The Economics of Tobacco: The Market for Cigarettes in Ireland

A recent report from the Revenue Commissioners Research and Analytics Branch examines "The Economics of Tobacco: Modelling the Market for Cigarettes in Ireland" (Padraic Reidy and Keith Walsh; February 2011). Highlights from the executive summary are below.

"Numerous explanatory variables of cigarette consumption are explored but the only factors that are found to be statistically significant in the most efficient econometric regression are: price, income, the introduction of the smoking ban, EU enlargement and the point of sale advertising ban. Of these, the most important effect is from price.

The model suggests a price elasticity of -3.6, i.e., a 1 per cent increase in price results in a 3.6 per cent reduction in cigarette consumption. This price elasticity is extremely high compared to other estimates for the Irish market, most suggest a figure of between 0.5 and 1. A price elasticity of -3.6 is too high to be realistic, for example it would imply that a 10 per cent increase in price reduces smoking by 36 per cent... Therefore another factor must be at play.

...The price elasticity estimated refers to taxed cigarettes: a 1 per cent increase in price leads to a 3.6 decrease in consumption of taxed cigarettes. The most reasonable theory to explain such a large decrease in taxed consumption is that only part of the reduction is caused by lower smoking levels, the remainder must be caused by smokers switching to substitute cigarettes. The most likely substitutes in the case of taxed cigarettes are non-Irish taxed cigarettes...

...Revenue estimates that currently around 20 per cent of cigarettes consumed in Ireland are not Irish taxed and this figure has been increasing in recent years... Further analysis finds some evidence that cigarette tax levels have moved beyond a critical point at which increases in tax rates lead to lower, rather than higher, tax revenue. Further tax (price) rises will reduce smoking somewhat but they will also greatly encourage more untaxed consumption.

Increasing the taxation of cigarettes in Ireland no longer carries the combined benefits of better public health and higher revenue for the public finances... This suggests that taxation increases are no longer the optimum tool for reducing smoking in Ireland. This is further supported by the significance in the model results of the effect of the smoking ban. Such non-price measures are shown to reduce taxed consumption and do not carry the same incentive to switch to untaxed cigarettes as higher rates of taxation."