§ Mr. Marlowasked the Chancellor of the Exchequer why it is that raising an additional revenue of £500 million by three different means, by taxes on beer, cigarettes and derv, leads to three significantly different levels of increase in the cost of living under conditions where all things are equal and tax increases are passed intact to the consumer, given that the same amount in total is being consumed and the same amount in total is being raised.
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§ Mr. Peter ReesIncreases in prices reduce consumption. The effects of duty increase on consumption of the dutiable goods depend on two factors (a) the relative importance of the duty as an element in the price and (b) the price elasticity for those goods. The duty on cigarettes represents an appreciably higher proportion of the typical retail price of cigarettes than is the case for beer; also price elasticity is higher for cigarettes than for beer. Thus an increase in the duty on cigarettes would reduce consumption by more than a corresponding increase in the duty on beer.
The additional revenue from a duty increase is not pro rata to the relative change in the duty and the total yield of the duty. In practice, the additional revenue is the difference between (a) the yield of the higher rate of duty on the—lower—post-increase consumption and (b) the yield of the original rate of duty on the original consumption—ignoring second-order effects on other taxed goods and services. The greater the reduction in consumption resulting from the duty change, the less the additional revenue reflects pro rata the increase in the rate of duty.
On the other hand, price increases reflect pro rata an increase in a rate of duty; and the impact effect on the retail price index—RPI—of course follows price changes. Hence duty increases which affect consumption of the dutiable product by relatively large amounts—eg cigarettes—normally result in larger increases in the RPI for a given amount of extra revenue than those which affect consumption less—eg beer.
The RPI is a measure of the prices of goods and services bought by households. Increases in the price of derv bought by businesses have no direct impact on the RPI.