“The tax burdens of sin taxes on tobacco products is shared equally between consumers and producers”
This statement is arguably incorrect. In this piece of information I am going to explain why the statement given is not true and I will show, with illustrations that producers pay less or even no tax than the final consumer. Included in this information are concepts that will be explained and applied to show the truth of this statement and how each of these concepts relates to the tax burdens of sin taxes. Briefly, this information will consist of a theoretical framework, an analysis and a conclusion where I will conclude that, according to research, consumers carry out the tax burdens of sin taxes. At the end of it all will be a bibliography, a list of resources I have used to gain data and have processed it to receive information to prove my argument correct.
Sin taxes are negative externalities which are products like cigarettes and alcohol that are not beneficial to society or a person1. Everything we can buy includes a price, a cost and a producer and what their cost is. Also it leads to a concept of demand and supply3. Basically, demand is just a relationship between the quantity of a good that consumers plan to buy and the price of the good when every other influence on a buyers’ plan stay the same.
Supply on the other hand is also just a relationship between the quantity of a good that producers, not consumers, plan to sell and not to buy and the price of the good when all other influences on sellers’ plans remain the same. There is a demand and supply for almost any sellable product. But when there is too much demand, the product could lead to a black market; this is an illegal way of getting an item through a much higher price. Other concepts to be introduced are the price elasticity of demand, elasticity, which includes inelasticity, unit elasticity and elasticity itself. Firstly, the price elasticity of demand, this is a unit-free measure of the responsiveness of a quantity demanded of a good to a fluctuation in price. The price elasticity of demand is calculated as follows:
Price elasticity of demand = percentage change in quantity demanded / percentage change in price.
To calculate this we need to know the quantity demanded at different prices. Furthermore, inelasticity refers to inelastic demand which is a demand with price elasticity 0 and 1. A good has an inelastic demand when the percentage change in quantity demanded is less than the percentage change in price:
A good can also have unit elasticity. This is a demand with a price elasticity of 1 which means that the percentage change in quantity demanded is equal to the percentage change in price:
0 1 2 3 Q
Then there is the elastic demand, now this is a demand with a price elasticity greater than 1. Therefore every other thing remains constant. This occurs when the percentage change in quantity demanded exceeds the percentage change in price.
With the price elasticity of demand comes perfectly elastic demand and perfectly inelastic demand. Perfectly elastic demand is when its size is infinity which means that the smallest increase possible will cause an infinitely elastic large decrease in quantity demanded and perfectly inelastic demand is when the size is zero, the quantity demanded is the same at any price.
Cross elasticity of demand is a method of how reactive is the demand for a good subjected to a change in the price of a substitute or a complement, example: tea for coffee.
It is calculated as follows:
Cross elasticity of demand = percentage change in quantity demanded / percentage change in price of substitute or complement.
? Price of the substitute rises.
And the opposite direction when the price decreases.
The curve moves outward if the substitute’s price increases, therefore it is positive cross elasticity.
There are 4 relationships and are best described as perfect substitutes, substitutes, independent and complements. Perfect substitutes are infinite when the smallest increase in price of 1 good causes an infinite large increase in the quantity demanded of that item.
Substitutes, when positive, but less than infinity occur when the price of an item increases, the quantity demanded of the other item also increases. They are independent when the size is 0 which means that the quantity demanded of 1 good remains constant whether the price increases or decreases. Complements however are less than 0, meaning that the quantity demanded of 1 item decreases when the price of the other increases.
Income elasticity of demand refers to how responsive is the demand for a good or service subjected to a fluctuation in income when everything else is constant. For a normal good, income elastic, when it is bigger than 1, the percentage increases in the quantity demanded is greater than the percentage increase in income. While income inelastic for a normal good when it is less than 1 but bigger than 0, simply means that the percentage increase in quantity demanded is less than the percentage increase in income. Lastly, negative income elastic for an inferior good, which is less than 0, explains that when the income increases, the quantity demanded decreases.
Now, moving onto the elasticity of supply. What the elasticity of supply does is to measure how responsive is the quantity supplied subjected to a change in the price of a good when everything else remains the same. It is however calculated as follows:
Price elasticity of supply = percentage change in quantity supplied / percentage change in price.
Perfectly inelastic supply is when the size is 0, this means that the quantity that is supplied is the same regardless of price:
Perfectly elastic supply is when the size is infinite, the small increase in price causes an infinite big increase in the quantity supplied:
These are just concept graphs to gain an understanding of the elasticity of supply.
Tax incidence is the one concept that has a majority part involved with sin taxes. Tax incidence is and I quote: “the division of the burden of a tax between the buyer and the seller”
This is a typical illustration and representation of the result of a tax increase on cigarettes:
P S + tax
The point reaches new equilibrium and therefore will elasticity have a role in this change.
The graph of perfect elasticity:
S + tax
Now that we gain an understanding of elasticity and tax incidence, it is important to know how the one affects the other. It is the tax incidence that affects elasticity. But how? If the price of cigarettes increase because sin tax has increased, some people would stop smoking because of this and some will stay constant in their smoking because it is a habit and some would just reduce by a small amount. Therefore the person that carries on smoking regardless of the price has a perfectly inelastic demand for that good whilst the person that reduces smoking has unit elastic demand. With this information we can see that tax incidence does have an effect on elasticity.
According to the statement given, it is stated that the sin taxes on tobacco products are shared equally between consumers and producers. The tax can be shared partly between the consumer and producer but not equally. Therefore I disagree with this statement because if the government increases the tax on cigarettes, the price paid by the consumer can rise by the full amount and therefore pays the entire tax or by a lesser amount or nothing at all. If it’s the lesser amount, it will be partly paid by buyer and seller. If the consumers’ price does not change then the tax falls completely on the seller.
To also prove my argument, according to the article, “smokers cough up” from the financial mail, 24th October 2008, it is stated that it is not the sellers of sin products that foot the tax bill, it is the consumers2. Also an approximately 52 percent of tax is paid by the consumer alone on cigarettes and 43 percent tax is paid on alcohol. Since it is not environmentally friendly to smoke, government could have increased the tax to try and make people not to pay and quit smoking. This is also where we involve the rich and the poor. The poor cannot afford it and therefore slack down or quit smoking while the rich carry on smoking; they are a good example of perfectly inelastic demand.
Therefore I conclude that the above statement is incorrect because due to tax incidence and elasticity, it clearly illustrates that the final consumer is the one that pays most of the tax burdens of sin taxes on tobacco products. It will never be shared equally between producer and consumer because, the more inelastic the demand for a good, the larger the share of the sin tax pushed to the consumer, also including reasons such as environmental issues that can occur and that the sellers will want to maintain their profit margin.
2) “Smokers cough up” Financial mail, 24th October 2008
3) PARKIN, POWELL and MATHEWS(Economics,2008)
• Economics 7th edition, 2008
o Parkin, Powell and Matthews
• Economics for South African students second editor
o Philip Mohr, Louis Fourie and associates
• Economics X-kit, 2009
o Pearson, Maskew Miller Longman
• Grade 12 Economics
o Exam study guide
o Human, Van Zyl and Cele