Illicit Smokes Up 25% since Tax Rise - Case Study Example

Economics 100 Assignment Table of Contents Article Summary: 2 Introduction: 2 Analysis: 3 Conclusion: 8 References 9 Article Summary: The article “Illicit Smokes up 25% since tax rise” by Eli Greenblat talks about the effects of increase taxes on the illegal trade and smuggling of cigarettes in Australia. It was published on March 1, 2011; exactly a year after the Australian government increased the taxation on cigarettes and vowed to legislate for the plain packaging of cigarettes in order to deter its use. (Greenblat 2011) Introduction: The Australian government was wary of high smoking rates among its citizens. It was concerned about the health issues that this can pose to the health of its population and the working class. In order to counter the problem, it was decided to increase the tax rate on cigarettes in order to make sure that less people smoke. The government was also aware of affinity that consumers have towards certain brands and some will never smoke if their brand is not available. In order to deter people it decided to legislate for the plain packaging of cigarettes. However, the rise in cigarette taxes did not reduce the consumption of cigarettes, but instead resulted in illicit trading of cigarettes and several black markets for trading of cigarettes popped up. (Hunt 2011) Since we can see that the Australian government has used several strategies to discourage the use of cigarettes, we are going to test these strategies from economic point of view using various economic theories and diagrams. This report will examine several issues such as what happens to the market when the tax is introduced and what happens when a tax is levied on a highly inelastic good like cigarettes. The effects of imposition of a tariff on a good are going to be analyzed, in order to see why the imposition of taxes increased smuggling of cigarettes in Australia. In the end, the paper will conclude whether the Australian government has used the right policies to discourage the use of cigarettes or is there a need for more work to be done. Analysis: Demand and Supply: Demand is an ability and willingness of people to buy certain goods and services. There are several factors that cause a change in demand. The change in demand is usually represented by movement along the curve. Imposition of taxes on cigarettes would make cigarettes more expensive. This means that less people would demand it now as a general rule higher the price, lower is the demand. This can be represented in the following diagram: It can be clearly seen in the diagram, how tax reduces the quantity demanded and supplied in the market and how the price of a good increases after the imposition of a tax. This means that the consumers will now have to pay more for a pack of cigarette. This would reduce their willingness and ability to buy cigarettes and the new equilibrium will form at Q with tax where the quantity demand and quantity supplied in the market is less than when there were less taxes. This was what the Australian government tried to do. They tried to reduce the consumption of cigarettes by making them more expensive by levying a tax on them. (Chrystal and Lipsey 2004) Elasticity: This could have been a successful way to discourage the use of a product had the product not been a cigarette. As cigarette is an addictive product the demand for this product is price inelastic. Consumers don’t look at the price of product, but instead keep demanding the same amount of product as they were when the prices were less. This meant that the strategy devised by the Australian government to discourage the use of cigarettes was not effective because the good they were targeting was a good with an inelastic demand. This situation can be represented by the following demand and supply diagram: Since cigarettes have an inelastic demand, the slope of the demand curve is very steep. As a result any increase in price due to taxation won’t affect the quantity of cigarettes traded in the market. As we can see in the above diagram that a large increase in taxation has brought a very little change in quantity of cigarettes traded in the market. This is because that most of consumers have accepted the incidence of taxation on their own pockets because of their addiction of the product. (McConnell, Brue and Flynn 2011) However, the article tells us that the situation is more complex in the Australian markets. Many people chose to indulge in illicit trading of cigarettes rather than to pay their taxes which were planned to be spent on health and care in Australia. The emergence of black markets reduces the tax revenue for the government and as a result government can spend less money on its welfare program. We can see how black markets of cigarettes have affected the government revenue in the following curve. Tax Revenue and Black Markets: Suppose that the Australian government earns the tax revenue from Ptax – Pbm by levying heavy taxes on the cigarettes consumption. This revenue would go to the health care centers. However as a result of this tax many illicit traders find that they can smuggle cigarettes and sell it a lesser price then the ongoing taxed price. They sell cigarettes at the price of Pbm and do their work without any documentation in isolation so that they do not have to pay any tax. This leads to a black-market situation where the profits are being made on the sale of cigarettes but no money is going to the government for its health care and other welfare projects. Same situation is prevailing in Australia and many economic experts are predicting that in the article. There is a huge black market operating in Australia and government is not meeting its tax targets as result despite levying heavy taxes on cigarettes. The government can correct the situation by lowering their tax amount in order to reduce the difference between the black market and official price so that more people choose to trade in legal markets rather than indulging in illicit trade which has grown by more than 25% according to the article. (Bamford and Grant 2008) Economic Efficiency and Taxes: Taxes also affect economic efficiency of a transaction. The incidence of taxation reduces both consumer and producer surplus and makes an economic transaction inefficient. This can be seen in the following diagram. We can see that if no tax is changed on cigarettes then the optimal quantity of cigarettes will be traded in the market and both producers and consumers will get the best out of this transaction. However, as soon as a tax is levied the price of a product is reduced and quantity traded in the market is also reduced. This affects both the consumer and producer surplus as we can see that the happiness, profit and optimization of the transaction has been reduced by the area equal to “abc”. This means that the less profits and happiness have been derived from this transaction and resources could have been used more economically if there was no or little tax on cigarettes. (Tobacco taxes in Australia 2011) Conclusion: It can be concluded from the application of the economic theory in the article that the decisions made by the Australian government are not effective in order to reduce cigarette consumption and won’t earn much revenue for the government in order to aid its spending on the welfare programmes. Since cigarettes are an inelastic commodity no matter how much tax is charged people will still continue to consumer it. They will also try to save their hard-earned money by trading in black markets and this will do the government no good. Since, it won’t earn any revenue for the government to spend on welfare programs such. Another reason why these strategies won’t be affective is because they will hamper the economic efficiency and cater inefficiency in the cigarette market. Any inefficiency means that resources are being wasted and could be put to better use. In light of the above discussion we can clearly see that tax and plain packaging is not the solution to reduce the consumption of cigarettes. Instead government should run awareness programmes in order to make sure that people are aware of all hazard of smoking. These awareness programmes could be in the form of advertising, workshops and with the help of doctors and public figures. This is the only solution to discourage the use of cigarettes and taxation and plain packaging strategy won’t work well and won’t be as effective the awareness campaigns. : References Bamford, Collin, and Susan Grant. OCR AS Economics Students Book. London: Heinemann, 2008. Chrystal, Alec, and Richard Lipsey. Economics. London: Oxford University Press, 2004. Daft, Richard L. Management. New York: The Dryden Publishing, 1994. Greenblat, Eli. "Illicit smokes up 25% since tax rise : tobacco boss." The Age, March 1, 2011. Hunt, Albert R. "Politics, Not Economics, Drives Anti-Tax Stand." Bloomberg , July 17, 2011. McConnell, Campbell, Stanley Brue, and Stanley Flynn. Economics. McGraw Hill, 2011. Tobacco in Australia. "Tobacco taxes in Australia." 2011. Read More