Sin tax reform: Making the grade

June 13, 2012 – Through the congressional phase of the sin tax reform debate, it has been clear the proponents on both sides have zeroed in on various specificities to bolster their case. The role of Congress and now the Senate is to sort through the rhetoric and weigh the sides in light of what is in the best interests of the nation.

After all, nothing in life is “100% good” or “100% bad” And there are pros and cons to each side.

In an attempt to take a holistic view of reform, this provides a grade — a winning side — for each of the 5 key areas of debate regarding sin tax reform.

  1. Finances. The Department of Finance calculation of incremental revenues from reform estimates P30 billion total — and this assumes a quite large reduction of various segments of the cigarette market of nearly -50% which is quite a conservative assumption. This is versus only several billion incremental pesos under the various “status quo” excise proposals. And reform also abolishes the artificial classification freeze that has deprived the Philippines of at least P200 billion in lost revenues over the past years. The winner is clear: REFORM.
  2. Health. This is a no-brainer. The more expensive “sin products” are, the less they are consumed. And that’s a plus for health. Plus the incremental revenues of reform shall be partially allocated to funding national health care plan. Easy call. Winner: REFORM.
  3. Level playing field. Free market competition stimulates economies and investment. The existing excise system has, what can only be termed a bizarre provision, that gives preferential treatment to pre-1997 brands, giving them permanent classification and allowing their 1996 prices to be the base for taxation — regardless of where inflation price increases take them. This has resulted in a monopoly dominating 94% of the market, and little success for any new entries. Despite the “status quo” side harping on the fact that “26 new brands have entered the market since 1996,” what they conveniently fail to mention is these brands have collectively failed. They have garnered less than 2% of the total market because they pay higher excise taxes. By simplifying the tiering and abolishing the 1996 annex, a new brand or company can effectively enter and hence drive competitiveness and investment. Winner: REFORM.
  4. Smuggling. There are two types. The first is smuggling current leader brands from neighboring countries in which the landed price allows one to undercut local pricing. This is the most predominant form of smuggling involving cigarettes in particular. This is so because brand loyalty is high and consumers are not always open to new brands and hence new tastes. Even after reform, Philippines will still remain among the lowest priced cigarettes in the region, and therefore the smuggling risks on existing brands remains low. The second form of smuggling is bringing in new brands, normally “cheap” brands of low quality. It is likely there will be an increased influx of some of these brands behind higher local prices, although traction among consumers is highly questionable as the category demonstrates high loyalty to particular brands and tastes. And one can rightfully argue that smuggling is not something to be “fixed” via tax policy but via effective actions in the Bureau of Customs. Regardless, it is hard to argue against some small level of smuggling increasing as taxes rise. Winner: STATUS QUO.
  5. Tobacco Farmers. This is a complex subject. On the one hand, local tobacco grades are indeed of lower quality and hence used as “filler” for lower tier blends. So yes there may be SOME contraction in local market sales behind drastically higher prices. However, status quo proponents fail to mention that nearly 60% of local tobacco is already exported, a figure that will remain untouched regardless of local excise rates. Thus, the claim “This will decimate the local tobacco farmers” is a massive exaggeration. On top of this, while there are indeed multiple tobacco leaf processors such as Universal Leaf, the ultimate customer is the cigarette companies like Philip Morris Fortune, Japan Tobacco, and British American Tobacco. For this remaining 40% of local volume, getting more ultimate consumers into the market would far than overcome some contraction behind higher taxes. Winner: REFORM.

Overall, when one puts it all together, indeed nothing is perfect. No option ever is. But it is clear the current bill is an overall win for the Philippines. Let’s just hope the Senate continues the reform-minded, visionary, and courageous thinking.

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