A case study of hike in tax over cigarettes causing panic buying
When policy makers decide to implement tax changes by increasing or reducing tax revenues on consumer products such as cigarette and alcohol, this is known as a monetary or fiscal policy. Fiscal policies are measures taken by policy makers when the economy of a country is having instabilities; a fiscal policy is active for a given period of time which may be one year or varied (Hall, 2010).
The main objective of a fiscal policy is to act as an instrument of demand management which it regulates by increasing the product price and thereby hopefully reduce the demand of the specific product (Hall, 2010). The following is a case study of a fiscal policy by the federal government that increased tax of cigarette by 25% causing panic buying among consumers (Hall, 2010).
In this case, the intention of the government was to drastically reduce the demand of cigarette and its usage among users and consequently promote good health by restricting the financial ability of smokers to afford cigarettes regularly. In addition to further restrict the number of persons smoking the government undertook further measures such as banning cigarette advertisements among others (Hall, 2010).
It is estimated that majority of smokers who are poor, young and of low income are likely to reduce the consumption of cigarette significantly by “cutting total tobacco consumption by about 6 per cent and cut the number of smokers by 87,000” (Hall, 2010).
The bottom line of this measure is expected to enable the government make savings on medical care of non-communicable diseases that are directly as a result of smoking and which are compounded by use of tobacco such as lung cancer and diabetes which at the moment costs the government billion of dollars to treat.
According to Hansen, this kind of fiscal policy is intended to stem down cigarette smoking, promote health and enable the government save on healthcare related costs (2003).
An economic move of this kind is an automatic fiscal change also known as contractionary fiscal policy because it is implemented through increasing tax revenues on some products which is expected to decrease government spending in some areas (Hansen, 2003).
However, at times such measures are intended to reduce the demand of targeted products without necessarily having to benefit the government in any way.
On the other hand, fiscal measure such as this most often causes panic buying by consumers in anticipation of the price hike just so that they can buy more stock at current rates before new rates become effective.
Thus the sharp rise in tax on such product are known to cause queer consumer behaviors that involve stock hoarding and panic buying that ultimately impact on the dynamic of the market. These measures also encourages unfair trading practices such as trader stocking cigarettes as they await implementation of new prices so as to make huge profit margin.
The main reason that motivates the government to hike taxes is so as to raise the revenue amounts and generate more funds that can be used by the government in its budgeting towards health and other programs (Hall, 2010). Cigarette is a consumer product with low elasticity of demand and hence an increase in tax will not affect much of its consumption, however, there will be a small decrease in demand.
This will nevertheless result in increase tax collection that will increase revenues. Unfortunately, when increase of tax is directed towards products such as cigarettes and alcohols the result is that consumers restructure their budget by cutting more on basic items such as healthy foods in order to further direct the extra money towards the hiked product.
It is for this reason that charity activists have always advocated for health education of consumers that will enable them to stop use of cigarettes rather than just relying on the strategy of price hike alone.
In any case critics of fiscal policies that are directed towards cigarettes argue that this approach does not address issues of equity and fairness since the poor people are taxed at the same rate like rich people.
The result is that more money is actually collected from poor people who actually need it more because a huge proportion of their income ends up being part of the collected tax revenues. Also, personal savings for those people, who use the product like cigarette, would go down since they will be forced to use the extra money they have in order to have the cigarette anyway.
Thus, in this case the poor people and those with low levels of income are affected the most compared to people with high levels of income (Hall, 2010).
Finally, such policies have an impact on individual businesses and hence on economic growth. Generally, low rates of taxes always serve to facilitate trade and spur create economical growth due to high turnover of goods.
But an increase in taxes negative impacts on trade as it reduces the rate of trade on that particular product and the effects are translated to industries, workers, retailers, consumers and finally to the economy as a whole (Hall, 2010).
The results are therefore slow economic which will reduce the gross domestic product (GDP) by a certain percentage, job reduction because of the reduced capacity of the impacted industries which in this case is tobacco industries and the advertisement industry as well.
If employment rates reduce for instance the citizens will directly be affected since they will not have employment opportunities and this situation would persist as long as economic growth is slow. In this happens the percentage of unemployment rates will increase which would imply that the particular fiscal policy created more problems than it solved (Romer, 2007).
Within the tobacco sector there will be a reduction in wages and income to employees who work in tobacco industries as the companies affected would want to cut the cost of production so that they can increase their profit margins (Romer, 2007).
Indeed, there is evidence that most businesses in the tobacco industry normally experience financial constraints and sometimes collapses as a result of fiscal policies such as this (Romer, 2007). What is even more is that investors will shy away from investing in this sector due to the risks and uncertainties associated with such fiscal policies.
Theories related to fiscal policy measures
Keynesian Theory and Classical Theory
John Keynes is one of the scholars who had developed a theory that attempts to investigate issues and effects caused by government fiscal policies. In his theory Keynes suggested that fiscal policy is very effective since it provides the government with means of intervention in regulation of supply and demand of some products that cannot be achieved through the normal economic concepts (Hansen, 2003).
Keynes advocates for what he refers as countercyclical fiscal policies which are meant to keep in check persistent instabilities in the business environment such as issues of recession and persistent inflation through increase of taxes on consumer products such as cigarette or by cutting down on government spending (Hansen, 2003).
These methods can enable a government to solve its short term financial constraints while at the same time regulate consumption of certain unhealthy products. In fact, Keynesian theory advocates for automatic and discretionary countercyclical policies that are aimed at reducing the adverse effects caused by the business cycle.
In a nut shell Keynesian theory advocates for increase tax on goods as a method of stimulating economic expansion.
On the other hand classical theory point of view is quite different from Keynesian theory and argues that such fiscal policies causes increased saturation of government bonds which results in reduction of price of bonds in the market (Hansen, 2003).
Consequently, this encourages increased interest rates that discourage business investment leading to an overall slow economic growth. This is a result of government increasing its spending combined with reduced taxes which result in spending money on borrowing which keeps the credit market with less funds and thereby driving interest rates high.
Classical theory also argues that a contractionary fiscal policy that is directed at increasing taxes so as to raise the budget is not necessary at all because the government is able to maintain the budget balance throughout the year.
Reference
Hall, A. (2010). Cigarette tax hike sparks panic buying. [Online] (Updated 2010) Available at: https://www.abc.net.au/news/2010-04-29/cigarette-tax-hike-sparks-panic-buying/415828
Hansen, B. 2003. The Economic Theory of Fiscal Policy. London: Routledge publishers.
Romer. D 2007. The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks.[online] (updated 2007) Available at: https://www.nber.org/