Gains, Pitfalls of Raising Excise Tax

Excise tax contribution to the total tax revenues has been decreasing in the past decade, but this will be reversed very soon. The government is planning to increase excise tax levied on items including tobacco, alcoholic products, and vehicles. Many worry that this would bring unintended consequences, including paving a way for the illegal market to thrive, on top of exposing consumers to higher prices. EBR’s Kiya Ali delves into the subject to offer this report.

 

The public’s attention was at one point grabbed by the issue of a global tobacco company, Japan Tobacco International (JTI), taking over the National Tobacco Enterprise (NTE) at a cost of USD944 million, becoming the principal shareholder and owning 71Pct of the company. While the acquisition made Japan one of the top six major foreign direct investment sources for Ethiopia, it was the biggest privatization deal in the history of the country. On top of this, the money secured from the tobacco producer helped the government pass through hard times when the country was facing a serious foreign currency shortage.

As the manufacturer of major brands like Nyala, Delight and Nyala Premium, they currently enjoy close to 50Pct of the market share in Ethiopia, mainly because of the inexpensiveness of its product. This is about to change. In April 2019, Eyob Tekalign, State Minister for Finance and Economic Cooperation, announced that the government had finalized a revision to the excise tax law of the country. “The increase of revenue from excise tax will play a crucial role in enhancing the development of various sectors, including education, health and agriculture,” Eyob said during the press briefing.  

Yayehyirad Abate, director of Corporate Affairs and Communications at NTE, however stressed that before increasing excise tax rates, its effects must be seen from the different perspectives of all stakeholders. “Otherwise, it is the consumers who will be affected the most because we will be forced to increase prices of tobacco,” he argues.

The amendment that is planned to be introduced during this financial year is not only expected to raise the price of tobacco products such as cigarettes, cigar, cigarillos and pipe tobacco, which are now liable to 70Pct excise tax rate but also prices of vehicles and alcoholic drinks, according to sources. “Increasing excise tax rates would finally affect the customers as we will expectedly shift the cost,” says Natnael Habtom, a car importer based in Addis Ababa.

In Ethiopia, products such as petroleum, any type of sugar (in solid form) excluding molasses, soft drinks, alcohol, tobacco, salt, television and video camera, perfumes, textile, types of adornment like gold or silver, washing machines and bottled water are among items liable to excise tax. The rate varies from 10Pct on garments and textiles to 100Pct on perfumes and vehicles above 1,800 cc.

Excise tax, which is also referred to as sin tax, is an indirect tax imposed on a transaction and not directly on a person or corporation.  As opposed to broad-based taxes such as a general sales tax, a value-added tax, or an expenditure tax, excise taxes are narrow-based taxes. Mainly levied on a range of products that the government considers harmful like alcohol, tobacco, gambling and certain foods that have high sugar and fat content as well as luxury and basic goods, which are demand inelastic. It is payable on a range of selected imported or locally produced consumer goods within a certain country.

Supporters of excise tax cite four major reasons to justify its existence. The first reason is that excise taxes can discourage the consumption of potentially harmful substances such as alcohol and tobacco, which are hazardous to health and cause social problems. Tizita Wondwossen, Project Officer at Mathiwos Wondu Ye-Ethiopia Cancer Society, is among the proponents for the excise tax. “If we consider the medical costs that are incurred because of tobacco and alcohol-related diseases, the net effect of tax revenue from such manufacturers will become zero. Most of these products cause early death which is very costly from an economic dividend perspective,” she argues.

The youth, who constitute 70Pct of the population, are the main users of tobacco and alcohol products, according to Tizita. “Bearing this in mind, the significant increase in excise taxes on harmful products will reduce the frequency of use, discourage consumption and reduce social cost and negative externality.”
The other justification given by supporters of the excise tax is its ability to bring equity in the society by taxing luxury items consumed largely by higher-income individuals. “Excise tax is crucial to reduce social costs and bring equity,” explains Dawit Tadesse, Assistant Professor of tax and accounting at Addis Ababa University. “It is used to promote equity by spending the collected revenue on employment-generating and poverty alleviation programmes, which benefit low-income groups.”

The third justification is that excise tax can be tailored to impose tax burdens on those who benefit from government services financed by the very excise taxes. Supporters of this argument say that people whose preference is more toward luxury in comparison to the large portion of the society must pay more taxes as they use public goods. “A person who can afford to buy luxurious cars, for instance, should pay excise tax, says Endris Ahmed, Owner and Manager of Endris Ahmed Authorized Auditor and Tax Consultant.  “They drive a car on the road, which is the asset of the public. So, they should pay duty for using the society’s asset built by the poor as well as the rich tax payers,” he states.

The last argument on the rationale of excise tax brings the issue of the tax as a source for government revenue. Revenue generation is the more important justification for excise tax. This is because it increases government revenues significantly at a lower cost than any of the other types of taxes. The government did not deny that the main objective of amending the excise tax law is increasing the tax revenue. “The amendment will enable the government to collect upto ETB30 billion additional revenues annually,” Eyob said during the press briefing.

The current data obtained from the Ministry of Revenues, indicate that the share of excise tax out of the total tax revenue collected by the government has decreased in the last decade. In 2010/11, the government collected ETB4.75 billion in the form of excise tax. This amount constituted 9.37Pct of the total tax revenue collection. However, the share of excise tax dropped to 4.39Pct in 2016/17 even though the amount collected rose to seven billion birr.  In 2019/20, the government plans to collect ETB19.3 billion from excise tax. If it goes accordingly, the share of excise tax to the total tax collection will increase to 8.57Pct.
Despite its ability to raise tax revenue, however, excise taxes may have undesired consequences, by disproportionately affecting the incomes of the poorest households or by contributing to emergence of the black market and thriving contraband market. Studies also affirm that excise tax would bring unwanted results if it is not implemented by taking current situations into consideration. A study by Valentin Petkantchin, Associate Researcher at the Institute Economique Molinari, warns that excise tax must be put into practice with caution. If not, it will become the source of unintended results, according to him. “Not only do ‘sin taxes’ generally fail to meet their stated goals, but by artificially raising prices on the legal market, they are a source of distortion and illegal trafficking,” Valentin explains.

Yaye Hyirad agrees. According to him, for countries like Ethiopia where the border is loosely protected and contraband trade is widespread, the idea of reducing tobacco consumption by imposing excess excise tax is wrong. “Currently, around 45Pct of tobacco products are getting into the market through contraband routes. Illegal suppliers of tobacco have a market share of as high as 90Pct in the eastern part of the country, without paying any duty to the government.”
“Customers may consume tobacco products that are produced below expected standard and are hazardous to their health,” Yayehyirad says. “The impact of illicit tobacco trade is multidimensional. The government might lose a huge sum of revenue from tax if the  illegal market expands.”

Dereja Shimeles, a legal consultant at Ethiopia Food and Drug Authority, argues differently.  For him, the main reasons for illicit trade are; weak law enforcement, poor tax administration, loose border protection measures and security issues. “Illicit trade is not necessarily related to the price increase of the products,” he argues. “For instance, one of the most important factors for early deaths in Ethiopia is related to tobacco consumption. Close to 10,000 citizens will die annually as a result of tobacco consumption related diseases. One of the most effective methods to deter this is to levy significant excise tax.”

However, if the rate is not significant, the action will miss its goal, which is to deter tobacco consumption and protect the public’s health, while being a source of government revenue used to fill the budget gap, Dereje argues. “To bring a big change in the market, the base price should be considered while levying the sin tax. And the amount increase should be significant enough to make the consumers cost sensitive. It should also be frequently adjusted for inflation,” he said.

Besides tobacco products and alcohol, vehicles are the other commodity that the government has planned to levy a higher excise tax, but retailers think this would make the commodity more unaffordable. “I recently bought a second-hand car, a 2002 Toyota Vitz model, with ETB 240,000,” says Fitsum Hagos. “I have been waiting for the promised decision by the government to reduce the tax on new cars and do the opposite on used cars. But up until now, no decision has been passed while the price keeps rising every day.”

Minister of Revenue, Adanech Abebe, shares the concerns on the detrimental effects of used cars. “The costs of using old cars are many.  It exposed the country to air pollution, traffic accidents and huge expenses for spare parts. The Ministry of Revenue is working to either put limitations on the import of old cars or provide incentives for those who import and assemble new cars.” said Adanech, who supports the idea of levying more excise tax. “Contraband cannot be a justification for a higher excise tax. It is illegal.”EBR


8th Year • Aug.16 - Sep.15 2019 • No. 77




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