Analysis of the Temporal Evolution of Cigarette Market Elasticities in Brazil

Abstract

The current Tax Reform proposal includes products that are harmful to health and the environment, such as tobacco derivatives, in the Selective Tax (SI). These will have rates higher than the other sectors, whose estimated average rate will be 26,5%. The data shows that the current cigarette tax structure has not been effective in reducing the number of smokers and increasing tax revenue, due to the presence of substitute products represented by the illicit cigarette market. The variable coefficients model was used to estimate the respective elasticities at each point along the time evolution of each type of elasticity. This paper aims to determine the importance of the inclusion of the illicit cigarette market in the formation of the price of licit cigarettes in Brazil. The results show that increases in the price of licit cigarettes, through higher taxation, make the price elasticity unitary, reduce the market share of licit cigarettes and increase the illicit market. The cross-price elasticity of demand showed an increasingly inelastic trend during the period of successive increases in the price of legal cigarettes. Therefore, the increase in the tax burden on cigarettes, which does not consider the presence of illicit cigarettes, contributes to reducing government revenue and intensifying cigarette smuggling. In view of this fact, and given the current tax reform proposal, an alternative tax policy is presented that considers market segmentation and enables the production and sale of cigarettes at prices close to those practiced by the illegal market.