Fiscal policy, affordability and cross effects in the demand for tobacco products: the case of Uruguay

Uruguay, a country with a solid tobacco control policy since 2005 shows, contrary to expectations, an insignificant decrease in total tobacco products' sales in the last five years. The hypothesis is that on one side, changes in household income and the income elasticity of the demand for cigarettes were important countervailing factors in the demand of both products. The period 2005-2009 shows a large increase of 36% in household real income in Uruguay due to fast economic recovery after the 2002 crisis. The second factor is the interchangeability of roll your own and cigarettes and the impact on the demand of each product as a reaction to tax and price changes. The tax and price of roll your own tobacco remains substantially lower than that of cigarettes. This fact, and the increased substitution of roll your own for cigarettes seems to be the main reasons for the low impact of the policy of tobacco tax and price increases. This paper then consists of a revision of a 2004 study to estimate separate demands for both main tobacco products and obtain estimates for own price, cross price and income elasticities. Then, a simulation study was performed using the elasticities found and two scenarios of increases in household income: moderate (2.5% per year) and high (5% per year) confirming that countries where income is growing fast and with a potential for substitution towards cheaper products require substantial cigarette tax and price increases for a fiscal tobacco control policy to become effective.