The government… has failed in its goal to raise revenues through higher tax structures.
Too much of anything, oftentimes, is good for nothing. The context of this idiom finds relevance in the law of diminishing returns, where the marginal output gets smaller as each new unit of the increasing input is added.
The same truisms apply to the current tax structure of the Philippines for tobacco products. The current high rate is putting legal cigarettes and vapor products at a significant disadvantage, leading to widespread illicit trade and substantial government revenue losses.
The government, thus, has failed in its goal to raise revenues through higher tax structures.
An analysis of the tobacco market shows that excessively high taxes can act as a de facto prohibition, pushing consumers toward cheaper, illegal alternatives. The inadvertent consequence not only undermines public health goals but also harms legitimate businesses and reduces government revenue. To put it simply, tax-driven price increases under current laws have made legal cigarettes less affordable, boosting demand for illicit ones.
According to the Department of Agriculture’s daily cigarette price monitoring, the cheapest legal 20-stick pack, RGD, costs P125. Most legal brands range from P160 to P225 per pack. However, illicit brands retail for P30 to P80 per pack, and even less online.
While higher excise tax rates theoretically should increase revenue, excessive rates can drive the industry underground, depriving the government of its rightful share. This explains the large quantities of counterfeit cigarettes confiscated in Metro Manila and provincial warehouses in recent months.
A low tax rate would naturally result in low revenue collection, but an excessively high one can frustrate consumers, pushing them toward illegal channels—or the black market. This challenges the linear assumption that higher taxes always equate to higher revenue.
Illicit traders also exploit regulatory loopholes to evade higher taxes on certain nicotine products, ultimately undermining public health efforts and fair market practices.
There is also a need to rationalize taxes on freebase vapor products due to the current disparity in tax rates. Some producers declare nicotine salt products as freebase nicotine, which has a lower tax rate under current law. This highlights the need for a unified tax rate on both types. Unscrupulous producers misdeclare their vapor products to evade taxes.
Also, under existing law, the tax rates for cigarettes, heated tobacco products, and vapor products increase by 5 percent annually. But economists explain that a higher tax rate would not necessarily generate an equivalent increase in tax collection.
Data from the Bureau of Internal Revenue (BIR) supports the assertion. Tobacco excise tax collections fell from P176 billion in 2021 to P160 billion in 2022 and P135 billion in 2023 despite consistent tax rate increases. The decline, contrary to conventional wisdom, can be attributed to the flourishing illicit tobacco trade.
The common explanation for declining tax collection is a decrease in smoking rates. But this is unlikely in the Philippines, where smoking rates may have increased due to the availability of cheaper, untaxed illicit cigarettes that encouraged smokers to switch.
If smoking rates rise and tobacco excise taxes also increase, the decrease in government revenue points to illicit trade.
Economists Bienvenido S. Oplas Jr., president of Minimal Government Thinkers (Manila), and Dr. Arthur Laffer, creator of the Laffer Curve, contend that the current tax rate may have exceeded the revenue-maximizing point.
Oplas, citing data showing tobacco tax revenue peaked to P176 billion in 2021 with a tax rate of P50 per pack, argues that subsequent increases have led to declining revenue. He said that based on the Philippine experience, “the optimal tax rate is P50 per pack, which produced peak tobacco tax revenue of P176 billion in 2021.” Oplas noted that revenue “went south” as tobacco tax rates climbed further.
Dr. Laffer explained that applying the Laffer Curve shows that increasing tax rates beyond a certain point can actually decrease revenue as it incentivizes tax evasion and the growth of the illicit market. He said that in the Philippines, the tobacco excise tax rate has reached a “prohibitive range.”
“Based on the Philippines’ experience with ever-increasing tobacco tax rates and subsequent revenue declines, it seems that tax rates have exceeded the revenue-maximizing rate and ventured into what is known as the ‘prohibitive range’ of taxation,” said Dr. Laffer, a former member of President Ronald Reagan’s Economic Policy Advisory Board.
Both economists claim that a lower tax rate could narrow the price difference between legal and illegal products, reducing the incentive for consumers to switch to the illicit market.
Dr. Laffer said by reducing tax rates and expanding the tax base, the Philippines could increase overall revenue while minimizing economic damage. Under the Laffer Curve, which explains the relationship between tax rates and tax revenue, tax revenues increase with increasing tax rates until a revenue-maximizing point is reached, after which further increases in tax rates result in declining tax revenue.
The analysis suggests that a temporary suspension of the annual tax increase, coupled with a reevaluation of the optimal tax rate, could be crucial for maximizing tobacco tax revenue and combating the growing illicit trade in the Philippines.
Dr. Laffer summed it up: It is time to re-evaluate the optimal cigarette tax rate.
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Tags:
Cigarettes, illicit trade, vape, Bureau of Internal Revenue
