US economist warns Phl is overtaxing tobacco

Arthur Laffer, founder/chairman of Laffer Associated, an economic research and consulting company, has raised concerns that the Philippines’ tobacco excise tax rate has entered a “prohibitive range,” as indicated by declining government revenue.

Laffer, known for the Laffer Curve theory which describes the relationship between tax rates and government revenue, highlighted that the continuous increase in tobacco tax rates has surpassed the revenue-maximizing point.

Laffer explained that the Philippines’ experience shows that higher tax rates have led to reduced revenue.

The phenomenon of declining tobacco tax collections in the Philippines can be explained using the Laffer Curv– the relationship between tax rates and tax revenue. 

Tax revenues increase with increasing tax rates until a revenue-maximizing point is reached, after which further increases in tax rates result in declining tax revenue,” Business World quoted him.

Under the Tobacco Tax Law of 2019 (Republic Act 11346), the excise tax on cigarettes was increased to P50 per pack on January 1, 2021, with a 5 percent annual increase, it’s currently at P63. Vapor products are taxed at P54.6 per milliliter (ml) for nicotine salt and P63 per 10 ml for freebase.

He emphasized the need for the government to adjust tobacco tax rates to align closer to the revenue-maximizing rate, warning against further increases that could exacerbate revenue losses. 

“Of course, the government should take steps to realign tobacco tax rates closer to the revenue-maximizing rate. Doubling down with further revenue-losing tax rate increases is never a sensible solution to a tax revenue loss,” Laffer advised.

He elaborated on the dual effects of tax rate changes: an arithmetic effect, where lower tax rates reduce revenue; and an economic effect, where lower rates boost output, employment, production, and consumption, thereby expanding the tax base. Conversely, higher tax rates can have the opposite effect.

He also discussed the impact of price elasticity on the Laffer Curve, noting that if demand is elastic, the revenue-maximizing tax rate will be lower, as consumers are more sensitive to price changes. If demand is inelastic, the rate can be higher.

Laffer pointed out that the Philippines’ successive tobacco tax hikes have likely pushed rates past the revenue-maximizing point, leading to further revenue declines and increased illicit trade. 

“When a commodity becomes too expensive for consumers due to taxation, they will reduce consumption of that commodity or substitute away from that highly taxed commodity in part through consumption of illicit goods,” he warned.

He lauded the Philippines’ efforts to streamline its tobacco tax system but cautioned against excessive rate increases. “The mechanism that has resulted in continuous annual tax rate increases in order to achieve continuous revenue growth has clearly taken tax rates too high and has failed to generate the anticipated revenue. Due to declining tax revenue and increased growth in the illicit trade of tobacco, it is time to reevaluate the optimal cigarette tax rate,” he said.

In commending the Philippines’ approach to taxing novel tobacco and nicotine products like heated tobacco products and nicotine pouches, he suggested the simplification of its tax structure for e-cigarettes.

“Unlike other tobacco and nicotine products, e-cigarettes are taxed under a two-tiered system in the Philippines, which is leading to significant enforcement issues. Reforming e-cigarette taxation into a simplified uniform rate — as has been done for other tobacco and nicotine products –should be an immediate priority,” he said.

Laffer recommends a tax system that raises necessary revenue while minimizing economic damage. 

“By coupling tax base expansion with tax rate decreases, the Philippines can bolster and diversify tax revenue collection without jeopardizing economic growth. Other areas in which to consider simplifying and rationalizing are regulations for capital markets and the fiscal regime surrounding the mining sector,” he said.