Ad Valorem Tax versus Specific Excise Tax: Tobacco Price Variability in Indonesia

The challenge of controlling cigarette consumption remains significant, leading governments worldwide to implement excise taxes on tobacco products through ad valorem or specific systems. This study examines the relationship between various excise tax systems and price variability in Indonesia. Using transactional excise data from 2005 to 2017 obtained from the Directorate General of Customs and Excise (DJBC), the research employs the Pooled Least Square (OLS) method for analysis. The sample includes Machine-made Kretek Cigarettes (SKM), Machine-made White Cigarettes (SPM), and Hand-rolled Kretek Cigarettes (SKT). Price variability is measured using the Interquartile Range to median ratio. The findings reveal that Indonesia’s multitier specific excise tax system behaves similarly to an ad valorem tax. More complex tax structures lead to greater price variability, undermining the effectiveness of the specific system in controlling cigarette consumption. Higher excise rates correlate with increased price variation across production categories, and market concentration significantly influences price variability, with a more competitive market resulting in greater fluctuations. To control cigarette consumption effectively, reducing price variation is crucial. Despite Indonesia’s transition from an ad valorem to a specific excise system, neither effectively reduces price variability due to the complexity of the multitier structure. Simplifying the excise framework and reducing the number of tiers could decrease price variation and consumption. These findings align with economic theory and suggest that further refinement of Indonesia’s excise policy is needed for better control over cigarette consumption.