Understanding tobacco industry pricing strategy: evidence from China's 2015 Tax Reform

Abstract

Background: Tax increases are the most effective means of reducing tobacco use, but their effectiveness also depends on tobacco industry pricing strategies - which determine the extent to which taxes are passed-onto consumers. Common strategies include the over-shifting or absorption (under-shifting) of taxes. China raised cigarette taxes in 2015, providing a unique opportunity to examine the pricing strategy of China's State Tobacco Monopoly Administration (STMA). Method(s): WHO TaXSiM China model was used to calculate the magnitude of the tax pass-through for each cigarette Class at the wholesaler, retailer, and consumer levels after China 2015 tobacco tax increase. The net effect across STMA's entire market was assessed using sales-weighted averages. Result(s): China's tax increase was partly absorbed in the profit margins of wholesalers across all classes. However, on a weighted average basis, it was fully passed-on at the wholesale level. The tax increase was over-shifted at the retail level, with retail margins increasing except for Class III. The impact on consumers varied by Class, but with the net effect being an over-shifting of tax. Tax was over-shifted for Class V (the cheapest category) and under-shifted for Class III (the most popular and mid-price category). Conclusion(s): The STMA employed a pricing strategy that was tailored to different Classes with the aim of managing the shape of the market in the manner consistent with its wider "key brand" strategy to promote mid and premium-priced brands.