In this year's budget speech, Enoch Godongwana, the Minister of Finance announced a 5.5% increase in cigarette taxes. If you’re a seasoned smoker, you probably weren’t shocked by the announcement. Government increases the excise tax on cigarettes every year, and has, in fact, done so since the dawn of our country’s democracy.
Though we usually get upset when we hear news that taxes are increasing, the average smoker doesn’t know how much tax they pay per box of cigarettes. All people really care about is the price they see on the shelf aka the retail price. In the case of cigarettes, this price has been increasing dramatically over the last 30 years.
The retail price of a box of cigarettes is made up of three components: the net-of-tax price (the price set by the tobacco industry);VAT and the excise tax. The graph below shows the breakdown of cigarette prices in South Africa between 1961 and 2018. Since 1994, National Treasury has followed a clear and transparent principle in setting the excise tax level. It sets the excise tax in such a way that the total tax burden (i.e., the combination of excise tax and VAT) of the most popular-priced cigarette is 50%. This percentage was increased to 52% in 2002. What this means is that if the tobacco industry increases the retail price of cigarettes, National Treasury would then increase the excise tax in the next budget cycle to keep to the targeted tax burden percentage of 52%.
Between 1994 and 2010 the inflation-adjusted retail price of cigarettes nearly tripled. What’s interesting is that what drove this overall retail price increase was increases in the net-of-tax price by the tobacco industry. Between 1994 and 2010, the excise tax was increased at a rate above the inflation rate because the tobacco industry increased the retail price at an above-inflation rate.
In 2010, the competitive environment of the South African cigarette market changed dramatically. New entrants came into the local cigarette market. These new entrants were primarily competing in the low-price segment, selling at prices substantially lower than the brands sold by the once-dominant major cigarette manufacturer in the country. While the manufacturer that dominated the market between 1994 and 2010 had been able to exploit its near-monopoly power to increase cigarette prices and therefore profits, this was no longer possible after 2010. As a result of the changed competitive environment, cigarette prices across the price spectrum increased subtly, but below the rate of inflation, since 2010. Had the Treasury followed the same tax formula it had followed before 2010 during the post-2010 period, the tax increases would have lagged behind the inflation rate.
To prevent this outcome, Treasury added a new dimension to its rule for setting the excise tax: if the increase in the retail price from one year to the next is such that the increase in the excise tax is less than the inflation rate, the excise tax will increase by the inflation rate. What this means for smokers is that you can expect cigarette prices to increase by at least the inflation rate each year.
The moral of the story: cigarette prices are going to keep going up in South Africa. In fact, the South African government has made an international commitment to ensuring that this is the case. In 2005, the South African government endorsed the Framework Convention on Tobacco Control (FCTC). The FCTC is an international treaty that requires countries to implement certain measures to control the supply and demand of tobacco products. One of the key measures that countries are required to implement is increases in excise taxes such that the price of tobacco products become less affordable over time.
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Economist, byegwaai co-founder