The substitution effect of cigarette excise tax for tobacco leaf tax in China

Abstract

PurposeThe purpose of this paper is to examine the increase in the cigarette excise tax needed to keep tax revenue constant in the face of the cancellation of the tobacco leaf tax.Design/methodology/approachEquilibrium‐displacement model was employed to simulate the substitution effect.FindingsThe results suggest the “substitution effect elasticity (SEE)” is between −0.127 and −0.063. This means a 100 per cent cut in the tobacco leaf tax rate would necessitate an increase in the cigarette excise tax rate of between 6.3 and 12.7 per cent. Sensitivity analysis indicates SEE is most sensitive to the retail demand elasticity and oligopoly power and least sensitive to input substitution elasticity and returns to scale.Originality/valueThis paper provides a framework to analyze the policy effects of the Chinese tobacco industry. The findings in this study are very important for government to make policies in the future.