Over 340,000 children and more than 5 million adults consume tobacco in South Africa every day (ACS and WLF 2010).<sup>5</sup> Despite the progress of the past two decades, smoking rates are still high among men. Fewer than 8 percent of South African women ages 15 or older smoke relative to 35 percent of men. Similarly, colored adults exhibit a higher smoking prevalence (45 percent) than white adults (25 percent), Indians (20 percent), or black Africans (17 percent).<sup>6</sup> Yet, daily smoking rates in South Africa remain comparable with those in countries of the Organisation for Economic Co-operation and Development, 19.0 percent and 18.2 percent, respectively (OECD 2017).

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 This paper argues that if indirect effects, especially on health, are taken into account, this is no longer valid.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 stop or never start smoking.

This paper describes and quantifies the 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 in tobacco consumption that is 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, and the third is a rise in incomes because of gains in years of employment. 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 briefly 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 describes the methodology. Section 4 presents an overview of the data used to forecast the impact of the tobacco tax. Section 5 examines the estimation results. The final section concludes with a discussion on policy implications.

# **2. Literature review**

Blecher and van Walbeek (2008) estimate cigarettes became more affordable in developing countries between 1997 and 2006. This means 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 non-communicable diseases. This has negative consequences on human capital development and imposes an increasing economic burden because smoking decreases earnings potential and labor productivity (WHO 2015a). Atun (2014) estimates that the incidence of premature disability and mortality could be reduced by a fifth in South Africa if the risk factors associated with non-communicable diseases are addressed. Approximately 40 percent of deaths in South Africa are related to non-communicable diseases, and a high prevalence is attributed to avoidable risk factors such as tobacco use (WHO 2013). In 2015, over 12,000 deaths of individuals ages 15 or older who smoked were attributed to cardiovascular diseases, and over 16,000 to respiratory diseases (OECD 2017).

Several studies have quantified the economic cost of smoking, though most have been carried out in highincome countries. Annual tobacco-related health costs are estimated at US$81 billion in the United States, nearly US$7 billion in Germany, and US$1 billion in Australia (Guindon et al. 2007). Goodchild, Nargis, and

> 5 There are other calculations that estimate more than 7 million tobacco consumers in South Africa: https://www.iol.co.za/the-star/about-8-million-adults-in-sa-smoke-27-billion-cigarettes-a-year-9429417 6 Estimates based on harmonized datasets by World Bank staff of the National Income Dynamics Study, wave 4, 2014– 15.

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