Tobacco Taxation Increase

Increasing the tobacco excise duty rate by $4 per carton of 200 cigarettes, along with corresponding increases to the excise duty rates for other tobacco products outlined in the table below:

Inventories of cigarettes held by certain manufacturers, importers, wholesalers, and retailers at the beginning of the day after Budget Day are subject to an inventory tax of $0.02 per cigarette, subject to certain exemptions.

PBO determined the volume of historical legal cigarettes sold by dividing cigarette excise duty revenues by the corresponding excise duty rate. This history allowed PBO to calculate the rate of secular decline in legal cigarettes sold. We applied that rate to historical sales to project future sales.

Consistent with provisions of the Excise Act, PBO determined future excise duty rates by growing historical and proposed rates by CPI inflation.

PBO modelled two scenarios to estimate incremental excise duty revenues. In the “status quo” scenario, PBO multiplied our projection of future legal cigarettes sold by the corresponding excise duty rates. PBO increased the resulting cigarette excise duty revenues by the share of tobacco revenues from non-cigarette products (manufactured tobacco and cigars).

In the “post-Budget” scenario, PBO reduced the projection of future legal cigarettes sold to account for consumers’ responsiveness to price changes in legal tobacco products (i.e., the price elasticity of demand). Over the projection period, PBO determined that higher excise duty rates would increase cigarette retail prices by 3.0%. Based on results in Gruber et al. (2002), PBO assumed a price elasticity of demand of -0.47. This means that the 3.0% increase in the (real) price of legal cigarettes results in a reduction in legal cigarettes sold of 1.4%. PBO multiplied these reduced sales by the higher, post-Budget excise duty rates. PBO increased the resulting cigarette excise duty revenues by the share of tobacco revenues from non-cigarette products (manufactured tobacco and cigars).

PBO calculated the difference between the “status quo” and “post-Budget” scenarios to project incremental excise duty revenue arising from the measure.

Finally, PBO determined the GST revenue impact as the difference between GST revenues (future prices multiplied by future legal cigarettes sold multiplied by the GST rate) in each scenario.

PBO did not expect any incremental administrative costs or savings.

Data on historical legal cigarettes sold, inferred from the Public Accounts, suggest that while historical sales have been subject to an overall trend of secular decline, sales in any given year have deviated from that trend by up to 10 percentage points. Future volatility in legal cigarettes sold could impact the cost estimate.

PBO assumes that historical trends in cigarette retail prices and legal cigarettes sold will continue throughout the projection period. Future price growth may differ due to provincial and territorial decisions to change or maintain their excise duty rates. Future legal cigarettes sold may differ if consumption habits, legal cigarette prices, and the relative price and availability of contraband tobacco evolve differently than what is captured in historical trends.

Future excise duty rates are indexed to CPI inflation and are sensitive to uncertainty in the economic outlook.

The share of impacted tobacco revenues from non-cigarette products (manufactured tobacco and cigars) has been relatively stable over time, and so represents a minor source of uncertainty.   

PBO approximated consumers’ behavioural response to higher legal tobacco prices (i.e., reduced smoking frequency and incidence, or migration to the contraband market) with a price elasticity of demand impact. Projected revenues are sensitive to the choice of price elasticity factor. The literature shows a moderate range of price elasticities for legal cigarettes. PBO’s chosen price elasticity factor, from Gruber et al. (2002), was estimated excluding data from the early 1990s in Central and Atlantic Canada. Between 1990 and 1993, legal cigarette prices rose by approximately 50 per cent in real terms and contraband cigarettes flooded those markets (Gruber et al., 2002). We do not anticipate a similar increase in contraband due to this measure, but a similar effect could significantly increase the price elasticity of legal tobacco and reduce tobacco excise revenues. The price elasticity estimate may be biased if consumers’ responsiveness to legal market price increases has changed since the 1980s and 1990s.

Higher legal tobacco prices may increase (decrease) consumption of substitute (complementary) goods such as alcohol and cannabis, which are subject to federal excise duties, and vaping products, which are not. These potential behavioural responses, which may have fiscal impacts, were not included in this cost estimate.

The incrementality of the GST revenues is uncertain. Though the higher price of legal cigarettes is expected to generate more GST revenue per sale, those gains may be offset by smokers reducing their consumption of other GST-taxable products to compensate for higher legal cigarette costs. GST revenues may also be overstated if tobacco companies lower product prices in reaction to the increase in excise duty rates.

• Estimates are presented on an accruals basis as would appear in the budget and public accounts.
• Positive numbers subtract from the budgetary balance, negative numbers contribute to the budget balance.
• “-“    \= PBO does not expect a financial cost.
• Numbers may not add due to rounding.