How Much Tax Is in a Pack of Cigarettes? How Much Less Do E-Cigarettes Pay?

Recently, the U.S. House Ways and Means Committee approved a tax provision for nicotine e-cigarettes, which will impose a tax of $50.33 on every 1810 milligrams of nicotine e-liquid. This means that the U.S. will impose a tax on nicotine liquid for the first time.
 
The bill's proponents stated that the aim is to raise e-cigarette prices, thereby reducing the proportion of youth users. According to the U.S. Joint Committee on Taxation, this will generate $9.9 billion in federal revenue over the next decade.

Not only the U.S., but several countries including Russia, the Philippines, and South Korea are also studying and formulating tax regulation policies for e-cigarettes. It is foreseeable that taxation, as another powerful tool for e-cigarette regulation, will gradually be implemented globally.

China's e-cigarette regulatory measures are also moving. On November 1, the National Tobacco Monopoly Administration and the State Administration for Market Regulation jointly released a notice titled "Notice on Further Protecting Minors from the Harm of E-Cigarettes" (hereinafter referred to as the "Notice"), which clearly states that e-cigarettes are a supplement to traditional tobacco products such as cigarettes, indicating that e-cigarettes are likely to be regulated similarly to traditional tobacco to a considerable extent.

"E-cigarettes are classified as electronic consumer products, tobacco products, or pharmaceuticals, each corresponding to different tax policies," said a person close to the Ministry of Finance. If e-cigarettes are taxed similarly to traditional tobacco, the impact on e-cigarette companies will be enormous. According to estimates, with the current domestic e-cigarette penetration rate of 1%, the e-cigarette industry will generate approximately 4.6 billion yuan in tax revenue annually.

Buying a pack of cigarettes, two-thirds goes to taxes

The tobacco industry is a heavily taxed industry, with many tax items and high rates. According to data from the National Tobacco Monopoly Administration, in 2018, the tobacco industry achieved a total industrial and commercial tax profit of 1.1556 trillion yuan, contributing 1 trillion yuan to the national treasury.

How is traditional tobacco taxed?

The Tobacco Economic Research Institute of the National Tobacco Monopoly Administration has previously introduced to the media that China's tobacco tax mainly includes seven taxes and two special fees, namely, tobacco leaf tax, consumption tax, value-added tax, corporate income tax, import duties, urban construction maintenance tax, education fee surcharge, as well as state-owned capital gains and special profits based on after-tax profits.

Taking Class A cigarettes with a distribution price of over 70 yuan as an example, a 56% ad valorem tax is first levied at the production stage, followed by a quantity tax of 0.06 yuan per pack. At the wholesale stage, both ad valorem and quantity taxes are levied again, with an 11% ad valorem tax and a quantity tax of 0.1 yuan per pack. Just the consumption tax alone requires four detailed items to be paid.

In addition to the consumption tax, this cigarette incurs a 13% value-added tax throughout the entire chain from production to wholesale to retail. On this basis, a 7% urban construction maintenance tax and a 5% education fee surcharge are also levied based on the total amount of consumption tax and value-added tax. Throughout the entire chain, tobacco factories, tobacco companies, and tobacco retailers also need to pay a 25% corporate income tax based on their profits as the tax base. In addition, there are also relatively low amounts of tobacco leaf tax and taxes during the production of tobacco strips.

After multiple layers of accumulation, taxes constitute a large part of the retail price of a cigarette. The "2018 Report on China's Progress in Tobacco Control Compliance" from the Tobacco Economic Research Institute of the National Tobacco Monopoly Administration shows that the comprehensive tax rate for cigarettes in China is currently 66.6%. This means that for a cigarette with a market price of 150 yuan, about 100 yuan is paid in taxes.

If we extend the tax chain of traditional tobacco companies to include their after-tax profits, state-owned capital gains, and special after-tax profits, the fiscal revenue generated by cigarettes is even larger.

E-cigarettes have "avoided" the major consumption tax

In contrast, e-cigarettes have been caught in the "high profits + low taxes" trend. Many e-cigarette professionals have told reporters that due to low entry barriers and a lack of national standards, the production costs in the e-cigarette industry are relatively low, and the overall industry profit margins are not low compared to traditional tobacco. However, e-cigarettes are currently only taxed as ordinary consumer goods, and their tax burden is far lower than that of traditional tobacco.

Many e-cigarette industry practitioners have reported that the taxes currently paid by the e-cigarette industry in China mainly include value-added tax and corporate income tax, as well as urban construction maintenance tax and education fee surcharge based on value-added tax, without paying consumption tax.

The current scope of consumption tax collection mainly includes tobacco, alcohol, oil, and vehicles, among which tobacco includes Class A cigarettes, Class B cigarettes, cigars, and tobacco strips, but does not yet include e-cigarettes or pods.

It is worth noting that although the tax burden composition of traditional tobacco is complex, the consumption tax is levied at both the production and wholesale stages based on value and quantity, with relatively high rates, resulting in most of the tax paid by a cigarette coming from consumption tax. For the aforementioned Class A cigarettes, consumption tax accounts for about 60% of the total tax amount, meaning that for a 150 yuan cigarette, about 60 yuan is consumption tax.

Looking at the overall consumption tax revenue in China, Liang Ji, a researcher at the Chinese Academy of Fiscal Sciences, stated that tobacco consumption tax is one of the 15 tax items in China's consumption tax, with considerable revenue scale, occupying "half of the consumption tax revenue." When we say that tobacco is a major taxpayer, we are mainly referring to consumption tax. This also means that currently, compared to traditional tobacco, a significant portion of the major taxation of e-cigarettes is missing.

10% penetration means hundreds of billions in taxes

Ao Weinuo, secretary-general of the Electronic Cigarette Professional Committee of the China Electronic Commerce Association, introduced that in 2018, the consumption scale of the e-cigarette market in China was about 4 billion yuan.

Although this figure is negligible compared to the trillion-yuan scale of the traditional tobacco market in China, with over 300 million traditional smokers as a base, the future tax revenue potential of e-cigarettes should not be underestimated.

Industry estimates suggest that the current penetration rate of the domestic e-cigarette market is still low, at only about 1%. This year, the market consumption scale brought by these 3 million e-cigarette consumers may exceed 5 billion yuan. Taking this conservative data, if we refer to the 66% tax burden ratio of traditional Class A cigarettes, it is roughly estimated that e-cigarettes will generate about 3.3 billion yuan in tax revenue, with consumption tax being around 2 billion yuan.

In the main battleground for e-cigarette consumption in Europe and the United States, the conversion rate of traditional smokers to e-cigarettes is already at a high level. Data shows that the number of e-cigarette users in the UK is half that of traditional cigarette users, and the penetration rate of e-cigarettes among the approximately 100 million traditional smokers in the U.S. has also reached 13%. If the penetration rate of e-cigarettes in China reaches 10% in the future, and taxes are levied similarly to traditional cigarettes, it will mean generating hundreds of billions in tax revenue.

Moreover, data from the Ministry of Finance shows that in 2018, the environmental protection tax revenue in China was only 15.1 billion yuan. It can be seen that looking to the future, e-cigarettes, which currently seem to have a small scale, have significant tax revenue potential.