Do Excise Taxes Drive the Market for Heated Tobacco
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Do Excise Taxes Drive the Market for Heated Tobacco
products?
Estelle Dauchy ∗ Naomi Feldman† Ce Shang‡
Abstract
Heated Tobacco Products (HTPs) are a new form of tobacco products that heat raw to-
bacco sticks to generate an aerosol containing tobacco flavor, nicotine, and other chemicals.
Essentially because the tobacco is not combusted for HTPs, in contrast to traditional cigarettes,
companies have aggressively promoted them as “reduced-risk” products that could help con-
sumers to quit cigarette use. HTPs have rapidly gained market shares over traditional cigarettes
in several countries. Despite the lack of evidence on their impact on health of demand, most
countries that sell HTPs have heavily subsidized these products though lower excise taxes
than cigarettes. This study constucts a model that describes the demands for to substitutable
harmful products, cigarettes and HTPs, but where consumers perceive one of the product as
reduced-risk and therefore derive a higher marginal utility from them. We construct a unique
quasi-panel database for HTPs and cigarettes over 2014-2018. We estimate the model with
reduced-form regressions to study the combined demands for cigarettes and HTP in response
to taxes and prices. We find that the demand for HTP packs is highly responsive to price
changes, especially changes induced by excise tax policy. HTP demand also appears to be
much more responsive to price changes than cigarette demand confirming that cigarette con-
sumption is inelastic. We also find evidence that HTPs and cigarettes are complements rather
than substitutes, but only in one direction: cigarettes or HTP prices are inversely related to HTP
consumption, but the decrease in either prices does not significantly affect cigarettes demand.
JEL:
Keywords:
Acknowledgements:
∗
Campaign for Tobacco Free Kids. 1400 I (Eye) Street NW, Suite 1200, Washington, DC 20005.
edauchy@tobaccofreekids.org.
†
Department of Economics, Hebrew University of Jerusalem, Israel.
naomi.feldman@mail.huji.ac.il
‡
University of Oklahoma Health Sciences Center, Oklahoma City, OK. Ce-Shang@ouhsc.edu1 Introduction
Heated tobacco products (HTPs), also known heat-not-burn tobacco products are a new type of
tobacco product created by large tobacco multinationals. Their main difference with cigarettes is
that the dry tobacco contained in a cigarette stick or pod is heated instead of combusted, to emit an
aerosol containing nicotine, and other chemicals that is inhalable by users.
For smokers, they are likely to be close substitutes to traditional cigarettes because in addition
to providing nicotine, the aerosol contains the tobacco flavor also desired from cigarettes. The
tobacco units (cigarette sticks or pods) are heated by an electronic device below the temperature
required for full combustion. Users need to use the HTP device and the cigarette stick simulta-
neously. Contrary to e-cigarettes–another older cigarette substitute that heats a liquid containing
nicotine but not tobacco–HTPs provide what most consumers desire in a conventional cigarette: a
flavorful nicotine-containing tobacco.
An initial version of heated tobacco products was introduced by the tobacco industry in the
1980s, but these older products revealed a market failure for their lack of popularity. The first
recent and popular form of HTPs–HEETs sticks heated by IQOS devices–was introduced in Japan
by Philip Morris International (PMI) in 2014. Since then, HTPs have been launched in almost 50
countries, rapidly gaining market shares over conventional cigarettes. Although IQOS still capture
the largest market share worldwide, PMI’s main competitors’ featured products have gained pop-
ularity in many countries, including Ploom TECH from Japan Tobacco International (JTI), Glo by
British American Tobacco (BAT), and lil from the Korean company KP&G. These new versions
of HTPs cannot be compared with their older version three decades earlier.
The WHO defines them as “specially designed cigarettes” (World Health Organization, 2019).1
Likewise in the US where IQOS have recently been approved by the Food & Drug Administration,
the FDA recognizes that they meet the definition of cigarettes and therefore should be regulated as
cigarettes (Food & Drug Administration, 2019a,b).
1 “FDA
permits sale of IQOS Tobacco Heating System through premarket tobacco product application pathway”,
FDA News Release, April 30, 2019. http://www.fda.gov/news-events/.
1Whether heated tobacco products and traditional cigarettes should be regulated similarly or
not requires careful consideration of the intended and unintended effects of the policy. Because
the new generation of HTPs have not been on markets long enough, there is no evidence on their
long term health impacts, whether they are reduced- or modified-risks to conventional cigarettes,
though the evidence is growing that HTPs provide consumers similar satisfaction than traditional
cigarettes (Glantz, 2018a).2 Therefore to this day the proposition that their consumption should be
subsidized has not been proven scientifically. In their systematic analysis on the existing literature
on HTPs Dautzenberg and Dautzenberg (2019) find that contrary to the tobacco industry’s claim
that HTPs can help smokers to quit smoking, HTPs are a more likely to be a gateway to smoking.
In fact, the authors find that HTPs are likely to be a gateway to tobacco use, as research has found
that between 11% and 45% of HTP users were not using tobacco previously.
A growing number of studies show that contrary to industry’s proposition that HTPs are not
combusted, their aerosol should be classified as “smoke”, making them even closer equal to
cigarettes (Zervas and Katsaounou, 2018; Auer, Concha-Lozano, Jacot-Sadowski, Cornuz and
Berthet, 2017; Rosen and Kislev, 2018; World Health Organization, 2019). Researchers inves-
tigating industry data point out that HTPs emit several harmful substances, sometimes at higher
levels than found in comparable cigarette smoke (Bekki, Inaba, Uchiyama and Kunugita, 2017;
Li, Luo, Jiang, Zhang, Zhu, Hu, Hou, Hu and Pang, 2018; Leigh, Palumbo, Marino, O’Connor
and Goniewicz, 2018a; Davis, Williams and Talbot, 2019). Studies using biomarkers of poten-
tial harm find no statistically significant difference between users of HTPs and users of cigarettes,
and several experimental studies find no evidence of improvement in lung function or inflamma-
tion among smokers who switched to cigarettes (Leigh, Tran, O’Connor and Goniewicz, 2018b;
Nabavizadeh, Liu, Havel, Ibrahim, Derakhshandeh, Jacob III and Springer, 2018; Sohal, Eapen,
Naidu and Sharma, 2019). There is growing evidence that in spite of the proposition that HTPs
can potentially help smokers to quit traditional cigarettes toward the potentially “less harmful” use
of heated tobacco, smokers are more likely to use both products simultaneously rather than quit
2 Most of the research that suggests HTPs are reduced-risks is funded by the tobacco industry (Glantz, 2018b;
St.Helen, Jacob III, Nardone and Benowitz, 2018).
2cigarettes completely, or that HTPs might be a gateway to tobacco use. The WHO recognized the
lack of evidence that HTPs users completely stop using conventional cigarettes or that HTPs are
safer than cigarettes World Health Organization (2019).
In many countries, the tobacco industry has taken advantage of the lack of clear consensus or
scientific evidence about the specific forms of harm caused by HTPs to engage in active market-
ing campaigns, promoting these products as “reduced-risk”, “smoke-free”, “conventional smoking
cessation aids”, or “cleaner alternatives (Elias, Dutra, St. Helen and Ling, 2018; Popova, Lempert
and Glantz, 2018). These messages obviously misinform consumers, generating confusion among
current or new tobacco users(World Health Organization, 2019; Hair, Bennett, Sheen, Cantrell,
Briggs, Fenn, Willett and Vallone, 2018; Max, Sung, Lightwood, Wang and Yao, 2018; McK-
elvey, Popova, Kim, Chaffee, Vijayaraghavan, Ling and Halpern-Felsher, 2018; Lee, Blanchflower,
O’Brien, Averett, Cofie and Gregory, 2019; Kim, Yu, Lee and Paek, 2018; Elias et al., 2018).
Tobacco companies use marketing strategies that appeal to younger adults, such as social net-
works, TV series, cell phone apps, fashion magazine, cultural and social events, display the prod-
ucts near youth merchandize, and package their products as i-phones or smartphones(McKelvey et
al., 2018; Bar-Zeev, Levine, Rubinstein, Khateb and Berg, 2019; Hair et al., 2018; Halpern-Felsher,
2019). As a result there is evidence that HTPs might be relatively more attractive to younger and
wealthier generations, or internet users (Marynak, W, A, Agaku, Reimels and Graffunder, 2018;
Tabuchi, Gallus, Shinozaki, Nakaya, Kunugita and Colwell, 2018; Caputi, Leas, Dredze, Cohen
and Ayers, 2017; Wu, Wang, Ho, Li, Cheung, Tabuchi, Kwong, Lai and Lam, 2019; Kang and
Cho, 2019).
The lack of initial guidance about how to regulate these new tobacco products, combined with
misinformation about the risks of these products compared to conventional cigarettes has limited
countries ability to regulate them. In most countries where HTPs are currently sold, HTPs are
still subject to a much lower excise tax than conventional cigarettes. Nevertheless, in light of the
rapid gains in market shares of HTPs and the growing use of these products among exiting or
new generations of smokers, yielding rapidly growing profit margins for tobacco companies, many
3countries have changed their tax code to increase HTP excise taxes with the goal of taxing them
equivalently to cigarettes.
Despite the emergence of HTPs as a potential substitutes to combustible cigarettes, there is so
far no scientific evidence that determines their joint demand, and especially whether subsidizing
HTPs through lower excise tax rates than those on conventional cigarettes affects their demand. In
light of the fact that the demand for HTPs is rapidly growing in most countries, mostly because
they are perceived by consumers as healthier products and aggressively promoted by the industry
as such, we still know very little about their health impact or whether they might attract new gen-
eration of smokers. In this study, we construct a model that describes tobacco use in a market with
two potentially substitutable products, cigarettes and HTPs. For both products, we obtain detailed
price and tax information over time and across most countries where HTPs are currently available
on the market from various sources, and complement the data with data on sales (values and vol-
umes), to obtain a unique semi-panel dataset for HTPs from 2016-2018 and for cigarettes from
2014-2018. We then evaluate the model by estimating reduced-form regressions of the demands
for cigarettes and HTP in response to taxes and prices. We find that the demand for HTP packs is
highly responsive to price changes, especially changes induced by excise tax policy, and possibly.
The HTP demand also appears to be much more responsive to price changes than the demand for
cigarettes. We also find evidence that HTPs and cigarettes are complements rather than substitutes,
but only in one direction: cigarettes or HTP prices are inversely related to HTP consumption, but
the decrease in either prices does not significantly affect cigarettes demand.
This paper is structured as follows. Section 2 provides a model where cigarettes and HTPs are
consumption substitutes. Section 3 provides our empirical approaches. Section 4 describes the
data. The results are presented in Section 5 and discussed in Section 6.
42 Cigarettes and HTPs: A Model
Based upon the model of DiNardo and Lemieux (1992, 2001), we develop a utility maximizing
model of the joint decision to consume conventional cigarettes and HTPs based on the neoclassical
consumption model.3 The model has the advantage of delivering substitution hypothesis between
the two products that can be empirically tested, as cigarettes and HTPs deliver what tobacco users
are ultimately demanding, that is, tobacco flavor and nicotine. An individual’s preferences are
represented by a utility function that is separable in a composite consumption good, x, and a two-
tuple (c, h) of tobacco products providing nicotine, where c is the quantity of cigarettes consumed
and h is the quantity of HTPs consumed. An individual’s utility is represented by the following
equation:
U(x, c, h) = u(x) + φ (c, h), (1)
where U is increasing in each of its arguments, quasi-concave, and twice-continuously dif-
ferentiable. The sub-utility function φ (c, h) is assumed to be quadratic in c and h with a local
approximation to an arbitrary utility function:
φ (c, h) = γ0 + γc c + γh h + γch c · h + (γcc /2)c2 + (γhh /2)h2 . (2)
The parameter γch determines whether cigarettes and HTPs are Frisch complements (γch >
0) or Frisch substitutes (γch < 0).4 The parameters γc and γh represent the marginal utility of
cigarettes and HTPs when c = h = 0. The parameters γcc and γhh are negative in the standard case
of decreasing marginal utility in consumption.
3 DiNardo and Lemieux study the relationship between two “psychoactive substances,” marijuana and alcohol.
4 The conceptual experiment corresponding to a Frisch demand is one in which consumers are money compensated
for a price change until their price of utility returns to its original value. The inverse of the lagrange multiplier, 1/λ , is
defined as “the price of utility.” Frischian demands can be transformed into Marshallian demands by solving for 1/λ
in terms of prices and income and applying the budget constraint to quantities defined as a function of prices. See
Browning, Deaton and Irish (1985) for a more thorough exposition of Frischian demand functions.
5The individual’s maximization problem can be stated as follows:
maxU(x, c, h) s.t. (3)
x,c,h
x + pc c + ph h ≤ y
c≥0
h ≥ 0,
where y is equal to exogenously determined income. The price of the composite good is nor-
malized to one.
The first order conditions are as follows:
x : u01 (x) − λ = 0 (4)
c : γc + γch h + γcc c − λ pc + ζc = 0
h : γh + γch c + γhh h − λ ph + ζh = 0,
where λ , ζc and ζh are the Lagrange multipliers corresponding to the constraints x + pc c +
ph h ≤ y, c ≥ 0, and h ≥ 0 respectively. Complementary slackness adds the following two condi-
tions:
ζc c = 0 and (5)
ζh h = 0.
Under these conditions, the individual falls into one of four outcomes defined by her decision
to consume c and/or h in Equation 5: consume both products, consume cigarettes only, consume
HTPs only, or abstinence.
6More specifically, the participation decisions can be written as follows:
Ic = 1 ⇔ c∗ − Ih (γch /γhh )h∗ > 0 (6)
Ih = 1 ⇔ h∗ − Ic (γch /γcc )c∗ > 0, (7)
where Ic and Ih represent binary indicators for a positive consumption of cigarettes and HTPs,
respectively. The latent variables, c∗ ≡ γc − λc pc and h∗ ≡ γh − λh ph , represent the differences
between the marginal utilities at zero and the prices (in utility terms). Equations (6) and (7) make
it clear that the decision to consume HTPs depends on whether or not the individual is consuming
cigarettes and vice versa. The participation constraints simplify in the special case where cigarettes
and HTPs are neither complements nor substitutes (γch = 0), that is, the decision to consume one
good is separable from the consumption of the good. An individual who derives higher marginal
utility than the price of one dollar worth of HTPs in utility terms (i.e., h∗ > 0), will choose to
consume HTPs, and, similarly, an individual who derives higher marginal utility than the price of
one dollar worth of cigarettes in utility terms (i.e., c∗ > 0), will choose to consume cigarettes.5
Assume, momentarily, that the price of cigarettes (HTPs) has no effect on the latent variable
for consuming HTPs (cigarettes). Any effect of the price of cigarettes (HTPs) on the consumption
of HTPs (cigarettes) must therefore arise indirectly from changes in the consumption of cigarettes
(HTPs), that is, through the Ih (γch /γhh )c∗ parameter. Thus, a decrease in price of cigarettes (HTPs)
negatively affects the probability of HTP (cigarette) consumption if the two goods are substitutes
and positively affects the probability of HTP (cigarette) consumption if the two goods are com-
plements. However, conditional on consuming only HTPs (cigarettes)– or, for that matter, neither
good–changes in the price of cigarettes (HTPs) should have no effect. A contribution of this paper
is that, in addition to the substitution effect, the structural model allows for the price of cigarettes
(HTPs) to affect HTP (cigarette) consumption more directly through the latent variable for HTP
5 In particular, h∗ > 0 ⇔ γh − λh ph = −γhh h > 0 and analogously for consumption of HTPs.
7(cigarette) consumption, h∗ . Allowing for the price of cigarettes (HTPs) to affect the latent variable
for HTP (cigarette) consumption allows a change in the price of cigarettes (HTPs) to affect even
those households that consume only HTPs (cigarettes) or neither good. The structural model de-
veloped above allows for separately identifying both the substitution and other effects of the price
of cigarettes (HTP) on HTP (cigarette) consumption. That is, the price of cigarettes can directly
affect h∗ either via γh or via λ ph (or both). Similarly, the price of HTPs can directly affect c∗ either
via γc or via λ pc (or both).6
3 Cigarettes and HTPs: Stochastic Specification
Assuming that γc and γh are stochastically distributed across people, and considering that the frac-
tion of households in the four outcomes corresponds to the fraction of γc and γh ’s drawn in each of
the four outcomes, it is then possible to analyze the impact of the price of cigarettes donations on
the total proportion of households that fall into each of the four outcomes.
An estimable model is obtained by specifying the latent variables as functions of observable
covariates and stochastic components. An individual’s marginal utilities at c = h = 0 are defined
as:
γh = Xβh + εh (8)
γc = Xβc + εc , (9)
where X is a vector of individual characteristics and εc and εh are random variables with zero mean
and assumed to follow a joint normal distribution with correlation coefficient ρ.
Because the marginal utility of income, λ , is assumed to be a function of only income and not
prices, we use the first order approximation:7
6 DiNardoand Lemieux (1992, 2001) allow the “price” of alcohol (where laws increasing the drinking age to 21
proxy for price) to affect the propensity to consume marijuana through the indirect substitution effect but also more
directly via the latent variable for marijuana. They argue that this latter effect arises primarily because an increased
drinking age creates a climate of “societal disapproval” for all drug use, not just alcohol.
7 The implicit assumption used for the approximation that the marginal utility of income depends only on income.
8λh ph ≈ α0h + αyv y + αhh ph (10)
λc pc ≈ α0c + αyc y + αcc pc . (11)
Substituting expressions (8) - (11) into the equations for the latent variables yields the following
linear functions for the thresholds:
h∗ ≡ Zηh + εh (12)
c∗ ≡ Zηc + εc , (13)
where the vector Z consists of individual characteristics, income, and prices.
TBU
4 Data
A series of reduced-form analyses are performed using country-year level data to inform the struc-
ture of tobacco use behaviors and choices between HTPs and cigarettes. Annual market values
of cigarette (2014-2018) and HTP sales (2016-2018) are obtained from the Euromonitor (EM)
database in local currency units. For HTPs, data are obtained separately for the devices and the
tobacco units. These values are converted into US dollars using period-averages exchange rates
from the International Monetary Fund.8 The EM database also provides the market volumes of
cigarettes, HTP devices, and HTP HEETS (HTP sticks sold by PMI), respectively, measured in
thousand units/sticks. The market values and volumes of cigarette and HTP sales are used as the
primary outcomes in the reduced-form empirical models to analyze the relationship between taxes,
This assumption is reasonable when consumption of cigarettes and HTPs represent a small share of total “consumption
expenditures.”
8 Heated tobacco devices generally represent a small proportion of total HTP sales values
9prices, and demand for HTPs and cigarettes.
The explanatory variables in the reduced-form analyses are the prices of a pack of 20 cigarettes
or HTP sticks and excise taxes imposed on them. No country imposes excise taxation on HTP
devices. The price data come primarily from the EM database, supplemented with price infor-
mation from the Philip Morris International (PMI) price books. Taxation information is obtained
from country-specific tax codes or amendments thereof. Among countries that allow HTP sales by
2018, many had amended their tax code to impose excise taxes on HTPs during the study period
(2016-2018), while in others HTPs have been taxed by default using an existing category, often
on a case-by-case basis, as “other smoking products”, “smokeless products”, or “pipe tobacco”,
implying that HTPs have been generally taxed at the lowest tax rate tiers for combustible tobacco–
much lower than cigarettes–and often using weight (kilograms) tax bases instead of the number of
sticks for cigarettes.
Table 1 summarizes countries where the HTP and cigarette sales data are simultaneously avail-
able in at least one year over the period and for which we have sales, price and tax information.
The second line lists 5 additional countries used in the cigarette sample, where PMI also reports
sales of HTPs in its financial reports to investors, but for which HTPs sales are not provided by
EM. As of December 2018, 29 countries had with usable HTP sales and price information. The an-
alytic samples can be described as panel data that consists of country-year cells of these sales, tax,
and price measures. We supplement the data with other country-year macro-economic measures
that likely affect the demand for tobacco products, including non-tax regulations such as whether
e-cigarettes are allowed for sales.
Figure 1 displays the average excise tax burden gap, as of the end of 2018, between PMI’s
HTP HEET sticks and Marlboro in all countries for which we obtain tax and price data. Clearly,
the average excise tax burden is much smaller for HTPs than for cigarettes. In addition, the gap
between HTPs and cigarettes tax burdens tends to be larger for lower income countries than for
high income countries.
10Table 1. Countries with cigarette or HTP sales & price data
Country
With both HTPs and Bulgaria, Canada, Colombia, Croatia, Cyprus,
cigarettes sales, Czech Republic, Denmark, Estonia, France, Germany, Greece
simultaneously1 Hungary, Israel, Italy, Japan, Kazakhstan, Latvia, Lithuania
(n=29) Malaysia, Netherlands, Poland, Portugal, Romania, Russia, Serbia
Slovakia, Slovenia, South Korea, Spain, Switzerland, Ukraine, UK
Added countries Austria, Belgium
for cigarettes 2 Cyprus, Estonia,
(n=5) Hungary
1 EM data provides HTP sales information for up to 36 countries in 2018. These countries are
excluded either because price data are not obtained, or because these countries do not have a
market for HTPs (e.g., in Indonesia, Vietnam sales are online only or duty-free).
2 Countries for which PMI reports HTP sales in its annual reports, and therefore with a known
market for HTPs, but EM does not provide sales information.
4.1 Summary Statistics
Table 2 presents summary statistics of the samples analyzed during the period. The sample size for
HTPs is 63, whereas the sample size for cigarettes is 166. There are fewer observations for HTPs
than cigarettes because fewer countries have sizable market for HTPs between 2014 and 2016. On
average per country and year, the annual market value of HTPs is $0.277 billion, consisting of
$0.254 billion for HTP units and $0.228 million for HTP devices. In comparison, the country-
year average market value of cigarettes is $7,035 billion–24 times larger than that of HTPs. With
regards to the average market volume per country per year, the HTP sales consist of 1,231 million
HTP sticks and 355 thousand HTP devices. One this account, the market volume of cigarette sales
is also considerably greater-34,552 million cigarette sicks are sold per country per year. This said,
in contrast with cigarettes sales which are relatively stable over time–though on a slowly declining
decreasing trend–there is a large variation in HTP sales over years and countries. The majority of
the world’s sales of HTPs has taken place in Eastern Asia–with Japan and South Korea capturing
60% and 11% of the market by 2018, respectively. Japan, once the largest market (88% or the
world’s market for HTPs in 2016) lost market shares to other countries, especially North Korea
11Figure 1. Average Excise Tax Burden of HTP and Cigarettes, 2018 by HTP Tax Burden Level
NOTE. Tax burden is defined as High = 40% or more; Medium = 20% to 40%; Low = 10% to 20%; Very low = Less
than 10%.
Tax burden is the amount of excise tax in the retail sales price (it does not include general sales tax or VAT). Local
prices are converted to US$ using end-of-year current exchange rates (IFS, International Monetary Fund). Price data
are obtained from PMI reports to investors (when available) and Euromonitor International for IQOS HEETS and
co-branded Marlboro cigarettes. Regional figures excludes regions with regions for which we have data for only one
country: North America (Canada,) Latin America (Colombia,) and Middle East & Africa (Israel). Kazakhstan is
classified as Eastern Europe. Asia Pacific includes only Japan and Korea.
(from less than 1% of the world’s market in 2016) and to several European countries.
All countries impose excise taxes on cigarettes. In our data, the average tax amount for a pack
of 20 cigarettes is $2.98. Given that the average prices during the same period are $5.28, the excise
tax burden on cigarettes is 56% of the retail price. In countries where HTPs are sold, the average
price of 20 HTP sticks is $5.21, which includes $0.95 in excise taxes. Therefore, the average
excise tax burden on HTP sticks is merely 18% of the retail price, as previously revealed in figure
1, confirming that while the price per unit is about the same for both products, the tax burden
imposed on HTPs has been consistently much lower than that on cigarettes over the years covered
12Table 2. Summary statistics
Variable N Mean SD
HTP market value (’000 $) 63 276,775 1,116,256
HTP HEET sticks market value (’000 $) 63 253,988 1,052,994
HTP device market value (’000 $) 63 22,787 69,064
HTP HEET sticks market volume (’000 sticks) 63 1,231,404 5,041,000
HTP device market volume (’000 units) 63 355 1,321
HTP pack(20s) tax ($) 63 0.95 0.87
HTP pack(20s) price ($) 61 5.21 2.34
Cigarette market value (’000 $) 166 7,034,519 8,506,313
Cigarette market volume(’000,000 sticks) 166 34,552 54,375
Cigarette pack(20s) tax ($) 166 2.98 1.61
Cigarette pack(20s) price ($) 162 5.28 2.65
NOTE. Summary statistics are show at the country-year levels.
in our study.
4.2 Reduced-form models
A series of reduced-form regressions are performed to inform on the structure of tobacco use
behaviors and consumer choices between HTPs and cigarettes. First, we assume that the demand
for cigarettes and the demand for HTPs are independent from each other, and thereby can be
estimated using separate equations:
Consumptionhit = Taxhit βh + εhit (14)
Consumptioncit = Taxcit βc + εcit , (15)
where Consumptionhit is HTP sales measures (market value or volume) in country i and year t;
Taxhit are HTP taxes; and Consumptioncit and Taxcit are corresponding measures for cigarettes.
In the literature, if the log transformation forms of consumption and taxes are entered into the
equations, β estimates the tax elasticity of demand. However, some countries with HTP sales (e.g.,
Kazakhstan and Poland in 2018) have not implemented excise taxes on HTPs, for whom the tax rate
is 0. To avoid performing log transformation on 0s, we run equations (14) and (15) in a semi-log
13form where the log transformation of the dependent variables is regressed on tax rates, controlling
for country and year fixed effects. We includes country fixed effects to control for other aspects
of county-specific consumption and production features that affect both prices and HTP demand
and do not vary (or vary slowly) over years, such as income and age distribution or smoking
prevalence. We also include year fixed effects, and a linear year trend to control for aspects of
market environments such as new products innovation or improvements by tobacco companies.
Clustered standard errors are estimated to account for inter-temporal correlation within country
over time. As described in the model presented in section 2, we also estimate these equations
jointly using seeming unrelated regressions (SURs) to allow for a demand of HTP and cigarette to
be correlated.
Next, we examine the price elasticities of HTP demand and of cigarette demand, respectively,
by modifying the equations above as
Consumptionhit = Pricehit βh + εhit (16)
Consumptioncit = Pricecit βc + εcit , (17)
where Pricehit is the price of a packs of 20 HTP HEET sticks and Pricecit is the price of s pack
of cigarettes in country i and year t. Given that prices are always greater than 0, we use the log-
linear versions of regressions (16) and (17) to directly estimate price elasticity of demand.That is,
to regress the log transformed sales measures on the log transformed price measures.
We note that prices might be influenced by both supply- and demand- side factors that are not
captured with country and year fixed effects. This is partly suggested by the fact that companies
appear to sell HTP sticks and cigarettes at very similar prices, even if there is a large variation
across countries and periods in tax gaps between cigarettes and HTPs. For example in Japan when
HTPs were first launched in 2014, PMI sold them at the same prices as cigarettes even if the
effective tax burden of HTPs was much smaller that that of cigarettes, also suggesting large profit
margins for PMI. This was due to aggressive marketing promotion strategies by PMI that made
14HTPs highly popular, triggered especially by a popular TV show Ame Talk (Caputi et al., 2017).
Yet although prices of HTPs and cigarettes were similar, HTPs have gained market share at the
expense of cigarettes and there is evidence that that at least part of the drop in cigarette sales was
due to the launch of IQOS (Stoklosa, Cahn, Liber, Nargis and Drope, 2019). Facing the rapid
increase in HTP sales and concerned with the potential health and use impacts, Japan significantly
increased the tax rate on HTPs, effective in October 2018, and made the tax base similar to that of
cigarette, hence almost closing the tax gap between HTPs and cigarettes.9 Japan also implemented
regulations to limit the promotion of HTPs. Yet although HTP sales have dropped, price differences
between HTPs and cigarettes have not changed as much as the large increases in HTP taxes would
have suggested.10
To obtain unbiased estimates of the direct and cross-price elasticity of demands, we use taxes
per packs of each products as instruments for their respective prices to estimate equations (16) and
(17) as two-stage-least-square regressions. We test the validity of taxes as instruments for prices,
we examine the first stage by regressing prices on taxes for HTPs and cigarettes, respectively.
These regressions also examine the extent of the tax pass-through rates to prices.
5 Empirical Evidence
Table 3 shows the estimated impact of excise taxes on the market values of tobacco products. HTP
excise taxes are inversely related to the market values of HTPs. Specifically, a one-dollar increase
in HTP excise taxes reduces the total market value of HTPs by 54-61%, the HTP HEET units
(HTUs)market value by 61-70%, and the HTP device market value by 26-34%. In regressions
excluding year fixed effects, cigarette excise taxes are positively associated with the market value
9 The excise tax burden of HEETS was 16.34% in 2015 in Japan, while that on equivalent Marlboro brands was
53%, even though a pack of HEETs and a mack of Marlboro were both sold at JPY 460. In 2018, Japan reformed HTP
taxation to define HTP products as tobacco products taxed based on the number of sticks, and increasing their excise tax
rates. We compute that as of the end of 2018, the tax burden of HTPs was similar to that of cigarettes at 53% of the retail
price. For more information, see https://www.nta.go.jp/information/other/data/h29/tabacco/03.htm
10 See “New rules in Japan take aim at heated tobacco: Measures are part of efforts aimed at reducing dangers of
passive smoking,” Nikkei Asian Review, Business Trends, Sotaro Yumae, Feb 5, 2018 at https://asia.nikkei.
com/Business/Business-trends/New-rules-in-Japan-take-aim-at-heated-tobacco
15of cigarettes, suggesting a possible reverse causality of tax policy. However, this impact becomes
non-significant once year fixed effects are adjusted instead of a linear year trend, which suggests
that the market value of cigarette consumption is relatively inelastic to policy measures that affect
prices.
Table 3. The impact of excise taxes on market values
HTP HTP HTU HTU Device Device Cig Cig
HTU tax -0.61** -0.54** -0.7** -0.61* -0.34** -0.26** - -
(0.23) (0.25) (0.29) (0.31) (0.13) (0.13) - -
Cig tax - - - - - - 0.2*** 0.07
- - - - - - (0.03) (0.08)
Year Trend Y N Y N Y N Y N
Year FE N Y N Y N Y N Y
N 63 63 63 63 63 63 166 166
Note:∗ ∗ ∗p < 0.01, ∗ ∗ p < 0.5, ∗p < 0.1. HTP combines HTP HEET sticks (units, or HTUs) and
devices. Standard errors are clustered at the country-year levels.
To evaluate the possibility that HTPs and cigarettes are substitutes, and in countries with both
HTP and cigarette markets (n=63), we conduct seemingly unrelated regressions where cigarettes
and HTPs demands depend on either products’ tax measures (Table 4). A one-dollar increase in
HTPs excise taxes decreases both HTP and cigarette market values, by 46% and 5%, respectively.
Furthermore, a one-dollar increase in cigarette excise taxes decreases the value of HTP demand by
60%. Again, cigarette taxes do not significantly affect the market value of cigarettes, suggesting
that HTPs are more likely to be responsive to tax measures than cigarettes. The Breusch-Pagan
test of independence cannot reject the null hypothesis that the error variances are correlated. This
suggests that the classic linear regression models may be appropriate in explaining the impact if
taxes on the demand for HTPs and and the demand for cigarettes in countries and years where
both products are legally sold. To simplify the models to a two-products choice scenario, the table
shows specifications where the market values of HTP HEETS and devices are combined. We also
conduct SURs using three equations by separating the HTP market values into respective measures
for HTP HEET sticks and devices. These additional regressions further show that the cross-effects
16of cigarette taxes on HTP market values occur primarily through influencing the market value of
HEETS, rather than that of devices.
Table 4. The impact of excise taxes on market values, SUR n=63
HTP Cig HTP Cig
HTU tax -0.53*** -0.05** -0.46*** -0.05**
(0.17) (0.02) (0.18) (0.02)
Cig tax -0.61*** 0.01 -0.6** 0.005
(0.3) (0.04) -(0.3) (0.04)
Year Trend Y Y N N
Year FE N N Y Y
Note:∗ ∗ ∗p < 0.01, ∗ ∗ p < 0.5, ∗p < 0.1. HTP combines HTP HEET sticks (HTU or units) and
devices. Standard errors are clustered at the country-year levels.
Table 5 directly estimates the impact of respective excise taxes on the quantity of demand
for HTPs and for cigarettes. A one-dollar increase in HTP taxes decreases the market volume of
HTP HEETS sales by 60-69%. Higher HTP taxes are not significantly associated with the market
volume of HTP devices. Additionally, a one-dollar increase in cigarette taxes reduces cigarette
sales volume by 6-9%.
Table 5. The impact of excise taxes on market volumes
HTU HTU Device Device Cig Cig
HTU tax -0.69** -0.6* -0.3 -0.22 - -
(0.28) (0.3) (0.87) (0.23) - -
Cig tax - - - - -0.06*** -0.09**
- - - - (0.02) (0.03)
Year Trend Y N Y N Y N
Year FE N Y N Y N Y
N 63 63 63 63 166 166
Note:∗ ∗ ∗p < 0.01, ∗ ∗ p < 0.5, ∗p < 0.1. HTU stands for HTP HEET sticks (units). Standard
errors are clustered at the country-year levels.
In table 6 we use a SUR analyses to allow for HTP and cigarette to be substitutes in demand, in
countries where both products are sold. Because HTP devices are fixed costs to consumers, as they
can be used several times (Liber, 2018) and continuing innovations by the industry tend to increase
17their usable lives over a year, while HEET sticks constitute variable costs comparable to cigarette
sticks for consumers, and to simplify the exposition of the results, we focus on the market volume
of HTP sticks and cigarettes and how respective taxes jointly impacts their market volumes. The
results show that a one-dollar increase in cigarette taxes reduces the sales volume of HTP HEETS
by about 81%, but does not influence cigarette sales volume. A one-dollar increase in HTP taxes
reduces HTP HEETS sales volume by 50-58%, and does not significantly influence the sales vol-
ume of cigarettes. The Breusch-Pagan test of independence rejects the null hypothesis that errors
are independent, suggesting that the equations for tobacco volumes need to be estimated jointly.
Neither HTP or cigarette taxes appear to significantly influence the sales volumes of HTP devices
when separated equations for HTP HEETS, HTP devices, and cigarettes are jointly estimated.
Table 6. The impact of excise taxes on market volumes, SUR n=63
HTU Cig HTU Cig
HTU tax -0.49** 0.02 -0.58*** -0.02
(0.19) (0.02) (0.19) (0.02)
Cig tax -0.81** -0.04 -0.82** -0.04
-(0.3) (0.03) (0.34) (0.03)
Year Trend Y Y N N
Year FE N N Y Y
Note:∗ ∗ ∗p < 0.01, ∗ ∗ p < 0.5, ∗p < 0.1. HTU stands for HTP HEETS sticks (or units).
Before investigating the impact of prices on demand volumes, we test the whether taxes are a
strong instrument for prices, as well as the pass-through effect of taxes on HTPs and cigarettes. Ta-
ble 7 reports the effects of taxes on log-transformed prices, for HTP HEETS and cigarettes, respec-
tively. The results show that higher cigarette taxes significantly increase the prices of cigarettes.
In addition, higher HTP taxes likely increase HTP HEETS prices. Though the impact of HTP
taxes on prices is only significant in the specification with a linear year trend instead of year fixed
effects, they may still function as valid instruments considering the limited waves of HTP data that
are available. The regressions also suggest that the pass-through of taxes to prices are smaller for
HTPs than for cigarettes. This confirms the fact previously described that in spite of large excise
18tax gaps between cigarettes and HTPs, companies tend to market the two products at the very
similar prices, suggesting large profit margins for companies. This also confirms that aggressive
promotion strategies by the industry–featuring the possible health benefits of these products over
cigarettes –have influencing consumers perceptions of risk, as described by our theoretical model
in section 2.
Table 8 estimates the price elasticities of cigarettes, HTP HEETS, and HTP devices using 2SLS,
using the respective taxes of each products as instruments for prices. [For this version of the paper]
We did not have price data for HTP devices. However as the only reason for consumers to buy
HTP devices is to use them simultaneously with HEET sticks, we directly HTP HEETS prices to
the sales volume of HTP devices. Results show that a 10% increase in cigarette prices leads to a
2-6% decrease in the sales volumes of cigarettes. Interestingly the price elasticity of HTP demand
appears to be considerably greater than that of cigarette demand. A 10% increase in HTP HEETS
prices reduces the demand for HTP sticks by 83-132%, and the demand for devices by 36%.
Table 7. The impact of taxes on prices (log-transformed)
HTU Price HTU price Cig price Cig price
HTU tax 0.09* 0.05 - -
(0.04) (0.04) - -
Cig tax - - 0.28*** 0.15***
- - (0.04) (0.04)
Year Trend Y N Y N
Year FE N Y N Y
N 61 61 162 162
Note:∗ ∗ ∗p < 0.01, ∗ ∗ p < 0.5, ∗p < 0.1. HTU stands for HTP HEETS sticks (or units).
6 Discussion
Heated tobacco products (HTPs) are a new type of tobacco products that has the potential to be
a substitute for traditional cigarettes, with the main difference that the raw tobacco contained in
sticks or pods is heated with battery-powered heating systems. HTPs emit aerosols containing
19Table 8. The impact of prices on market volumes, 2SLS price elasticity estimates
HTU HTU Device Device Cig Cig
HTU price elasticity -8.31*** -13.18** -3.64* -4.97 - -
(1.81) (5.86) (2.02) (3.76) - -
Cig price elasticity - - - - -0.21*** -0.61**
- - - - (0.06) (0.26)
Year Trend Y N Y N Y N
Year FE N Y N Y N Y
N 61 61 61 61 162 162
Note:∗ ∗ ∗p < 0.01, ∗ ∗ p < 0.5, ∗p < 0.1. HTU stands for HTP HEETS sticks (or units).
tobacco flavor, nicotine and other chemicals also contained inc conventional cigarettes. Although
the lack of evidence on the relative harms of HTPs compared to combusted tobacco, especially
cigarettes, preliminary evidence suggests that HTPs are unlikely to lead to significant harm reduc-
tion. Nonetheless, HTPs have been highly promoted as reduced-risks by the tobacco industry and
have experience a significant and rapid successes since thy were launched in Japan 2014, and Italy
in 2015. Aggressive promotion in Japan has confirmed their success and that consumers evidently
perceive them as both trendy and less harmful than cigarettes. HTPS are currently legally available
for sale in almost 50 countries, especially in Europe and Asia.
Most HTPs are sold in packs of 20 sticks and their prices are very close to cigarette prices.
Consumers must initially buy a heating device as a fixed cost, while packs of tobacco units (sticks
or pods) are variable costs similar to traditional cigarette packs. Contrary to e-cigarettes, HTPs
contain tobacco and are sold by a small number of large tobacco multinationals that also sell
cigarettes. The leading HTP brand, ”IQOS” devices used with HEET sticks, is manufactured and
distributed by PMI, and captures the bulk of market shares in countries that sell HTPs. As of
December 2018, 22 countries with HTP sales had explicitly amended tax codes to include HTPs
as a separate category in their tax codes, while others tax them by default as an existing category,
especially pipe tobacco or smokeless tobacco. Nevertheless in almost all countries were HTPs
are sold, the effective excise tax burden of HTPs is several times smaller than that of cigarettes,
mostly due to much lower excise tax rates, but also because most other tobacco products–contrary
20to conventional cigarettes–are taxed using a volume based tax burden (in weight) rather than a
system based on the number of units (or sticks). This implicitly results in subsidization of HTPs
by governments over cigarettes (through lower excise taxes), even though most countries agree
that cigarette taxes should be high to reduce the harms of tobacco use.
To date, although there is no evidence so far that evaluates on how the prices of HTPs may
affect its demand and how users may choose between cigarettes and HTPs in response to costs and
potentially difference in harms between the two products, and wether they are substitutable, the
industry promotes them-and consumers perceive them–as a reduced-risk means to quit traditional
cigarette smoking. We construct a model that describes the demands for two harmful tobacco prod-
ucts, HTPs and cigarettes. Consumers perceive one product as healthier, or reduced-risk (HTPs),
and therefore derive an additional marginal utility from them compared to cigarettes. Assuming
similar costs of tobacco sticks production, consumers’ reservation price for HTPs is smaller than
that of cigarettes. Therefore when HTPs first enter the market, and if companies collude to sell
the two products at similar prices in spite of much lower taxes for HTPs–or in the presence of
a monopoly (like PMI when HTPs were first launched)–their demand grows at the expense of
cigarettes demand until a new equilibrium is reached.
Capitalizing on detailed information collected for taxes, prices, sales volumes and market val-
ues for HTPs and cigarettes, obtained from various sources, we construct a unique quasi-panel
dataset for HTPs from 2016-2018 and for cigarettes from 2014-2018. We evaluate the model using
reduced-form regressions that allow consumers to chose simultaneously between cigarettes and
HTPs in response to taxes and prices.
Preliminary findings suggest that the price elasticity of demand for HTPs is elastic (i.e., > 1)
and much greater than that for cigarettes, which is almost inelastic. Evidence from the litera-
ture that a significant proportion of HTP users are also cigarette smokers suggests that users are
sensitive to increases in HTP prices and taxes and are likely to substitute them for cigarettes if
HTP prices increase, or to completely reduce tobacco use is the prices of both products increase
simultaneously.
21A close examination of the relationship between taxes and prices shows that HTP excise taxes
are partly passed to prices. Nonetheless, the pass-through of taxes to prices may be lower for
HTPs than for cigarettes, confirming that tobacco companies’ aggressive marketing strategies have
highly influenced consumers perceptions of the reduced-risk potential of HTPs, enabling tobacco
companies to derive higher profit margins with higher prices compared to tax. In contrast, the
existing literature has documented that cigarette companies tend to also over-shift cigarette taxes
to prices, in order to recoup the lost profits due to reduced cigarette consumption.
HTP taxes show a large direct impact on HTP sales volumes, consistent with the finding that the
demand for HTPs is elastic. We also find that higher HTP taxes reduce the market value for HTPs.
This is not surprising given that the market value reflect both consumption and prices and that HTP
prices are as high as cigarettes prices. The impact of taxes on market value would decreases if an
elastic demand function was compounded with HTP prices that reflect their lower tax shares. In
contrast, cigarette market value may increase as cigarette tax increases, which corroborates with
the existing literature that the demand for cigarettes is inelastic and that manufacturers tend to
over-shift cigarette taxes to prices.
In models that allow the two products to be substitutable, in countries where both cigarettes
and HTPs are simultaneously available, we find that cigarette market volume is not influenced
by either HTP or cigarette taxes, while the market volume of HTP units decreases when the tax
on either products increases, suggesting that for HTP consumers perceive HTPs and cigarettes as
complements, and that increases in both HTPs and cigarettes taxes would reduce HTP demand.
The lack of a significant effect of higher cigarette or HTP taxes on cigarettes volume may be due
to insufficient variation as the number of countries and years is reduced for cigarettes (compared
to independent cigarettes regressions). Alternatively, if HTPs and cigarettes are complements, the
continuous growth and availability of HTPs may reduce the price sensitivity of smokers’ demands.
With regards to the market values of tobacco products in countries where HTPs and cigarettes
are simultaneously available, higher HTP taxes reduce the market values of both HTPs and cigarettes,
whereas higher cigarette taxes only reduce HTP market values, suggesting again that HTPs and
22cigarettes might be complements, hence that an increase in consumption of one product may lead
to an increase in the consumption of the other product.
We also examine HTP demand separately for HTP HEET sticks (units) and HTP devices, and
find that the effects of taxes and prices mostly influence HTP units, not devices, This is not sur-
prising given that devices are reusable and constitute a fixed cost to consumers (or at least a cost
amortizable over several months), and given that in all countries only HTP units are subject to
excise taxes, not HTP devices. Nonetheless, we find that higher HTP units prices may reduce the
demand for HTP devices, which is also not surprising given that the only purpose of purchasing a
device is to smoke tobacco sticks.
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