The literature on tobacco has shown that smoking has a negative effect on health and overall well-being. It has also shown that one of the most effective policies to reduce tobacco use is to increase tobacco taxes and prices. However, tobacco consumption is inelastic, which means that an increase in price does not translate into a reduction in consumption as equal as the increase in prices, and this is why the net effects of a policy to increase the price of tobacco is not clear.
The effect of a tax increase will depend on the sensitivity of consumers to higher prices which will determine the magnitude of the impact on revenues, as well as the increase in the benefits. Tobacco taxes have two main objectives: to discourage tobacco use to improve health and well-being; and to raise revenue for the public sector (ideally to at least to cover the externalities of tobacco use).
Results show that raising tobacco taxes in Mexico effectively reduces consumption by making people stop buying cigarettes (quitting) or preventing new smokers from starting to smoke. Tax increases reduce consumption, and also reduce medical expenses for each income group and at all levels of elasticity. The benefits are greatest in reduced medical expenses, which outweigh for each income group and level of elasticity any negative effects resulting from an increase in tobacco spending.
The implementation of a higher cigarette tax would have a progressive effect on the distribution of income, since it would allow the population to increase their income levels, by reducing cigarette expenses, and reduce healthcare costs from tobacco-related illnesses, while enabling them to be more productive.
Within the framework of a highly restricted fiscal space, the extensive economic costs from smoking and the progressiveness of the tax should be seriously considered by policymakers in increasing the cigarette tax rate.
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