BACKGROUND: In Pakistan, the Federal Excise Duty on cigarettes creates significant tax disparities between premium and economy brands due to its two-tier system. Recent substantial tax increases have exacerbated these disparities, driving consumers towards lower-priced brands, including the illicit market. Existing research on cigarette demand relies on average prices, neglecting the distinct price sensitivities within different price tiers. This hinders accurate policy simulations, potentially overestimating public health benefits and underestimating revenue generation from tax increases. This study aims to address these limitations by estimating tier-specific price and income elasticities of cigarette demand using data from a recent nationwide smokers' survey.
METHODS: This study employs a three-step framework to estimate the price and income elasticity of cigarette demand across two tiers: Economy, and premium and illicit. The analysis includes prevalence, tier-switching, and intensity elasticity. A seemingly unrelated regression (SUR) model is also used to account for the simultaneous decisions of brand choice and consumption intensity.
RESULTS: The analysis reveals significant variations in price and income elasticity across the tiers. Illicit cigarettes exhibit the highest price sensitivity with an own-price elasticity of -1.96. Economy brands demonstrate lower price sensitivity (-0.24), while premium brands exhibit moderate price sensitivity (-0.566). A strong substitution effect exists from illicit to economy brands, with a cross-price elasticity of 1.153. Premium brand price hikes modestly increase illicit consumption (0.95). Premium brand consumption is highly income-elastic (0.809), while economy brands have modest income elasticity (0.075). Illicit cigarettes have negative income elasticity (-0.07), showing it as an inferior good.
CONCLUSIONS: This study underscores the importance of tier-specific analyses for effective tobacco tax policy simulations. In Pakistan, increasing taxes on economy brands could significantly reduce consumption and generate substantial government revenue. Addressing the price advantage of illicit cigarettes through effective track-and-trace systems is crucial for both public health and revenue generation.