Monday, July 14, 2008

The Government should increase the tax on tobacco

The following article appeared on the opinion pages of The Jakarta Post on 02 July 2008. I reproduce the original for your reading pleasure.

Indonesia is addicted to smoking. Cigarette advertisements dot the skyline and clog the airwaves. If you go to a concert or a sporting event, it is likely that the cost of your ticket will be subsidised by a tobacco company. Over 63 per cent of Indonesian men over the age of 15 are smokers. Almost 5 per cent of the world’s smokers come from Indonesia even though Indonesia’s population makes up only 3.5 per cent of the global total. In 2005, it was estimated that Indonesians consumed nearly 200 billion cigarettes. In short, the tobacco industry is pervasive and tobacco consumption has reached epidemic proportions.

Despite clear evidence that high levels of smoking are a burden on a society’s health and well being, the Indonesian Government has failed to take any meaningful action to address the smoking epidemic and its associated problems. Indonesia is the only country in East Asia not to have ratified the World Health Organisation’s Framework Convention on Tobacco Control. Tobacco taxes in Indonesia are the lowest in South East Asia while there are few limits on the sale, consumption or advertising of tobacco products. Other countries in the region, having realised the malign influence of tobacco, are actively discouraging its consumption. Indonesia, the tobacco control “rogue state”, is being left behind.

The key reason for Indonesian government non-interventionism is because policy thinking in this country is captive to the idea that the tobacco industry is of greater benefit to the economy than tobacco control measures. The Government, it seems, is of the view that the increasing restrictions on the tobacco industry would harm the economy by reducing the valuable flow of taxation revenue from tobacco consumption.

The Government’s position is in stark contrast to mainstream and credible economic opinion on the issue of tobacco control. Most serious economic analyses of tobacco conclude that well targeted tobacco control measures are, in fact, good for an economy and government revenue.

A good way to look at the issue of smoking in an economic manner is to consider whether all of the costs of tobacco consumption are incorporated in the price paid by the smoker for tobacco related products.

When a smoker consumes a packet of cigarettes, for example, he damages the health of the people around him as they inhale his second hand smoke. The same smoker also increases the chance of damaging his own health and suffering an untimely death. Consequently, his contribution to society and the economy is reduced. When a poor smoker spends a disproportionate amount of his income on cigarettes he reduces his family’s ability to pay for education and food. Who bears the burden of all these additional costs? Although the smoker bears some of them as a result of his decision to smoke, these examples highlight the fact that there are significant costs imposed on others without their consent as a result of his decision.

Estimates from the World Health Organisation and others suggest that these negative impacts of tobacco consumption far outweigh the positive benefits of the tobacco industry. There is a significant cost to society resulting from increased healthcare and economic costs resulting from morbidity and mortality as well as the forgone opportunities resulting from consumption expenditure on tobacco.

The low price that Indonesians currently pay for cigarettes fails to capture the cost of all of these negative social impacts that are caused by the consumption of tobacco even with 22 per cent of the price flowing to government coffers. In economic terms, such a situation is called a “negative externality”: the “external” or social costs of consumption are not accounted for in the price of a good.

If there are negative externalities resulting from consumption or production of a good, it is now widely accepted that government intervention in the market may be an appropriate response. Happily, in the case of tobacco, there is an extremely powerful public policy intervention avalaible that makes economic sense, should be effective at reducing consumption and can be used to offset the social costs of that consumption. The intervention is simply to raise tobacco taxes.

Estimates, again from the World Health Organisation and others, suggest that if tobacco taxes are raised by ten per cent then consumption of tobacco falls by around eight per cent. This means that revenue from tobacco taxation is actually increased even though consumption falls. The ill effects from smoking are reduced from this reduction in consumption and the government has additional money in the bank to combat the negative social impacts resulting from the activities of the remaining smokers.

To evaluate whether tax increase is an appropriate policy two further issues should be considered. The first of these is whether the tax increase is “regressive” or, in other words, has a greater impact on the poor than on the rest of society. There is no doubt that the poor are less able to absorb the costs of tobacco tax increases. However, because of this, it is the poor that are estimated to reduce their consumption more than the middle class in response to a tax increase. In fact, many estimates suggest that the poor, unlike the middle class, will reduce their consumption by a larger factor than the tax increase. If this is the case, a lower proportion of their income is spent on tobacco than before the tax was imposed. Therefore, the effect of the tax increase is likely to be “progressive”. The wealthier strata of society will bear a greater burden of the tax increase.

The tax increase could, therefore, offset some of the social impacts of tobacco used in poor communities and frees consumption expenditure in those communities for more positive purposes. Meanwhile, the government is collecting additional revenue that can be used to deliver social welfare programmes to these same communities.

The government may be concerned about the negative economic consequences of a contracting tobacco industry. Again, economic analysis suggests that the overall impact of a tax increase on industry would be far outweighed by the benefits of reduced consumption. Studies suggest that, although some tobacco farmers would be effected by increased taxes, it would be no more pronounced than if a price/demand fluctuation occurred for any other agricultural commodity. Moreover, with rising food prices, other agricultural products become more attractive alternative crops for farmers currently farming tobacco.

On the manufacturing side, although taxes would likely see a fall in cigarette production, this is unlikely to lead to significant job losses. Meanwhile, the long term economic benfits of more productive healthy workers would likely increase opportunities, investment and growth. This would help offset the costs of any tobacco manufacturing downturn.

The message is simple. Increasing tobacco taxes should increase revenue, reduce tobacco consumption, diminish negative social impacts of tobacco consumption and improve overall economic outcomes. It would also go some way to reducing Indonesia’s status as the international pariah on tobacco control with some of the lowest tobacco taxes in the world. It would be an even more effective policy approach if it were implemented alongside other anti-smoking policies such as advertising restrictions, smoke free areas and education campaigns.

The writer is an advocacy consultant to the Indonesian Consumers’ Organisation (YLKI).

Mitigating the impact of the fuel prices increase

A heavily and, in parts, incorrectly edited version of the following article appeared on the opinion pages of The Jakarta Post on 27 May 2008. It was later cited at on 28 May 2008. I reproduce an unedited version for your reading pleasure.

On Friday, the Indonesian Government raised the price of petrol (BBM) by 28.7 per cent. International prices for oil have risen sharply over the last few years and maintaining a constant low price for petrol is a drain on the nation’s coffers. The economic and social consequences of the decision are significant. Obviously, the price of transportation will increase. Subsequently, the price of goods and services that rely on transport will also increase. This will include many of the essential goods and services that Indonesia’s poor struggle to afford even at today’s prices. The impact, therefore, will be particularly severe among the socially disadvantaged in Indonesia.

Despite this negative impact, the decision to increase fuel prices is appropriate, equitable and inevitable. The reality is that it is the wealthier strata of Indonesia’s society that uses more fuel and fuel dependent goods than Indonesia’s poor. Consequently, the subsidy, as it is currently structured, is of greater advantage to the rich than the poor. It seems ridiculous that a country with so many people that are socially disadvantaged is diverting money that could be used for development, health, education and the delivery of core government services towards a subsidy that benefits the wealthy. Undoubtedly, a better use for the money would be to enact policies that aim to improve the lot of Indonesia’s poor.

A further issue with the fuel subsidy is that its level is dependent on world oil prices. Each year, the Government commits an uncertain (but always large) amount of its budget to the subsidy. The resources required to maintain the subsidy fluctuate each year as a result of factors totally beyond the Government’s control. There are very few governments in the world that would be willing to have a large part of their fiscal policy determined by world oil prices. The pursuit of such a policy is economically negligent and the decision to remove the subsidy on this basis should also be applauded. Other policies, that provide greater certainty and control in the use of the Government’s money, can be better targeted at achieving strategically advantageous policy outcomes.

In order to counteract the impacts of the petrol price rise the Government has proposed a direct cash transfer (BLT) to Indonesia’s poor. While this policy should be welcomed, it cannot be seen as anything more than a short-term and, in the fullness of time, meaningless gesture. The BLT will provide immediate assistance to poor people affected by the price rise. However, in the face of rising prices for every day goods and services, the reality is that this assistance will soon be forgotten.

Therefore, it becomes extremely important for the Government to develop strategic policies for the use of its financial windfall resulting from the subsidy reduction. Amidst the hype surrounding the decision to increase prices, the long-term policy options have been infrequently discussed in policy circles and the media. Positive impacts from the decision to increase petrol prices are totally dependent on the policies that can now be pursued by the Government as a result of its substantially improved financial position.

There will be a variety of opinions as to the most appropriate policy application for the Government’s additional resources. Of course any government decision regarding resource allocation is contestable. However, it seems that there are a number of options for the use of the financial windfall that are relatively uncontroversial and will accrue substantial long-term benefits.

Perhaps the most important strategic use of additional money is a substantial investment in public education. In the long-term, all Indonesians will realise benefits accruing from investments in education. Time and time again such expenditure has been shown to have undeniably positive impacts on living standards, particularly among the socially disadvantaged.

As part of an expanded education programme, the Government should consider investments in the tertiary education sector. Indonesia’s universities suffer from underinvestment and inefficiency. Yogyakarta alone has countless universities and higher education institutions. Undoubtedly some resources could be used to rationalise these innumerable organisations to ensure that universities offer greater quality rather than quantity. A significant emphasis should be placed on the improvement of teacher and medical training. Investments in these areas will assist the Government in the delivery of better quality social programmes in the future.

The Government also should take steps to improve social assistance directly targeted at Indonesia’s poor. Rather than direct cash transfers, this assistance should be focussed on improving access to essential services through investments in hard and soft infrastructure. This assistance should include housing assistance where necessary as well as improved access to healthcare and clean water. Rural development programmes that improve access to efficient and sustainable farming technologies should also be expanded. Such programmes have the effect of reducing the already significant pressure on food prices. The windfall from the subsidy, through investment in such strategic programmes, should be sufficient to provide a limited social safety net for Indonesia’s poorest.

There are several other issues that should be considered by the Government as it prepares to reduce the fuel subsidy. One important consideration is the best structure, from an economic perspective, for the subsidy reductions. Should the subsidy reduction occur in the form of a large reduction, as occurred in 2005, or should the government consider a staged subsidy reduction over an extended period of time? Given that inflation is already high and is under increasing pressure as a result of higher food prices among other things, it may be better to articulate a plan for a staged reduction in the fuel subsidy. One-off subsidy reductions, such as the 28.7 per cent increase, have a relatively large inflationary impact when compared with smaller staged reductions in the subsidies that give individuals and businesses more time to adjust to changing conditions. The staged approach, while having the same policy effect, may mitigate the impact on Indonesia’s poor.

A final issue that requires consideration is whether the Government has the best institutional arrangements in place to maximise Indonesia’s domestic oil production and, thus, contribute to lower global oil prices. Indonesia has significant oil reserves that are not being exploited because the Government policies provide minimal incentive for exploration. The Government should consider reforming tax and bureaucratic structures that currently deter investment. As part of such reforms, the Government should consider reforming the inefficient behemoth that is Pertamina. Pertamina should have to adhere to best practice corporate governance and compete with other oil companies in order to drive the most efficient exploitation and distribution of Indonesia’s oil resource. The Pertamina stranglehold of Indonesia’s oil industry promotes inefficiency and poor service standards. The monopoly should be broken in favour of well-regulated competition that maximises business efficiency, consumer welfare and government revenue.

In conclusion, it is important for the Government to think strategically about the policy issues surround fuel subsidy. It should not squander an opportunity for meaningful reform with a focus only on direct cash transfers and other short-term measures.

The writer is an advocacy consultant to the Indonesian Consumers' Organisation (YLKI).