How does the e-cigarette industry respond to tax adjustments? Evidence from China.

Abstract

China enacted an excise tax on e-cigarettes in November 2022, which offers a distinctive opportunity to examine the industry's reactions to this fiscal adjustment. This study delves into the industry's pricing strategies following the introduction of the excise tax, facilitating a thorough assessment of the subsequent impact on market dynamics and the government's revenue streams. We developed a TaXSiM model specifically tailored for e-cigarettes in China by integrating the country's e-cigarette tax framework. Our approach involved leveraging market data obtained from a representative product, the RELX Phantom Series, to ensure the model's effectiveness and relevance. The excise implementation of 2022 significantly heightened the tax burden on e-cigarettes, marking an increase of approximately 150 RMB per device and 19 RMB per cartridge. Despite these financial pressures, electronic cigarette firms exemplified by RELX, strategically endeavored to sustain competitiveness. Their approach involved initially implementing a 'Razor blade model' and eventually a 'comprehensive under-shifting' strategy, which mitigated the health impact of the tax hike, resulting in a relatively minor decline in sales while amplifying the impact on tax revenue. However, this strategic pricing maneuver came at a cost, as it led to a substantial decrease in profits, and therefore expedited a reshuffling of the industry by compelling smaller brands to leave the market rapidly. To effectively curb the use of e-cigarettes through tax policies, it is advisable to relocate the imposition of excise taxes on electronic cigarettes to the retail stage. This shift aims to narrow the scope for industry-level pricing strategies. Furthermore, this approach should be coupled with the introduction of an additional specific tax, strategically crafted to accentuate the health-related benefits associated with the excise taxation on electronic cigarettes.