IN SEARCH OF A NEW TAX SYSTEM

The effectivity of RA 9334 ends in 2012. There are several proposals to replace this law on the sin products. Although a tax system is designed to increase revenue collection, a contradictory requirement in coming with a new tax system is to discourage smoking. One bill, House Bill 5727, seems to be the strongest contender among the proposals for change. While the other proposals continue to retain the classification or tiers of the brands, HB 5727 seeks to gradually eliminate the various classes and merge them into one by the Third Year of its implementation.

A study on the effects of the tax systems was undertaken, using sample brands that have available production and price data. These data are utilized to compute the base factors for expected production and revenue collections. The tax system of RA 9334 depends on classifying the brands into four tiers according to a set of values termed as “net retail price” or NRP.

The obvious advantage of the tax system laid out in RA 9334 is the ease in computing the collectible revenues. As mentioned above, the law expires in 2012 and thus needs another law to replace it.

On the other hand, as proposed by Rep. Abaya, HB 5727 (termed a unitary tax system) simplifies the process by imposing, in the Third Year, only one class or one tax value for all brands regardless of their qualities. The bill merely states that for the First Year, all Premium and High priced brands shall be taxed at P30.00 per pack, while all others at P14.00. For the Second Year, those brands taxed at P14.00 will be appraised at P22.00. By the Third Year, all brands are to be taxed P30.00.

Although the concept of HB 5727 eases the process of computing for the expected revenues, the tax system itself turns out to be too oppressive to the poor consumers (if they submit and accept the situation). While the tax system adds a mere 6 per cent addition to the Premium and High classes, the Low class (the 30 per pack brand) suffers an additional burden of 1554 per cent in taxes. Considering the reality of economic behavior, the “unitary tax” system will truly discourage consumption of legally manufactured cigarettes. However, as experienced by other countries, the heavy tax burden on the poor is conducive to encouraging the consumption of smuggled (cheaper) brands. Various countries have noted the effects of increasing taxes on their law and order situations.

In order to somehow “equalize” the tax burdens, the House subcommittee on Ways and Means proposes a reclassification of the brands by adjusting the NRP which would be the basis for computing for the expected revenues. The pattern of taxation is presented below.

A study of the various variations shows briefly some interesting results.

On RA 9334. The classification apparently was set “permanently” and was not adjusted even as the NRP must have changed due to inflation, among other factors. By recomputing the value of the NRP as proposed at the time the law was passed, and adjusting the rates to the available price and collection data, certain brands turned out to be classified differently. Some brands taxed as High-priced are supposed to be in the Premium class; and those classed as Low-priced are supposed to be parts of the Middle class. By readjusting the classification of the brands in accordance with the requirements of RA 9334, revenue collected would have increased by 200 percent. However, using the elasticity test only a few Low-priced brands survived; all others were eliminated.

On the other hand, the proposal of the House subcommittee adjusting the ranges of the NRP and applying the elasticity test increased expected revenue by 92 per cent but also increased production by 48 per cent.

As for HB 5727, in testing for expected production and revenue collections, the elasticity factor eliminated all of the brands included in the sample. Thus no revenue can be expected to be collected from them under this tax system.

One attempt to design a tax system to replace RA 9334 is to utilize an ad valorem method based on the NRP of the brands. This ad valorem experiment shows that the optimum ad valorem tax (AVT) is obtained using 50 percent of the NRP. The expected increase in revenue amounts to 48 per cent. On the other hand, consumption is decreased by 31 per cent.

The change to the ad valorem of NRP affects the values of the suggested retail price. In this tax system, the NRP is also expected to adjust to inflation, which will change, as well, the value of AVT. The drawback of the system is the various process of annually, if not quarterly, computing for the individual NRP of the brands so as to monitor revenue collections.

THOUGHTS ABOUT CIGARETTE MAKING

Before I go on to write about the present status of the tobacco industry, particularly about cigarettes, I take the liberty of citing my experiences during World War II Japanese Occupation. I was about twelve years old then.

In our daily struggle to survive – my father who used to work in an American company, Koppel Philippines, and thereby unemployed – we had to engage in a variety of businesses. One day, my mother brought home a contraption for rolling cigarettes. Having relatives in Biñan, Laguna, she learned about the thriving industry at that time in manufacturing cigarettes that competed with the Japanese brands, like Pirate and Akebono. Furthermore, there were already difficulties in importing cigarettes—the priorities of the Japanese were for munitions and logistics—which encouraged the making of local ones. The contraption was basically a roller, with a canvass or thick oil cloth (the same as those used as table cloth in restaurants) which rolled the paper over a small pile of tobacco.

For a time, we had to experiment on how much tobacco we had to put to roll a passable stick. If too few, the cigarette would burn too fast. If too plenty, the stick becomes too tight and the smoker would have problems puffing at it. Then after the roll is done, we would have to trim off the tobacco strands that stick beyond the edges of the cigarette stick.

I also had some creative moments designing the packages. I copied the packages of the ones in the market, which were like oversized match boxes that had the cigarette sticks slide out instead of being tapped to let only a stick or two come out. I prided myself in illustrating the cover and lettering the brand (I can’t remember what names we came up with at the time). There was a time when I copied the designs of Chesterfield and of Camel cigarettes to decorate the packs.

That was the situation during the Japanese Occupation when cigarettes were made and rolled manually.

After so many decades, I had the opportunity to watch how cigarettes were manufactured by huge machines. No longer a few seconds to make a stick but now hundreds of sticks per second are spewed by gigantic rollers and packed and made to pass through stages where they are sorted, qualified, quantified and packed. The sticks and/or packs that do not pass quality standards are disposed, either to be recycled or thrown away.

I had the opportunity also to see the reports that detail how many packs are “removed” or produced, and how much taxes are imposed on every pack. And I learned that cigarettes are graded according to their qualities based on the tobacco mix they contain, that is from Low to Medium, to High and to Premium. The first three qualities are produced in million packs, while the Premium brands are practically ignored in the revenue collection reports most probably because these are the imported ones.

I do not remember how the cigarettes made during the Japanese Occupation were taxed. Possibly, the local packs remained untaxed, although the Japanese must have some system of collecting taxes for the commodities produced during those times.

On the other hand, the taxes (net of retail price) collected lately by the Bureau of Internal Revenue are based on the quality of the brands. The Low-priced brands are taxed at P2.72 per pack; the Medium-priced at P7.56; the High-priced at P12.00, and the Premium class at P28.30 per pack. Excepting some Low-priced brands, all are packed in twenties. Some Low-priced brands are packed in thirties; these are not available for sale in the cities but seem to be consumed in the rural areas because of their low prices.

By the way, I am a non-smoker. Thus I cannot say how to distinguish the quality of the cigarettes based on the tobacco blend they contain. I can only recall the experience I had as a plebe in the Philippine Military Academy when I thought the brand Matamis, which my mother sent me, is no different from Chesterfield or Lucky Strike and gave a stick to an upperclassman who asked for one. He made me eat it.

Going back to the present, I also learned that most of the consumers, except among the elite and the rich, buy their smokes by the stick. That is the reason why there are vendors along the Metro Manila thoroughfares that weave among the traffic selling cigarettes to the jeepney drivers and even lighting the sticks for them. I think the main reason for buying by the stick is to discourage panhandling from other smokers. As well, it is cheaper to buy by the stick than to have them by the pack. One can smoke the High-priced brand, like Marlboro, for P3.00 (the retail price along the Service Road in Bicutan) instead of paying P44.00 for one pack selling at any 7-11 store.

Now, in 2012, I learned that Congress is passing a law raising the taxes on cigarettes as part of the drive to discourage smoking but not necessarily making smoking a crime. The proposed law, the Abaya bill, removes the distinctions between brands – no longer Low, or Medium or High or Premium – but all under one class and taxed at P30.00 per pack of twenties. Obviously, this tax rate will raise the prices of the sticks. The new rate is a not-too-subtle way of penalizing smokers. In the example I cited above, Marlboro will no longer cost P3.00 but will perhaps reach P5.00 per stick to make it worthwhile to walk the streets to sell.

I do not think the jeepney drivers will demonstrate against this rate increase like they do against the rising prices of gasoline where they demand the abolition of the value-added tax. The government raises taxes in order to support its various operations (as well as the perks and "intelligence" funds of its high officials). In fact, the official reason for taxing cigarettes – which is a “sin” product -- is for the purpose of raising P60 billion, they say, to ostensibly serve the health program of the government.

If the Abaya bill is passed into law, I am quite sure that the production and revenue collection of cigarettes will suffer serious decreases, particularly among the Low-priced brands. In turn, the P60 billion target of the new law will never be reached.

However, there will be no serious decline in smoking. I suspect that there will be “cottage industries” in the rural areas that will produce “local” smuggled brands that will satisfy the cravings of the smokers. It is easy to make the hand-operated contraptions to roll the cigarettes. These will not require huge buildings but can be operated even in the small rooms in any hut in the provinces (or even in the cities).

I also suspect that the blended discards in the cigarette factories will find ways to reach these “cottage industries” and be converted to cheap high quality tax-free cigarettes. If I were a cigarette addict, I will try and contact somebody in a cigarette factory, say, La Suerte or Mighty, and buy me a small sack of tobacco blend which I can roll on my own at home.

While the government will be watching the entry of smuggled brands from outside the country, some local politicians will be tolerating, if not abetting, the local-smuggled ones to proliferate. The situation will be jueteng type of operations in the clandestine production of cigarettes, perhaps mostly in the hinterlands of the tobacco producing regions.