The market of heated tobacco products (HTPs) has grown exponentially in recent years and many governments have imposed taxes on HTPs to regulate its use. Countries are debating over how HTPs should be taxed, especially whether at the same or lower rates than cigarettes, considering its potential harm reduction impact. To evaluate the impacts of HTP taxes on behaviors and health consequences, we first need to evaluate whether such taxes effectively raise HTP prices in ways that mediate the impact on downstream outcomes. Moreover, as most HTP brands are manufactured and marketed by large cigarette manufacturers, tax policy effectiveness also depends on companies' pricing strategies between products that are perceived as substitutes by consumers.
This study analyses the extent companies shift the burden of HTP and cigarette taxes to consumers into prices (i.e., tax pass-through to prices). We use the cross-country variation in statutory taxes along with retail prices of the most sold brand of heated tobacco units and their most sold comparable cigarette brand, in every country that sold or manufactured HTPs from 2014 to 2020. It is notable that in the majority of countries, HTPs have been taxed at lower rates than cigarettes, yet sold at similar prices, suggesting highly concentrated markets where taxes have little impacts on prices of goods that are sold with extra profit margins (HTPs), simultaneously to selling similar products (cigarettes) in competitive markets and with small profit margins. We build a model where a representative company manufacture and sell two similar products, or close substitutes with similar production costs, but with different degrees of competition. One is sold in competitive markets while the other is sold in highly concentrated markets. If the products are close substitutes, they face the same demands. The model implies that that taxes affects the sales of both products simultaneously. However, in certain market conditions—as describe above--the pass-through of taxes to prices is always larger for the product that bears the higher tax.
We find that the direct pass-thru effect of HTP taxes to prices is much smaller than that of cigarettes, which confirms the predictions of the model under current market conditions. We also find that the pass thru of cigarette prices to cigarettes prices is larger than unity. The combined pass-through (direct and indirect) of taxes to prices is negative for HTPs and cigarettes, with a larger negative effect for HTPs, leading to a negative association between tax incidence gaps and price levels. Overall the results strongly suggest that the only effect of differential taxation on the two tobacco products is to increase companies' profit margins, implying that the impact on demand is likely to be small. The results also suggest that increasing taxes on both products and taxing them equivalently could be an effective policy tool that simultaneously reaches the objectives of curbing tobacco use and raising additional tax revenue. They also confirm that companies respond to taxes by setting prices of HTPs and cigarettes jointly, with the goal of maximizing their profits.