Dr Eric Crampton: RNZ remains on-form

There are a few basic bits of reality that I'd hope we could agree on.

Minister Costello has set a lower excise rate for heated tobacco products as a bit of a trial to see whether it proves successful in encouraging remaining smokers to flip to something less harmful.

Even without any change in tobacco excise, a smoker shifting to an HTP will result in a drop in tobacco excise. Or at least I'm pretty sure. I'm pretty sure that a heated tobacco stick contains less tobacco than a cigarette does. And I'm pretty sure that heated tobacco draws the lower excise rate that applies to cigarillos and the like. The combination of the two means less excise in a heated tobacco stick than in a cigarette.

If the trial proves successful and a lot of smokers shift from cigarettes to heated tobacco, tobacco excise revenue will drop. The more successful the trial is in encouraging shifts from smoked tobacco to heated tobacco, the bigger the drop in excise revenue. If a lot of current vapers or non-smokers take up heated tobacco, excise revenue will increase on that margin.

While Philip Morris is a dominant supplier of heated tobacco products, heated tobacco competes with smoked tobacco and with vaping. So PMI does not face a vertical demand curve for its product. And even if you model them as a monopolist in the market for heated tobacco, a monopolist will pass through at least some of an excise reduction.

This is basic Econ 1 stuff. The monopolist sets marginal revenue equal to marginal cost looking across the quantity axis, then traces up to the demand curve to find price. That's the price that maximizes profit. If costs drop, the profit-maximizing price drops too. It's just math.


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I hope that all of this is completely uncontroversial.

Some mornings I am more annoyed than usual about being forced to pay for Radio New Zealand. This morning was one of those mornings.

Guyon Espiner had his latest update on Minister Costello's reduction in heated tobacco excise.

Let's have a look here.

Govt set aside 

$216m to pay for 

heated tobacco 

product tax cuts

Ok, so RNZ's main focus is going to be on the potential excise losses.

Now we know, from basic facts of the world, that there can only be substantial reductions in tobacco excise if the policy is incredibly successful in reducing smoking rates.

Let's continue.

The government has agreed to set aside $216 million it may need to pay for tax cuts for heated tobacco products (HTPs).

RNZ reported earlier this month that Associate Health Minister Casey Costello - who is also Customs Minister - had implemented a 50 percent cut to the excise tax on HTPs, where the tobacco is heated to a vapour rather than burned.

Costello's office had not publicly disclosed how much that would cost the government but a Cabinet paper, released without fanfare on the Health Ministry's website, shows Cabinet agreed in May to set aside $216 million as a contingency fund to cover the estimated lost revenue.

The excise tax cut is something tobacco giant Philip Morris has lobbied for in the past. Its IQOS product is a dominant player in the New Zealand HTP market.

The Cabinet paper, signed off by New Zealand First MP Costello, showed it was not even clear whether the tax break would be passed on to consumers.

"Because this product currently has a monopoly market in New Zealand, the extent to which a reduction in excise duty on HTPs would be passed on to consumers via lower retail prices is unclear," the paper noted.

I've highlighted a relevant bit here. Let's look at this section of the Cabinet Paper.


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The Cabinet Paper isn't saying that there might be no pass-through. It's saying that they don't know whether there will be one-third pass-through or 100% pass-through.

Officials could perhaps have been clearer that even a complete monopolist facing a downward-sloping demand curve is going to pass through at least some of a tax reduction, but they could be forgiven for thinking that it was awfully clear in context. They note one study finding a 31% pass-through rate, and that officials have advised to assume 100% pass-through. So the extent of pass-through is likely going to be somewhere between those.

But RNZ put this as a question of whether there would be pass-through. Not the extent of it.

If there is zero pass-through, and again this is just math, and it won't happen because even a monopolist will respond to a cost decrease by reducing price, there cannot be more than negligible effect on excise revenue. Why? The price of heated tobacco will not have dropped relative to smoked tobacco. It will not have driven any flipping from smoked tobacco to heated tobacco. Philip Morris would get a transfer equivalent to half of what they currently pay in excise. Excise from heated tobacco was just under $6 million in 2023, so the policy would transfer $3m to Philip Morris. $216 million is right out.

But RNZ sets the framing to have people expect a $216 million tax cut benefitting PMI that might have no pass-through to consumers.

Let's continue, again.

Costello declined an interview with RNZ and her office did not address questions about whether that monopoly position referred to Philip Morris.

In a statement the minister did say that she expected the industry to reduce the cost of its products.

"That means I'm expecting the excise reduction to pass to consumers, this is what we were advised would happen by officials and it is something we will also be monitoring," she said.

She also said she did not expect the cost to the government to be "anywhere close to what was modelled", as the tax collected on HTPs was only $3.62 million in 2022 and $5.97 million in 2023.

"Officials noted there is a lot of uncertainty around the modelling and fiscal impact because it was based on the very rapid increase in HTP use that happened in Japan, where vapes were unavailable."

Philip Morris did not respond to RNZ's questions.

Good context from the Minister here, and good that RNZ reported it.

Unfortunate that they didn't think through what those numbers mean. If current excise from heated tobacco is only on the order of $6m, what would have to happen in the real world for a drop in excise on heated tobacco to result in a $216m excise loss? It would have to mean that there was substantial pass-through of the excise reduction and consequently substantial switching to heated tobacco, which means substantial reductions in exposure to the bad things that come out of combusted cigarettes.

Another fun bit from the Cabinet paper. Guess which line of this paragraph RNZ chooses to emphasize? Hint: it's not the one saying that even the FDA recognizes that heated tobacco means less exposure to harmful chemicals.


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As always, RNZ's reporting on tobacco needs health warnings.

Dr Eric Crampton is Chief Economist at the New Zealand Initiative. This article was first published HERE