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Do cigarette companies use tax hikes in strategy?

By Andrew M. Seaman

New York (Reuters Health) - Large cigarette companies can keep their products affordable for young people and the poor by shifting the burden of rising excise taxes from cheaper brands to more expensive cigarettes, according to a new study from the UK.

The analysis of cigarette makers' behavior over a decade in that country found the companies may also often hide price hikes on expensive brands by timing them to coincide with the tax increases.

"They're playing a clever game with prices. They're making large profits with their expensive brands, and they're keeping their cheap brands very cheap to keep young people in the market," said Anna Gilmore, the study's lead author from the University of Bath and the UK Center for Tobacco Control Studies.

Typically countries impose taxes on tobacco products as a way to curb their use - especially by making them too expensive for young people and the poor. But Gilmore and her fellow researchers write in the journal Addiction that no one had studied how the UK tobacco industry responded to these taxes.

For example, did the companies absorb the taxes without passing the additional cost to customers? Did they pass the costs along to some customers but not others? Or did they raise prices on top of the new taxes to increase revenue?

The answer was all three, depending on which sector of the cigarette market one examines.

Using consumer and market research from 1999 through 2009, Gilmore and her colleagues found that the UK cigarette industry put its products into four categories: premium, mid-priced, economy and ultra-low priced.

UK tobacco firms started selling ultra-low priced cigarettes in 2006, when the companies bought the brands from supermarkets. The category's price to consumers has remained virtually unchanged since then, but their share of the market has doubled, according to the researchers.

Overall, Gilmore and her colleagues found the tobacco companies tend to pass on the cigarette taxes to consumers on the most expensive cigarettes, but taxes on ultra-low priced cigarettes are not always passed to consumers.

For example, the pre-tax price of a pack of ultra-low priced cigarettes dropped by 3 pence in the year after the companies took over the brands, while the price of a pack of premium, economy or mid-priced cigarettes increased between 2 pence and 4 pence from 2006 to 2007. One pence is equivalent to about 2 U.S. cents.

The tobacco companies then made up for the initial price cut on ultra-low priced cigarettes during the next year by increasing their pre-tax price more than 4 pence, compared to increases for premium, mid-priced and economy cigarettes of about 1 pence to 3 pence.

After that, the prices of ultra-low priced cigarettes remain virtually static while the other categories continued to rise.

Gilmore told Reuters Health that the tobacco companies win by volume among ultra-low priced cigarette smokers, and by keeping the young and poor in the market - instead of letting the taxes price them out.

"The idea is to keep those people in the market and one day they'll trade up to one of the more expensive brands," she said.

The researchers also note a distinct difference between categories in the timing of cigarette price changes - for the more expensive brands, pre-tax price increases happened between November and May, which is when new tax rates would take effect. For the ultra-low priced brands, the prices dropped during that period and rose again between May and December.

The researchers conclude that governments should monitor cigarette prices by type - premium, mid-priced, economy and ultra-low priced - and consider the industry's pricing strategies when setting taxes.

Gilmore told Reuters Health that she suspects these findings are also applicable to other countries.

But the UK's Tobacco Manufacturers' Association said tobacco pricing is a matter of competition, and that the new study's findings are based on a time of change in the industry.

"This report is based on 2001-2009, when tobacco duties rose by inflation and combined with greater enforcement action led to a gradual, but very much welcome decline in smuggled products, stabilizing Government tax receipts," the Association said in a statement to Reuters Health.

Moreover, the Association noted, tobacco taxes have increased significantly since 2010. That increase, the statement said, is leading smokers to get their products from other sources and ultimately costing the government money.

SOURCE: http://bit.ly/10l1gBp Addiction, online April 16, 2013.

(This story has been corrected to fix the dollar conversion in paragraph 10)

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