Cigarette prices in a complex cigarette tax system: empirical evidence from Indonesia

The complex cigarette tax system in Indonesia has created the opportunity for cigarette producers to avoid tax, which results in affordable cigarette prices. In addition to increasing cigarette tax every year, the government has adopted several policies to increase cigarette prices, such as reducing the number of tiers and applying cigarette tax based on the combined production of affiliated companies (ie, firms with a minimum 10% ownership of another cigarette company, sharing the same boards of commissioners or using input from other tobacco companies, in which a firm has at least 10% ownership).

To investigate the effect of cigarette tax, affiliated company rules and changes in the number of tiers on cigarette prices produced in Indonesia.

Using brand level data from 2005 to 2017, we model cigarette prices as a function of cigarette tax, affiliated company rules, number of tiers, cigarette types and cigarette tax system using random effect and fixed effect estimations.

We find that a percentage increase in cigarette tax increases cigarette prices by less than 1% for all cigarette types. The implementation of affiliated company rules is effective in increasing cigarette prices for both affiliated and non-affiliated firms. We also find that a fewer number of tiers are associated with a higher cigarette price. Our results suggest that a reduction in the number of tiers will increase the effectiveness of a specific tax system in making cigarettes less affordable.