02 February 2016
by Jacob Greber

Labor's tobacco plan worsens structural budget problem, say experts

Leading budget experts say Labor's plan to use higher tobacco taxes to pay for fast-growing social programs is misguided and potentially unsustainable.

The Labor opposition expects to raise $47.7 billion over 10 years by increasing tobacco excise dramatically until 2020 and generating a surge of revenue it has earmarked for education, budget repair and other still-to-be announced measures.

Top analysts questioned if tobacco revenue, which is being undermined by falling smoking rates, would keep pace over the longer term with the faster-growing policies it would have to pay for.

"You're taking a severe structural budget problem and making it even worse," John Daley, chief executive of the Grattan Institute, said. "Tobacco excise is a structurally declining tax base. It is not going to keep pace with inflation because tobacco use is falling."

"[Former Labor health minister] Nicola Roxon deserves some serious credit for plain-packaging legislation. It seems to be lowering consumption, which is the idea. Now if you put up prices further that will reduce usage even further.

"Yet the things they're talking about funding will go up at least as fast as gross domestic product or faster, and paying for that with things that will not go up as fast as GDP."

Labor has defended its policy as sound, and pointed to Parliamentary Budget Office forecasts of the probable revenue, which uses information derived from the Treasury and other government departments.

Proud of the policy
Shadow treasurer Chris Bowen said he was proud of the policy for saving lives and generating budget revenue.

"Here we are in an election year and you have this extraordinary situation where Labor has more costed tax policy out there for the public to debate than does the government," he said. "Labor will have more savings announcements to make well before the next election."

With this year's federal election increasingly shaping as a choice between a tax system overhaul by the Coalition and increased social policy spending by Labor, Opposition Leader Bill Shorten pledged last week to spend an extra $4.5 billion on schools by the end of the decade.

The money will come from $70 billion in "savings" identified by Labor since the last election, around two-thirds of which will be from driving up the price of a packet of 25 cigarettes to more than $40 by 2020.

The Budget Office has assumed the pace at which Australians quit smoking will double during the years in which the excise is increased.

The promised price hike has raised doubts in some quarters about whether future smoking rates could fall faster than predicted, eroding the revenue that would accrue.

Official health department figures show the proportion of daily smokers aged 14 or older fell from 25 per cent in 1993 to less than 13 per cent in 2013, with the decline showing signs of accelerating since the introduction of plain packaging laws in 2012 and a series of excise rises.

Tobacco consumed has plunged
In the three years they have been in place, the volume of tobacco consumed plunged more than 18 per cent to the end of the September 2015 quarter, GDP data released in December showed.

"There is some risk that the decline in tobacco consumption undermines that source of revenue," economist Stephen Koukoulas, a former adviser to former prime minister Julia Gillard, said. "If the number of packets sold falls at a faster rate than the price increases, you won't quite get the revenue effect you were hoping for."

RMIT University economics professor Sinclair Davidson, who has researched the impact of increased tobacco excise on poorer households, said smoking in Australia had been in a long-term decline for 50 years. "At some point it's going to reduce and not fund a growing area like education," he said.

Massive increases in prices would also raise incentives for illegal tobacco sales, potentially cutting into tax paid by tobacco companies, Professor Davidson said.

"The big challenge is in the very much longer term, in that education expenditure is going up and not down," he said. "I imagine there is some limit to excise revenue [hikes]."

Economist are split over whether the price of cigarettes is reaching a tipping point, which will result in an ever-rising number of smokers quitting and cutting government revenue. Others say the addictive nature of the product means many will continue to pay the higher prices, ensuring the government's revenue stream.

A government source said it wasn't clear if Labor's proposal was a funding measure or a health policy. "We can't figure out whether this is a health measure or a Gonski measure," the source said.

Close to tipping point
"The elasticity curve in Treasury modelling [on the excise] shows we're getting pretty close to the tipping point now. If it was as easy as getting ever-increasing tobacco revenue you'd triple it tomorrow."

Budget expert Stephen Anthony, an economist at Industry Super Australia, questioned the mix of policy objectives behind the move.

"We want to tax tobacco so heavily that its consumption in this country will fall," he said. "Therefore this revenue should not then be relied upon to fund longer-term spending committments."

Stephen Bartos, who was Parliamentary Budget Officer for the NSW Parliament between September 2014 and July 2015, said accurately estimating the revenue impact was "really tricky".

"Obviously there will be a point at which you raise tobacco excise so much that everyone stops smoking and you raise no money," Mr Bartos said, adding that the federal Budget Office's modelling for Labor's policy "looks to be in the bounds of what's reasonable" over a decade.

"Will the revenue decline over the longer term? Yes, but remember what [English economist John Maynard] Keynes said: 'In the long-run we'll all be dead.' If everything else stays equal for the next 30 years, this is legitimate. The trouble is, we know things will change in innumerable ways over that period," he said.

Piecemeal approach
Former Liberal leader John Hewson said Labor's tobacco plan was indicative of Canberra's piecemeal approach to the tax system, which has been allowed to drift for so long that any genuine changes will need to be significant if they are to work.

"I thought the tobacco excise was more of a political ploy for the ALP to say, 'We've got some tax revenue'. But it's not a sustainable long-term policy. If it works as a health measure, people stop smoking and your revenue evaporates," he said. "You really need to do a whole review of the tax system, not bits and pieces here and there."

Mr Daley, from the Grattan Institute, said the PBO's estimate of the probable revenue to be gained was as "good a guess as you're going to get", but the modelling didn't by definition address the question of whether it would improve the structural position of the budget.

"Is it responsible to spend all your 'saves'?" Mr Daley said of Labor's proposal. "One of the problems of [past governments] is that whenever they made budget savings, either by increasing taxes or reducing expenditure, they spent them.

"If you are predicting 'saves' of $70 billion over 10 years that's roughly $7 billion on average per year. But the current budget deficit is $35 billion or $40 billion, so the saves are pretty small relative to the current deficit."