The Effects of State Value-added Taxes on Tobacco Prices and Tax Revenues in India

Background: India is one of the biggest tobacco users worldwide, with smokeless tobacco, bidis, and cigarettes being popular tobacco forms. Tobacco taxes in India include central taxes that are imposed nationwide and state value-added specific taxes (VATs) that vary considerably across states. Both central and state taxes also differ sizably by tobacco form. Since 2009, many states have significantly raised their VATs on tobacco products.  

Aims: This study investigates how state VAT rates affect tobacco prices and tax revenues after adjusting for central taxes and national-level price increase. As India is considering a reform of tax system that replaces central and state taxes with national Goods and Services Taxes (GSTs) , this study will provide important information about whether state VATs were effective in increasing tobacco prices and generating revenues. Policy makers may use this information to evaluate the potential gains and losses of abolishing state tobacco VATs and to decide the future direction of sin taxes in India.  

Methods: Monthly city-level prices of cigarettes, bidis, and chewing tobacco during 2010-2014 were obtained from the CPI price data, and converted to real terms using city-level CPIs. Effective state VAT rates of cigarettes, bidis, and smokeless tobacco were linked to the monthly price data using state and month identifiers. The association between VATs and prices were analyzed using ordinary least squares after adjusting for common time effects (monthly fixed effects). Annual VAT revenue from all tobacco products by states during 2009-2014 were obtained through RTI and were linked to effective state tax rates in the fiscal year, whereas their association was analyzed using semi-log models after controlling for year fixed effects and the natural logarithm of the revenue in the 2009-2010 fiscal year. Standard errors were clustered at the state level.

Results: Higher state cigarette and bidi VATs are significantly associated with increases in their respective prices (p≤0.1), regardless of central taxes and price trend. The association between smokeless VATs and chewing tobacco prices is not statistically significant, likely due to the measurement errors in prices resulting from standardization of very heterogeneous products. Higher VATs of cigarettes, bidis, and chewing tobacco are associated with higher revenues collected from these three tobacco products (p≤0.05), with a 10% increase in VATs of cigarettes, bidis, and chewing tobacco associated with a 3.1%, 1%, and 2.4% increase in total revenues, respectively. This finding is consistent with the existing evidence that the price elasticity of tobacco demand is less than 1 in India, which implies that tax revenue would increase with increasing taxes.