bachi (13A3HP049)
7. Shiladityo Bhattacharya (13A1HP061)
8. Utsav Banerjee (13A3HP027)




1. Interpret table 3.1 and 3.5. Your team is asked to evaluate the future prospects of
ITCs tobacco products in the rural areas based on the numbers in these two tables.
Write a brief report explaining ITCs rural market potential based on the numbers in
the case.
Ans: According to Table 3.1, as per 2008-2009 tax on bidis was 12 per 1000 sticks
compared with 819 per 1000 sticks of the least taxed filtered cigarettes. This comparison is
negligible because such low taxes on bidis are the most important reason why they have such
high price advantage over cigarettes. This makes the tobacco consumption in India unique
with a very high presence of non-cigarette products, especially bidis.
Table 3.5 presents computations of excise duty as a percent of retail price for
individual tobacco products. For 2006-07, the impact of the new state VAT is incorporated
into prices for cigarettes and chewing tobacco to ensure the figures are representative of the
altered scenario. This is not done for bidis, which were kept out of the ambit of the state-level
value added tax. The brands listed are some of the most popular brands in their categories.
The last row also displays retail prices per gram of tobacco for each of the categories in 2000-
01 to illustrate the nearly twenty-fold difference in the post-tax price per gram at the two ends
of the spectrum of tobacco products.
Rural population is nearly 3 times the urban; hence greater population gives greater
opportunities to do business. ITCs future prospects lie in the cigarettes in the price range of
less than 50 per packet. Cigarettes like Gold Flake Small and Wills Flake come under this
category. In rural areas, cigarette is considered a luxury product. A 10% rise in the household
income increase the cigarette consumption by 23.7%. Keeping in view the household income,
people in rural areas prefer small and less expensive cigarettes.
Rural people are not aware of health hazards caused by unfiltered tobacco products
(bidis). Hence, ITC should spread health conscious awareness programmes in the villages to
promote the consumption of filtered cigarettes instead of unfiltered tobacco products.
Considering the per capita income of the rural India, small packs of cigarettes are more
acceptable as well as small size of the cigarettes. So ITC should concentrate on the Wills
Flake and Small Gold Flake cigarettes.


2. Based on the price elasticity estimates in table 4.2, explain own and cross price
elasticity for the tobacco products (bidi, cigarette and leaf tobacco). Assume a hike of
5% on bidis and 15% on cigarettes, how would the young consumer react?
Ans: Cigarettes, unlike other tobacco products are found to be luxury goods in both rural
and urban India with income elasticity greater than 1. Estimation of own and cross price
elasticity showed that own price elasticity estimation of different tobacco products in rural
and urban India range between -0.338 & -0.92 and -0.196 & -0.874 respectively. It can be
ascertained that cigarettes were the least price elastic of all. Analysis of the cross price
elasticity revealed that bidis are a complement to the cigarettes.
Table 4.2 indicates that own price elasticity of demand are negative, and with the
exception of cigarettes in urban India it is statistically significant. On the contrary, most of
the cross price elasticity are negative, but they are generally not statistically significant. It can
also be seen that cigarettes are relatively more price inelastic in urban India than in rural
India. A 10% increase in bidi prices could reduce rural bidi consumption by 9.2%, while a
10% increase in cigarette prices could reduce rural cigarette consumption by 3.4%. A given
increase in cigarette prices translates into a less than proportionate decline in cigarette
demand, because cigarette demand is relatively inelastic. However, there are no comparable
studies for bidis and leaf tobacco, for which the price elasticity presented in table 4.2 are
closer to unity.
A 5% hike in the price of bidis would result in 5.85% reduction in demand for bidis
(Own Price Elasticity is given -1.17). A 15% hike in the price of cigarettes would result in the
2.5% reduction in the demand of cigarettes (Own Price Elasticity of Cigarettes is given -0.17)
EQx, Px= Qd
x
/ Px.
3. Raising taxes on tobacco products saves lives and increases government revenue.
What are the pros and cons of such a view point?
Ans: Increase in Tobacco tax offers a win-win-win solution for states.
Health Win:
Tobacco tax increases are one of the most effective ways to reduce smoking and other
tobacco use, especially among kids.


Every 10 percent increase in cigarette prices reduces youth smoking by about 3.4%
and total cigarette consumption by about four percent.
People who are about to quit smoking, are less likely to start again.
Tax increases help the poor to stop using tobacco. This allows tobacco users who quit
to reallocate their money to essential goods, including food, shelter, education and
health-care.
Higher taxes also help poor families improve productivity and wage-earning capacity
by decreasing tobacco-related illness and death.
Budget Win:
Every state that has significantly increased its cigarette tax has enjoyed substantial
increases in revenue, even while reducing smoking.
Higher tobacco taxes also save money by reducing tobacco-related health care costs,
including Medicaid expenses.
States can realize even greater health benefits and cost savings by allocating some of
the revenue to programs that prevent children from smoking and help smokers quit.
Political Win:
National and state polls consistently have found overwhelming public support for
tobacco tax increases.
Polls also show that, when it comes to balancing budgets, voters prefer raising
tobacco taxes to other tax increases or cutting crucial programs such as education and
public safety.
Now, if we consider the other side,
If the cigarettes are highly taxed, they can induce tobacco smuggling inter bordered
through South East Asia.
If the good quality cigarettes are highly taxed, the inferior quality cigarettes (filtered
and unfiltered) shall target the market which can further enhance different health
hazards.
Increasing taxes on cigarettes would encourage the practice of stocking. People would
stock cigarettes in huge quantities and thus the government would suffer losses.


An increased tax on bidis need not be seen as regressive, as it would have multiple
benefits. First, increased taxes would directly translate to reduced consumption which would
have direct health benefits. Secondly, as high taxes would lead to a substantial decrease in
consumption, it would also have the effect of reducing money spent on consuming tobacco,
provided the tax is large enough. Reduced consumption coupled with reduced expenditure
would leave the poor with extra disposable income. Finally, tobacco taxes have the potential
to increase revenue, a portion of which can be earmarked for rehabilitating poor households
who are directly dependent on bidi rolling.

4. Public health vs increased revenues. What are the opportunity costs of this trade off?
Ans: Tobacco consumption has an important consequence for national economy through its
negative effects on health and productivity. Health care costs and lost products due to illness
and early death are matters of macroeconomics as well as personal concerns.
A tax increase directly benefits the government through increase revenues even when
taking reduce consumption into account. To maximise the health impact of higher taxes,
some revenues should be earmarked for tobacco control and other public health and social
programmes. It is also ethically correct for governments to use some of the increased tobacco
tax revenues to help tobacco users quit through comprehensive control tobacco programmes.
Basically, the governments can increase its tobacco control policies and pay for other public
health programmes.
In his article, India finalise tobacco control legislation, BMG, 2001, Mudur-G.
Stated that In the year 2000, Indian council of medical research estimated the costs of 3
major tobacco related diseases- Cancer, Heart Ailment and Chronic Obstructive Pulmonary
Disease (COPD) at 270 billion, considerably in excess of the direct contribution of the
tobacco industry to Indian government revenue of 70 Billion.
In another study by Shah S and Vaite S, Tobacco and Poverty: Observations from
India and Bangladesh, a study on 400 street children in Mumbai showed that most of them
who earned less than $2 a day, half of them used cigarettes and some spent upto 21% of their
income on locally made tobacco products. Figures for poor households that contain tobacco
users often show tobacco expenditure at around 10% of all household expenditure. For these
households, the opportunity costs of tobacco addiction are very significant.