Pricing and Taxation in Tobacco Harm Reduction

Introduction

Price is one of the strongest determinants of consumer behavior. In public health policy, taxation is widely recognized as the most effective single intervention to reduce smoking prevalence.^[1] However, the emergence of non-combustible nicotine products (such as e-cigarettes, heated tobacco, and oral pouches) has introduced a new dimension to fiscal policy.

Risk-proportionate taxation-the principle that products should be taxed in proportion to the harm they cause-offers a powerful economic lever to accelerate the decline of smoking. By ensuring that safer alternatives remain significantly cheaper than combustible cigarettes, policymakers can encourage adult smokers to switch to less harmful products.

The Science of Price Elasticity

To understand the impact of taxation, it is crucial to examine price elasticity of demand-a measure of how sensitive consumers are to price changes.

Elasticity of E-cigarettes vs. Combustibles

Research consistently shows that the demand for e-cigarettes is more price-elastic than the demand for combustible cigarettes. Estimates suggest that a 10% increase in e-cigarette prices can lead to a reduction in sales of approximately 11.5% or more, compared to a 4-5% reduction for cigarettes.^[2] This higher sensitivity means that tax-induced price hikes on safer products can drastically reduce their uptake and use.

Cross-Price Elasticity and Substitution

Crucially, combustible cigarettes and e-cigarettes are economic substitutes. This means that an increase in the price of one product leads to an increase in demand for the other.

• Positive outcome: Higher cigarette taxes drive smokers toward vaping.^[1]
• Unintended consequence: Higher taxes on e-cigarettes can drive vapers back to smoking or deter smokers from switching. A 2020 study found that for every 10% increase in e-cigarette prices, cigarette sales increased by 11%, suggesting that high taxes on safer products can inadvertently protect the cigarette trade.^[2]

Differential Taxation as a Public Health Tool

Differential taxation leverages these economic principles to benefit public health. By maintaining a large price gap between lethal combustible tobacco and safer non-combustible alternatives, governments create a financial incentive for harm reduction.

International Evidence

Sweden provides a compelling real-world example. The country has historically taxed snus (a low-risk oral tobacco product) at a much lower rate than cigarettes. This price differential has contributed to Sweden having the lowest smoking rate in Europe (approaching "smoke-free" status at <5%) and correspondingly low rates of tobacco-related disease.^[3]

The Risk of Uniform Taxation

Conversely, calls for "uniform taxation"-taxing all nicotine products at the same high rate as cigarettes-risk undermining public health goals. While intended to deter youth initiation, such policies fail to distinguish between the vast differences in risk profiles. The Royal College of Physicians argues that "a risk-proportionate regulatory framework" is essential to exploit the potential of harm reduction.^[3] Equalizing taxes eliminates the financial incentive for adult smokers to switch to safer alternatives.

Addressing Market Dynamics

Critics often point to industry pricing strategies, such as "undershifting" taxes (absorbing tax increases to keep budget cigarettes cheap) or "overshifting" (raising prices more than the tax increase on premium brands), as reasons to mistrust differential taxation.

While it is true that companies adjust prices to maximize profit or market share, the policy response should not be to abandon risk-proportionate taxation. Instead, tax structures should be designed to be robust against these strategies:

• Specific Excise Taxes: Using specific taxes (based on quantity/volume) rather than ad valorem (based on value) reduces the industry's ability to manipulate the final price through discounting.^[4]
• Minimum Price Floors: Implementing minimum unit pricing can prevent the "undershifting" that keeps budget cigarettes affordable, without needing to penalize safer products.^[5]

Phenomena like "shrinkflation" (reducing pack size) or price smoothing are standard market responses to inflation and taxation across many sectors. Effective policy anticipates these moves through specific regulation (e.g., standardizing pack sizes) rather than discarding the fundamental public health benefit of making safer products cheaper.

Policy Implications

To maximize public health gains, tax policy should follow these principles:

1. Tax in Proportion to Harm: Combustible tobacco, which causes the vast majority of disease, should carry the highest tax burden.
2. Incentivize Switching: Safer nicotine products should be taxed at low or zero rates to maintain a significant price advantage over cigarettes.
3. Monitor Cross-Border Effects: Policymakers must consider that excessive taxes on safer products can drive consumers to the black market, where product safety standards are non-existent.

By aligning fiscal policy with the continuum of risk, governments can save lives by making the healthier choice also the wealthier choice for consumers.