Every year, around March/April, the government puts up taxes on cigarettes. This is an important means of both reducing and preventing tobacco use, particularly amng price sensitive smokers such as the young and the least well off. The impact of these tax increases will depend on tobacco industry pricing strategy - whether they decide to pass on the tax increase or absorb it. Yet very little is known about tobacco industry pricing and no studies had addressed this issue in the UK. Using cigarette price and volume data from a variety of sources we therefore examined cigarette pricing in Britain in a paper just published in Addiction.
We found that:
- Tobacco companies are using their pricing strategy to win in two ways because when taxes increase each year they do two things. On their more expensive brands they add their own price increase on top of the tax increase. On their very cheapest brands (known as “ultra-low price” brands), they absorb the tax increase and cut prices. The first ensures their profits rise and that consumers are hoodwinked into believing the price increase is due to the government’s tax increase, the second ensures fewer smokers quit than would otherwise, providing a win-win for industry.
- Over the period 2006-2009, the average real price (ie once inflation has been taken into account) of ultra-low price cigarettes has remained virtually static in real terms. If we look at the individual brands within this group, the price of some has increased by around 1 pence, while the price of others has fallen by around 5p over this period in real terms.
- Across the market as a whole, and on all of its more expensive brands, however, the industry increased prices on top of the tax increases. Consequently the price gap between the most and least expensive cigarettes has increased over time.
- Unsurprisingly, given these pricing trends, the market share of ultra-low price brands has doubled in recent years while the market share of the most expensive (premium) brands has fallen.
- These issues were not identified before because the way in which government monitored cigarette prices focused on premium brands which make up a falling share of the market.
Why are these findings important?
- We know that the young and the least well off are most sensitive to price increases and the industry’s own documents show that low priced brands are developed to target young smokers. The way industry prices its cheapest brands is therefore likely to have particular implications for these groups.
- The growing gap between cheap and expensive cigarettes provides an incentive for smokers to switch to cheaper cigarettes rather than quitting when taxes increase each year and is likely to help explain the growing gap in smoking between the rich and the poor. (Currently there is a 3-fold difference in smoking rates between those in routine (31%) and those in higher managerial/professional (10%) occupations. Click here for the data.)
- Smuggling: Despite its long history of involvement in the illicit tobacco trade, the tobacco industry consistently argues that tax and price increases lead to smuggling (click here for example), but here we show clearly how the tobacco companies are increasing cigarette prices over and above inflation and tax increases. This suggests they are not genuinely concerned about the illicit trade, but instead want to ensure that price increases occur via their own price increases rather than tax increases enabling them to further increase profits at the expense of government revenue. Given the already very large tobacco industry profits, this indicates a missed opportunity for government.
- These findings help explain why tobacco industry profits are increasing despite cigarette sales falling.
What are the policy implications?
Narrowing the price gap between the most and least expensive cigarettes and helping to ensure that tobacco tax increases on the cheapest brands are fully passed onto consumers would help address the public health implications of our findings. There are changes that can be made to the way tobacco taxes are set that would help, notably increasing the “fixed” (specific) element of tobacco excise and ensuring that the minimum excise tax allowed under European Union legislation is set at the highest level. A ban on price promotions and below cost selling would also help.
However, these changes may be insufficient, particularly as EU legislation requires us to have some element of ad valorem (proportional) taxes on cigarettes which tend to increase the price gap between cheap and expensive brands. A system of price cap regulation that we recently suggested could fully address the issues identified and bring other public health benefits. It would place put a cap on the price manufacturers can charge, but not the price consumers face and in that way would shift the excess profit from the tobacco companies to government raising around £500M a year in the UK.
The study also shows that governments need to be far more sophisticated in the way that they monitor cigarette prices. Using weighted average prices will help but it is also essential to monitor price trends by price segment.
Public Attitudes to tobacco tax increases
A recent pan-European survey (including the UK) asked about public attitudes to tax increases. Overall, approximately 80% of non-smokers and 50% of current smokers were in favour of a 5% increase in prices if the revenues were used for tobacco control. Moreover, 74% of non-smokers and 40% of current smokers were in favour of a 20% increase in price.