(Microeconomics) Why didn't he simply say so? Smokers see cost of a packet of cigarettes rise by 35p

• From May, a minimum level of excise duty for a packet of 20 will be introduced
• The latest measures effectively wipe out cheaper prices on packs of cigarettes
• It means smokers will not be able to buy a packet for less than £8.82 plus VAT

 

Smokers face a double whammy of tax increases as the Treasury moves to raise the cost of 'budget' cigarettes.

From May, a minimum level of excise duty for a packet of 20 will be introduced.

 

But it was initially unclear what this meant for smokers, as it came in tandem with tax rises announced in previous budgets.

 

Yesterday Philip Hammond revealed that manufacturers will have to pay a minimum £5.37 duty per packet of cigarettes.

 

Following announcements in Wednesday's budget, smokers could end up paying more for cigarettes

 

However he did not explicitly refer to changes unveiled in the 2014 Budget, which meant that from 6pm last night cigarettes had already gone up by 35p per pack of 20.

 

In all, the measures effectively wipe out cheaper prices on cigarettes, meaning smokers will not be able to buy a packet for less than £8.82 including VAT.

 

The average cost of a 20 - pack of premium cigarettes could also now rise from £9.91 to £10.26, according to the Tobacco Manufacturers' Association. Meanwhile small packs of ten will no longer be available from May.

 

For drinkers, the price of a pint is also going up by 2p under new rules which will come into force on Monday. It is the first rise on a pint in five years.

 

There will also be an extra 10p to a bottle of wine and 30p on a bottle of whisky. Taxes on alcohol had previously been frozen.

 

The moves on cigarettes are designed to discourage companies from selling tobacco products cheaply, raising prices for consumers and encouraging smokers to quit.

 

Officials hope the moves will stop younger people buying cigarettes. However eradicating cheaper brands runs the risk that more smokers will be tempted to buy on the black market.

 

Cigarette makers are furious about the rises. The TMA director general Giles Roca said: 'We are disappointed that the Government has once again raised taxation on tobacco when tax on some of the cheapest cigarettes already accounts for 90 per cent of the price.

 

'Today's move will simply encourage people to buy from the black market. It takes business away from the legitimate trade whilst costing the taxpayer around £2.4billion in lost taxes in the last year alone.'

 

Colin Valentine, chairman of the Campaign For Real Ale, said of the alcohol price increases: 'UK beer drinkers, pubs and brewers have been let down by the Chancellor's decision to increase beer duty for the first time in five years. It will ultimately hit consumers in their pockets and lead to pub closures across the country.'

 

Commenting on the increased cost of alcohol, Lib Dem home affairs spokesman Alistair Carmichael said: ‘This is a kick in the teeth for people who are working hard’.

 

'It seems like the Tories are so committed to kick the self-employed that they won't even let them drown their sorrows without trying to fleece them for more cash.'”

The demand for cigarettes in the UK is creating a negative externality of consumption which carries an additional burden for society in the form of higher health care costs. There has been a market failure due to the consumption of demerit goods like cigarettes. Market failure is a lack of equilibrium, in a free market, between the resources allocated and the quantity demanded. The graph below illustrates the market failure -

The optimum social output is at points P*, Q*, because MSB is equal to MSC. However, the MSB produced by the negative externalities of consumption mean that the MSB is less than the MPB– although cigarette consumers enjoy their own private benefits, the cost to society diminishes their private utility. The shaded area is between MSB and MPB and represents the external cost, in this case health care, with a welfare loss. Furthermore, consumers aim to maximise their private benefits, over-consuming cigarettes at points P₁, Q₁, at a level where MPB is equal to MSC, thus ignoring the negative externalities resulting from this. This results in market failure, with an over-consumption of cigarettes of Q₁ to Q*, and government intervention is required.

 

This is why Philip Hammond introduced new taxes to producers on cigarettes, with the hope to “discourage companies from selling tobacco products cheaply, raising prices for consumers and encouraging smokers to quit.” (paragraph 10)

Figure 2 shows the effect of an indirect tax imposed on the cigarette manufacturers. This tax increases the firm’s private costs, shifting the supply curve from MPC to MPC + Tax, a point of greater social efficiency. The government is now applying a tax on producers in conjunction with a tax on consumers to further discourage the production and the consumption of cigarettes, by “raising prices to consumers”. Indeed, the price of cigarettes increases from P₁ to P₂, and there is a decrease in consumption from Q₁ to Q₂.

 

Because of this tax, smokers will be less able to and/or willing to spend money on cigarettes (quantity demanded decreases). Indirect taxes could provide benefits to third parties because of the reduced number of people suffering from passive smoking and lung cancer, ultimately positively impacting health care.

 

This decrease in demand could generate tax revenue which the government could spend to correct some of the negative externalities associated with smoking, for example by providing education about the dangers of smoking, to further discourage the consumption of cigarettes. However, it is difficult to know which firms are contributing the most to the negative externality, so the tax may be targeting the wrong firms. Another disadvantage is that there would still be a welfare loss, where MSC is greater than MSB.

 

Although an indirect tax could benefit UK citizens, it is not necessarily an effective way of solving the negative externality because since cigarettes are inelastic goods, the taxes probably won’t be so effective in reducing demand– therefore, although the government’s revenue might be raised, the quantity demanded may not fall to the socially efficient level.

 

Furthermore, this intervention does not consider short-term implications: with the increasing price of cigarettes, young smokers will probably turn their attention to black markets. Therefore, it is hard to say whether the government will achieve its goal to “stop younger people buying cigarettes” (paragraph 11). Moreover, adult smokers may find it necessary to go to the hospital for smoking related ailments, even if they cut down; this would lead to a greater burden to society. Nevertheless, in the long run, if smoking levels go down, the burden to society should be reduced.

 

If consumption does go down, some cigarette producers, especially “cheaper brands”, may go out of business due to the increase in tax (“Cigarette makers are furious about the rises”) (paragraph 12).

 

Since the rising prices of cigarettes would bring less demand, the manufacturers may not profit as much as before, and firms may shut down. Therefore, this shows that although the government might meet its aim of reducing smoking, there are nasty side-effects such as the closing of firms and unemployment.

 

In conclusion, although an indirect tax might be beneficial to the health of UK citizens, there is the possibility it might raise issues regarding the consumer’s freedom of consumption and the manufacturer’s production activities. Perhaps the government necessitates to run policies of education in order to further reduce the negative externality of cigarette consumption. Although this would bring less tax revenue, it would constitute less of a threat to firms.

“Smoking & Tobacco Use.” Centers for Disease Control and Prevention, Centers for Disease Control and Prevention, 15 May 2017, www.cdc.gov/tobacco/data_statistics/fact_sheets/health_effects/effects_cig_smoking/index. htm.

 

Staff, Investopedia. “Market Failure.” Investopedia, 10 Apr. 2015, www.investopedia.com/terms/m/marketfailure.asp.