## TAXES ON SMOKING, DRINKING, AND SUGAR SHOULD BETTER ALIGN WITH THE HARM THEY CAUSE

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### Steady revenue and role of excises
- Excise taxes on tobacco, alcohol, and sugar yield on average about 2 percent of GDP in both advanced and developing economies.
- Such taxes mobilize domestic revenue, can encourage healthier behavior, and help reduce public health expenditures.
- Recent trends: excise taxes are becoming more popular in developing economies but have recently declined in advanced and emerging market economies mainly because of revenue erosion through inflation and changes in consumer behavior.
- Revenue ranking by product: taxes on smoking yield the most revenue, followed by alcohol; taxes on sugary drinks typically raise more modest revenue and remain relatively uncommon.

### Core policy principles
- Three principles for a comprehensive approach:
  - Capture all unhealthy products.
  - Align tax rates with the potential harm to health.
  - Cooperate across borders to limit evasion and smuggling.

### Catch ’em all — closing loopholes
- Leaky tax nets examples:
  - Hong Kong SAR: wine is not taxed; distilled spirits face rates exceeding 100 percent.
  - São Tomé and Príncipe: palm wine is exempt while all other alcoholic drinks are taxed.
  - Ethiopia: khat leaves remain untaxed despite heavy taxes on alcohol and tobacco.
- Closing exemptions and loopholes can boost revenue and improve public health.

### Price the harm — aligning rates with health risks
- Taxation should reflect the degree of harm a product causes (direct and indirect) while preserving revenue.
- Harm depends on product contents (ethanol, added sugar, toxic chemicals), mode of administration (burning versus heating tobacco), and consumption patterns.
- Practical approach: tax products based on the amount of the harmful substance and its mode of administration, using average consumption patterns.
- Many countries already tax drinks based on sugar or alcohol per liter to capture risks from new products.
- Harm-based taxation can incentivize suppliers to produce safer alternatives (example: German brewers’ nonalcoholic beer accounts for about 9 percent of sales).

### Harm of smoking — differential taxation of nicotine products
- New nicotine products (e-cigarettes, heated tobacco, nicotine pouches) often reduce exposure to toxicants and can be taxed at lower rates, adjustable with evolving evidence and revenue needs.
- New Zealand case:
  - Over the past 15 years, successive governments increased excise rates for combustible tobacco products by 10 percent or more a year to widen the tax differential with less harmful alternatives.
  - Smoking prevalence fell from 18 percent in 2012 to 8 percent in 2024.
  - Uptake of less harmful e-cigarettes increased from near zero to 14 percent over the same period.
  - Tax revenues rose until 2020 but have since declined somewhat.
- European Commission proposal: draft Tobacco Excise Directive proposes minimum rates for 13 product categories, taxes cigarettes and loose tobacco at similar levels, and sets significantly lower rates for e-cigarettes, heated tobacco products, and nicotine pouches; no tobacco or nicotine product is exempt and rates are set to keep pace with or exceed inflation.
- Perverse incentives in some low-income and emerging markets:
  - South Africa: tax on a unit of alcohol in traditional African beer is roughly one-fiftieth what it is on a unit of alcohol in other beer.
  - India: bidis are taxed significantly lower than filtered cigarettes; smoke-free alternatives are banned.
- Such misalignment sustains consumption of often more dangerous products and diverts investment toward the wrong industries, undermining protection of low-income groups.

### Degrees of harm and alignment across countries
- Alignment across G20 and product types is mixed: most comprehensive for tobacco, less so for alcohol, and very patchy for sugary drinks.
- Policy responses vary: bans sometimes replace taxation (examples: novel tobacco products in Argentina and Türkiye); Saudi Arabia does not tax alcohol because it was outlawed until recently.
- Classification and rate-setting need to keep pace with evolving product lines.

### Cooperation across borders — limiting arbitrage and illicit trade
- Large tax differences across borders motivate cross-border shopping, reducing health impact and revenue.
- Examples and estimates:
  - Finland’s 2004 alcohol tax cut led to sales surging to 150 percent in some towns on the border with Sweden.
  - EU-wide annual cross-border alcohol purchases are estimated at 1.4 billion liters, resulting in excise duty losses of some €4 billion annually.
  - Paraguay’s very low tobacco taxes have made it a hub for cigarettes traveling to higher-tax neighbors; cheap products make up roughly 20 percent of Brazil’s cigarette market and cost that country about $400 million in lost revenue each year.
- Remedies include stricter enforcement where cross-border shopping is illegal and closer international dialogue with stronger consensus on product classification.

### The way forward — policy implications and recommendations
- Taxation should be used as a lever to shape healthier societies by linking excise taxes to relative health risks.
- Key actions:
  - Apply harm-based taxation comprehensively and consistently to reduce preventable diseases while supporting sustainable revenues.
  - Close loopholes and correct misaligned incentives that lead to revenue losses and continued exposure to avoidable harm.
  - Adapt tax systems to evolving consumption patterns and new product offerings.
  - Build internationally shared principles to curb cross-border arbitrage and illicit trade.
  - Leverage global and regional institutions (IMF, EU, African Union) to advance frameworks that align taxation with harm and promote innovation toward safer products.
- Expected outcomes: strengthened public health and fiscal resilience.

*Source: Rosenberg and van Oordt, “Taxing Harmful Habits,” Finance & Development, March 2026.*

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_Source: https://www.imf.org/-/media/files/publications/fandd/article/2026/03/rosenberg.pdf_