MAKATI CITY, Metro Manila — While lauding the government’s efforts to simplify its tobacco tariff system, a well-known American economist has cautioned authorities that excessive tax rate increase on tobacco products could actually incentivize illicit trade of tobacco products.

According to Dr. Arthur Laffer, founder and chairman of American economic and consulting firm Laffer Associates, “when a commodity becomes too expensive for consumers due to taxation, they will reduce consumption of that commodity or substitute away from that highly taxed commodity in part through consumption of illicit goods.” Laffer pointed out that the mechanism that resulted in continuous annual tax rate increases to achieve continuous revenue growth has clearly taken tax rates too high and failed to generate the anticipated revenue.

“Due to declining tax revenue and increased growth in the illicit trade of tobacco, it is time to reevaluate the optimal cigarette tax rate,” he noted.

The American economist said that the potential profit opportunities for smugglers—and savings for consumers—must be weighed against the likelihood and consequences of enforcement.

“In this sense, the proliferation of illicit trade is a function of high tax rates coupled with low affordability and likelihood of enforcement,” he cited.

Following the passage of Republic Act No. 11346, the Tobacco Tax Law of 2019, the excise tax on cigarettes rose to ₱50 per pack on January 1, 2021, with a 5 percent annual increase, now at ₱63.

In this view, Laffer asserted that the Philippines’ tobacco excise tax rate reached a “prohibitive range” based on declining government revenue.

“It seems that tax rates have exceeded the revenue-maximizing rate and ventured into what is known as the ‘prohibitive range’ of taxation,” he stated.

In ending, the former member of ex-US president Ronald Reagan’s Economic Policy Advisory Board, claimed that the phenomenon of declining tobacco tax collections in the Philippines can be explained using the relationship between tax rates and tax revenue.

“Tax revenues increase with increasing tax rates until a revenue-maximizing point is reached, after which further increases in tax rates result in declining tax revenue.

“Of course, the government should take steps to realign tobacco tax rates closer to the revenue-maximizing rate. Doubling down with further revenue-losing tax rate increases is never a sensible solution to a tax revenue loss,” he concluded.