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Balancing Interests:
The Economics of Tobacco Control in China
Teh-wei Hu, The Jamestown Foundation, China Brief
11/29/2006

With over 350 million smokers, China accounted for more than one-fourth of the world's annual tobacco consumption in 2002 [1]. In addition, these smokers affected an additional 460 million second-hand (passive) smokers, most of whom are women and children [2]. In other words, nearly two-thirds of the people in China have been exposed to cigarette smoke. The negative health repercussions of smoking are estimated to include about one million premature deaths in China each year [3]. Second-hand smoke has also contributed to 45,000 premature deaths from smoking-related diseases, such as cardiovascular or heart diseases. If this pattern of smoking continues, premature deaths attributable to smoking can be expected to continue to skyrocket and result in two million deaths annually by 2020 [4].

Government officials in the Ministry of Health and public health professionals in China have recognized the severity of the negative health impacts of smoking and have made efforts to discourage cigarette smoking through public health campaigns. To date, however, an important and effective tobacco control policy—increasing the tobacco tax—has not been adopted due to strong resistance from top officials in the Ministries of Commerce and Finance. Officials in these ministries fear that an increase of the tobacco tax would lead to a decrease in cigarette consumption, thereby reducing a major source of income for tobacco farmers, especially in the poor southwest regions, and more critically, lead to a loss of employment in the cigarette manufacturing industry and a loss of government revenue. Given that the industry produces 1.7 trillion cigarettes annually, the government believes that any decrease in tobacco consumption would also lead to a decrease in a major source of revenue for the central government [5]. Beijing is therefore facing a policy dilemma over the conflict between its public health concerns and its needs to maintain a significant source of government revenue.

Tobacco Farming

China is the largest grower of tobacco leaves in the world, producing about 2.66 million tons of tobacco leaf, about one-third of global tobacco leaf production [6]. More than 95% of tobacco leaf produced in China is for domestic cigarette production. To control the supply of tobacco leaf and to avoid a surplus, the government’s State Tobacco Monopoly Association (STMA) sets a tobacco leaf production quota. The STMA, a government monopoly organization, controls all Chinese tobacco leaf production and procurement prices and cigarette manufacturing and marketing. The Chinese Ministry of Agriculture does not have jurisdiction over the production, pricing, or marketing of tobacco leaf. Therefore, within the Chinese economy, the STMA is a vertically and horizontally integrated tobacco economic entity.

China has more than five million agricultural households involved in tobacco leaf production [7]; most are small farmers with less than one hectare of farmland and who cross-plant with other crops, such as grain, vegetables, beans or fruits. The top four tobacco leaf producing provinces are Yunnan, Guizhou, Sichuan and Henan [8]. While the central government collects taxes on cigarette products (cigarette smokers), provincial and local governments collect tax on tobacco leaves (tobacco farmers). The STMA sets the tobacco leaf production quota and procurement prices by leaf grade to ensure an adequate supply while avoiding a surplus. The local government, however, has an incentive to encourage or sometimes even force farmers to produce more tobacco leaves so that the local government can collect more tax from tobacco leaves. The result is a surplus of tobacco leaf. The average government leaf procurement price, in real terms (taken away from the inflation factor) has remained about the same during the past decade. A survey, conducted by this author and his team, of more than 2,000 tobacco farmers in Yunnan, Guizhou and Sichuan provinces indicates that tobacco farmers in general have lower economic returns from tobacco leaf than from other crops, partly because of tobacco leaf’s relatively low procurement price and partly because (flue-cured) tobacco is a capital and labor-intensive crop. The surplus tobacco leaf, largely due to local government enforcement policy, also leads to underground tobacco transactions, a source for “bootleg” cigarette products. Interestingly, the “bootleg” cigarette has been a major headache for both the Chinese cigarette industry as well as foreign cigarette companies, such as Philip Morris and the British American Tobacco Company.

Cigarette Manufacturing Industry

The China National Tobacco Company (CNTC), a state-owned enterprise with a monopoly over cigarette manufacturing, implements the STMA's policy and engages in all economic activities on behalf of STMA. While technically falling under the jurisdiction of the STMA, the CNTC and the former are in actuality identical institutions, with several top officials possessing two separate titles under this arrangement. The STMA or the CNTC has branches in each province all the way down to the district/county level. The CNTC employs more than half a million people. In 2003, it generated about US$2 billion (160 billion yuan) tax and profit for the central government, about 7.4% of central government revenue [9]. Nevertheless, its share of central government revenue has been declining since 1996, from 11.2% to 7.4%, due to rapid economic development in automobile, telecommunication, high technology and petroleum industries [10].

China entered the World Trade Organization (WTO) in 2001. One of the WTO requirements for China’s entry was to reduce its cigarette import tariff from 49% in 2001 to 25% in 2003. China's cigarette imports have increased 37% from 68.51 million packs in 2002 to 93.92 million packs in 2003. Although this consists of only 2.3% of the market share, it should reach 10% within a decade. Since 2003, under the WTO agreement, CNTC eliminated the special retail permit to sell foreign cigarettes, further increasing the competition between domestic and foreign brands. The prices of foreign brand cigarettes (such as Marlboro or 555) have been coming down from 20 yuan ($2.50) per pack pre-entrance to the WTO to about 12 yuan ($1.50) per pack post-WTO, similar to that of popular domestic brands, such as Red Pagoda Mountain (Hong Ta Shan). As the Chinese economy is growing and personal income is rising, the demands for foreign brands are increasing, particularly among urban youth adult males and female smokers.

Facing foreign competition, CNTC has closed down many inefficient and small cigarette companies, with the number reduced from 185 in 2001 to 57 in 2004. The number of domestic cigarette brands followed, dropping drastically from 1,049 in 2001 to 423 in 2004 [11]. Through domestic/regional mergers, CNTC hopes to achieve economic efficiency in cigarette production, pricing and marketing. In spite of China's entry into the WTO, the central government has not permitted foreign companies to either establish wholly foreign-owned factories or have joint ventures with local cigarette companies. Reports indicate that some local cigarette companies have established joint venture arrangements with a major foreign company, but the CNTC has always officially denounced these “rumors.”

In addition to the competition from foreign brands, the CNTC also faces challenges that have arisen from China's ratification of the Framework Convention on Tobacco Control (FCTC). The FCTC requires each ratified country to implement tobacco control policies, such as raising the tobacco tax, banning cigarette advertisements, promoting smoke-free public buildings and banning the sales of cigarettes to minors. Therefore, the CNTC is facing challenges from foreign market forces as well as domestic tobacco control policies. With the increasing economic role of other industries, such as automobile, petroleum, computer/information technology, there is little doubt that the future role of the CNTC in the Chinese economy will continue to decline.

Cigarette Consumption and Taxation

There have been two major surveys on smoking prevalence rates in China. A 1996 survey conducted by China Center for Disease Control and Prevention (CDC) revealed that 66.9% of adult males (age 15 and above) were smokers, and 4.2% of women were smokers. In 2002, it was 66% for males and 3.1% for females, only slightly lower than before. Yet, the average cigarette consumption per smoker was the same in 1996 as in 2002, about 15 cigarettes (about three-quarters of a pack) per day. Within income classes, this author’s survey in 2002 showed that the urban middle/high-income smokers (2,500 yuan per year) smoked higher-priced cigarettes, about eight yuan per pack, while low-income individuals (less than 1,600 yuan per year) paid about four yuan per pack. Higher income smokers smoked twice the amount of low-income smokers. Rural smokers smoked more than twice the amount of urban smokers, but they paid between one yuan to two yuan per pack. Poor urban households spent an average of 6.6% of their total expenditures on cigarettes, while poor rural households spent 11.3% of their total expenditures on cigarettes. In other words, the higher income smoker smoked more cigarettes and purchased high-priced cigarettes than low-income smokers in China.

One of the most effective tobacco control strategies in the world is to increase the tobacco tax. Currently, in about 50 percent of countries, around 66% of the retail cigarette price is attributed to tobacco tax, especially in northern Europe, Canada, Australia, Hong Kong and Taiwan. China currently levies a 67% tax at the producer level, equivalent to a 40% tax at the retail level, a relatively low rate compared to cigarette tax rates around the world [14]. Therefore, this gives leeway to raise the tobacco tax if the government wants to implement tobacco control programs. To analyze the impact of raising the tobacco tax on tobacco consumption and government revenue would require analysis of the relationship between price and consumption of cigarettes in China. This author’s research team has used the Chinese data to estimate that on average, a 10% tax increase (which will be passed on to smokers in retail prices) would reduce cigarette consumption by 1.5%, equivalent to 1.02 packs per person, or a total reduction of 1,017 million packs annually. Because the percentage of reduction in cigarette consumption is less than the percentage increase in price, the Chinese government’s revenue would, in fact, increase by $3.6 billion (or 30 billion yuan). Therefore, the Chinese government’s concern about losing government revenue due to tax increase is unfounded. The government would not only get additional revenue from an increase in tobacco tax, but also use a portion of the extra revenue to help low-income households in health and social welfare programs, the so-called earmarked tax programs. If the tax is imposed according to a retail price percentage, not on the per pack level, regardless of price (excise tax), higher income smokers would pay more than low-income smokers.

China’s Challenges in Tobacco Control

It is a well-known fact among Chinese officials that smoking causes lung and cardiovascular diseases and leads to high medical expenditures and premature deaths. Yet China has been reluctant to impose the most effective tobacco control policy—raising the tobacco tax—due to its concerns over the negative economic impacts of revenue loss, income loss among tobacco farmers or employment loss in the cigarette manufacturing industry. In reality, however, increasing the cigarette tax would increase revenue. Tobacco leaf is over-produced; many tobacco farmers earn less from tobacco leaf production than from other crops. For the sake of increasing local revenue, the local governments force farmers to plant tobacco leaf. If additional taxes were received from cigarettes, the central government could share the extra revenue with local governments, thus allowing farmers to plant other crops. With the WTO requirement, the Chinese cigarette industry is competing against foreign brands; thus, the advantages of conducting a monopoly are diminishing. Raising the tobacco tax would apply to all brands, domestic and foreign. Because of foreign competition, Thailand, Korea, Japan, Taiwan and Turkey have not only disbanded the monopolies but have also privatized the cigarette companies. Some insiders in the Chinese tobacco administration have already realized that tobacco has become a sunset industry, especially given the rapid economic growth in other high tech industries and foreign competition. These economic costs, the negative health burden of smoking and the economic consequences of raising tobacco tax need to be widely publicized, especially among high-level Chinese officials. With its ratification of FCTC, China needs to implement these tobacco control policies, including raising the tobacco tax. The challenge facing top policymakers is the formulation of a comprehensive health and economic agenda with an adequate intervention in public health education, training and intervention programs aimed at tobacco prevention and control.

Acknowledgements
Tobacco Control Policy Analysis and Intervention Evaluation in China is supported by the Fogarty International Center, U.S. National Institutes of Health, Bethesda, Maryland, USA

Notes

1. T. Liu and B. Xiong, Tobacco Economy and Tobacco Control (in Chinese) (Beijing: Economic Science Press, 2004).
2. G. Yang, “The Epidemiologic Investigation of the Smoking Behavior among Chinese Population in 2002.” Chinese Smoking and Health, No. 62, 2004, p. 7-18.
3. B.Q. Liu, R. Peto, A.M. Chen, et al., “Emerging Tobacco Hazards in China: 1. Retrospective Proportional Morality Study of One Million Deaths,” British Medical Journal1998 No. 317, p. 1411-22.
4. R. Peto and A.D. Lopez, “Future World Wide Health Effects of Current Smoking Patters, Chapter 18,” Critical Issues in Clobal Health 2001, p. 155.
5. T. Liu, Tobacco Economy and Tobacco Control.
6. J. Mackay and M. Eriksen, The Tobacco Atlas (Geneva: World Health Organization, 2002), p. 94-5.
7. T. Liu, Tobacco Economy and Tobacco Control.
8. Chinese National Statistics Bureau’s China Statistical Yearbook, Beijing: China
Statistics Press, 2000-2004.
9. T. Liu, Tobacco Economy and Tobacco Control.
10. Ibid.
11. T-W. Hu, “China at the Crossroads: The Economics of Tobacco and Health,” Tobacco Control No. 15, 2006, 37-41.
12. J. Mackay and M. Eriksen, The Tobacco Atlas (Geneva: World Health Organization, 2002), p. 94-5.

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