hours. Thus, given the economic and social costs of tobacco growing, additional tax revenues from a reformed tobacco excise system could be used to help tobacco farmers switch to more profitable alternative crops.

Although there are over 225,000 deaths annually from tobacco-related diseases in Indonesia, nearly 470,000 children ages 10–14 and 53 million adults ages 15 or older continue to use tobacco daily. In 2016, 21 percent of male deaths in Indonesia were caused by tobacco; this is higher than the average in countries with a medium human development index.<sup>3</sup> Similarly, Indonesia is among the few countries that has not signed or ratified the WHO Framework Convention on Tobacco Control (WHO 2017c). This policy creates an attractive space for the tobacco industry to continue growing because there is limited regulation of tobacco use.

Tobacco taxes are often considered regressive because the share of household budgets allocated to tobacco products is larger among low-income households than among high-income households. This paper shows that, if behavioral and indirect effects, especially health-related effects, are taken into account, this is no longer valid. The long-run benefits of not smoking offset the costs associated with tobacco taxes among low-income groups and the overall population. Potential benefits include a reduction in medical expenditures and an increase in healthy life years, factors that translate into economic benefits that outweigh the losses created by tax increases if consumers quit or never start smoking.

This paper describes and quantifies the medium- and long-run effects of tobacco tax increases on aggregate household welfare through three channels. The first implies that higher tobacco prices because of higher taxes induce a behavioral response involving a reduction and cessation in tobacco consumption that are manifest particularly among people who discontinue smoking and younger individuals who do not start smoking. The second channel is associated with a reduction in medical expenses associated with the averted treatment costs of tobacco-related diseases. The third channel is a rise in incomes because of gains in years of employment because of the prolongation of life expectancy. To assess the impact of these effects, this paper estimates the price elasticity of tobacco, simulates upper- and lower-bound scenarios, and calculates the welfare gains among various income groups.

The study is structured as follows. Section 2 reviews the literature on the health effects of tobacco, the economic costs associated with tobacco-related diseases, tobacco tax policies, and price elasticities. Section 3 presents the model. Section 4 presents an overview of the data used to estimate the impact of the tobacco tax. Section 5 examines the results. The final section concludes with a discussion on policy implications.

# **2. Literature review**

Blecher and van Walbeek (2008) estimate that, because the mean incomes in countries grew more quickly than average tobacco prices, cigarettes became more affordable in developing countries between 1997 and 2006. This indicates that, as smoking prevalence increases, these countries are more likely to bear the major health impacts of tobacco consumption. Furthermore, low- and middle-income countries are experiencing a rise in noncommunicable diseases. Kristina et al. (2015) estimate that, in Indonesia, cancer mortality attributable to smoking represented 74,440 deaths (30.6 percent of total cancer deaths), of which 95.0 percent were men. Cancer deaths attributable to smoking were responsible for 1.2 million years of potential life lost. This has negative consequences for human capital development and imposes an increasing economic burden because smoking decreases earnings potential and labor productivity (WHO 2015a).

Several studies have quantified the economic costs of smoking, though most have been carried out in highincome countries. Annual direct health care costs attributable to tobacco use amounted to US$2.2 billion in Indonesia in 2015, which is equivalent to 2.5 percent of GDP (Kristina et al. 2018). In Bangladesh, the overall economic cost of tobacco use is estimated at Tk 110 billion (US$1.9 billion) or over 3 percent of GDP in 2004

> 3 See “The Tobacco Atlas: Indonesia,” American Cancer Society and Vital Strategies, Atlanta, <u>https://tobaccoatlas.org/country/indonesia/.</u>

3