Article

UPDATE 1-Indonesia to slow down pace of tobacco tax hike due to pandemic
Source: Reuters

https://www.reuters.com/article/indonesia-tobacco-idUSL1N2IQ09J

Date: December-10-2020

* Indonesia to raise 2021 excise tax on tobacco by average 12.5%

* Rise compares with 23% average tax hike this year

* Finance minister says needs to balance health needs with economy

* Indonesia’s smoking rate among highest in the world (Adds context, detail)

JAKARTA, Dec 10 (Reuters) - Indonesia will raise the excise tax on tobacco products by an
average of 12.5% in 2021, the country’s finance minister said on Thursday, citing a need to
balance efforts to control smoking with the need to support an industry that is a major
employer. The 2021 increase compares with the 23% average excise tax hike this year and
may disappoint health groups pushing for stronger action in a country with one of the highest
smoking rates in the world.

“We are trying to balance the health aspect with the economic condition generally that is
impacted by COVID-19, especially for workers and farmers,” Minister Sri Mulyani Indrawati
told a virtual news conference.

About 70% of adult men use tobacco products in Indonesia, according to the World Health
Organization (WHO), one of the highest rates globally, with cigarette prices also among the
lowest of any country.

The WHO said every year around 225,700 people in Indonesia die from smoking or tobacco-
related diseases.

The government has been raising taxes on tobacco products almost every year since 2014, but
WHO data shows smoking prevalence among adolescents aged 10–19 years had jumped by
approximately 20% in a five year period to 2018, while the adult prevalence had not shown a
decline, bucking global trends.

The new excise policy, which takes effect on Feb. 1, 2021, is aimed at lowering the smoking
prevalence among youths to 8.7% in 2024, from 9.1% currently, the minister said.

“The excise hike will make cigarette prices more expensive ... so they’re less affordable,” Sri
Mulyani said.

She said, however, the tax hike would not impact hand-rolled clove cigarette producers,
which are dominated by small- and medium-sized players.

Tobacco taxes are often controversial in Indonesia, with big tobacco companies often saying
a decline in sales hurts the livelihood of farmers and increase sales of illegal cigarettes.
(Reporting by Gayatri Suroyo and Maikel Jefriando Editing by Ed Davies)
 Commentary

The article talks about how the Indonesian government will increase the excise tax
on tobacco products by 12.5% in the following year. Excise tax is a type of indirect
tax imposed on spending on particular goods and services. Tobacco is a
demerit good which creates negative externality of consumption, which the
government aims to eliminate with. Demerit goods have harmful effects when
consumed. The likely effect of the tax imposed is that the prices will increase which
would discourage its consumption in the teenagers of the country. Negative
externality of consumption is when the consumption of any particular good
creates a greater MPB than MSB.

The diagram above shows the tobacco market of Indonesia. In the diagram, the
equilibrium before the tax imposed is ‘e1’ with the quantity at ‘Qm’ and the price at
which the market operates at ‘Pm’. The market fails as the marginal private benefit of
consuming the tobacco is much greater than the marginal social cost at this point in
the market is said to failed as the output level is far greater than the optimum level of
output, this creates a negative externality, (E-e) in the market due to the quantity
consumed being over the optimum quantity. There is a welfare loss in the market
due to the over allocation of resources and this creates an increased inefficiency.
There is also a large number of adolescents that are currently smoking cigarettes.
The tax increase that the government will impose in the following year will bring shift
the supply curve to the left as the cost of producing each unit increase which
discourages the supply. This shifts the supply curve to ‘St’ from ‘S’. At the new
supply cure ‘St’ the quantity at which the market operates at is ‘Qopt’ and the price at
this quantity is ‘MPB=MSC’. The price that producers receive is ‘Popt’ after they’ve
paid the tax to the government. A new equilibrium forms in the market at ‘E’ from
‘e1’, where the welfare loss is eliminated and the externality created is reduced as
the market operates at the optimum level of output. The tax imposed will also
generate tax revenues for the government which it can use to help other areas of the
economy or spread awareness about tobacco consumption using campaigns. The
government can also use this revenue to subsidies goods that create a net positive
externality in the market.

However, consumers in this market are worse off as now they pay a much higher
price for the same product. The government’s aim to reduce the externality created
in this market might render useless as tobacco products are inelastic in nature,
which means that the responsive change in the demand is much less than the
responsive change in the price. This means that the level of consumption might
remain the same as tobacco products are addictive. The government is not taxing
hand-rolled clove cigarettes which can become a good substitute for the teenagers
that find the new price discouraging, this could further create externalities in a
different market. The government’s decision to impose the tax will can also directly
affect the economy. As mentioned in the article the tobacco industry in Indonesia is
very big and any policies to restrict this market can cause significant changes in the
economy structure, people can lose many jobs due to tobacco being produced less
and less labour force is required. The higher prices of the cigarettes can also lead to
the formation of black market which the very addicted teenagers could buy cigarettes
from, this overall only creates more externality in the market.

The government could use alternative methods to reduce the quantity at which the
tobacco market operates. The government could increase the regulations regarding
the consumption of tobacco products, by increasing the legal age of consuming any
tobacco products and to regulate it strictly to ensure that teenagers do not consume
any of this.

For an economy so heavily dependent upon the tobacco industry an excise tax
imposed can create negative effects on the economy such as unemployment, or the
creation of a black market for tobacco products which would negatively affect the
population and can possibly reduce t5he overall productivity of the economy and the
government should look at multiple factors before imposing another hike in the tax.
The government should invest in raising awareness in the youths of the economy to
ensure a decreased consumption for their age group.

Word Count:739

Bibliography
Economics for the IB Diploma, by Ellie Tragakes, Cambridge University Press, 2020