FactCheck: does Labor have a $19.5b black hole in its funding plan?

But Shorten is short by $19.5 billion. Shorten’s black hole just got bigger. – Advertisement authorised by the Liberal Party of Australia.

Both the Coalition and the ALP have committed to raising tobacco excise by 12.5% a year for four years, starting on September 1, 2017. However, both sides have produced vastly different estimates of the revenue gain over the next decade.

Ads authorised by the Liberal Party claim that the ALP faces a $19.5 billion “black hole” arising from the differences in the costings between the two parties.

Is that assertion correct?

What are the major parties proposing for tobacco tax?

The federal government imposes a tobacco excise on locally produced and imported tobacco products, raising an estimated $10.2 billion in 2016-17.

The ALP’s tobacco policy, released in November 2015, outlines a plan to increase the tobacco excise by 12.5% a year, each year, from September 2017 until September 2020. The ALP says that

The policy has been independently costed by the Parliamentary Budget Office to raise $3.8 billion over the current forward estimate period and $47.7 billion over the medium term.

In his 2016-17 budget speech on May 3, federal Treasurer Scott Morrison announced that the Coalition would also

implement a further four annual 12.5% increases in tobacco excise, with the first increase to take effect on 1 September 2017.

In the 2016-17 Budget Paper 2, on page 16, the Coalition government states that the increases in tobacco excise would raise $4.7 billion over the four years of the forward estimates – from 2016-17 to 2019-20.

However, we have no published figure in the budget papers for the government’s 10-year costing of the tobacco excise hike. Instead, news reports quoting the Treasury’s 10-year costings refer to a separate leaked Treasury document, circulated prior to the release of the budget, that reported its forecasts for the government.

Under both Coalition and ALP policy, the tobacco excise rate is expected to rise from around $0.54 per cigarette this year to about $1.10 per cigarette in 2020, as shown in the chart below. This includes continued indexation of the tobacco excise rate to wages.

Why are there two different revenue estimates for the same policy? The government and opposition parties use different public institutions to estimate the fiscal impact of their policies. The government’s tobacco excise policy was costed by Treasury, and the revenue estimates published in the 2016-17 Budget. Treasury estimates the policy will raise $28.2 billion over ten years. The ALP’s revenue estimate was prepared by the Parliamentary Budget Office (PBO), which costs policies submitted to it by parliamentarians. The PBO estimated the same policy will raise $47.7 billion over the same period. The ALP have not publicly released the full PBO response. However, a PBO response to what appears to be a very similar policy request by Liberal Democratic Party Senator David Leyonhjelm reveals estimates in line with those cited by the ALP. The difference between the PBO’s $47.7 billion estimate and Treasury’s $28.2 billion estimate is $19.5 billion. How can the revenue estimates be so different? Over very long time periods, small differences in assumptions can compound to large differences in revenue estimates over a decade. But even over the four years to 2019-20 – a relatively short period of time – there is a 25% difference between Treasury’s estimate in the Budget papers ($4.7 billion) and the PBO estimate published by Senator Leyonhjelm ($6.3 billion). The chart below shows tobacco excise revenue forecasts for the last two budgets are similar, after subtracting the impact of the new increase to the excise rate from the 2016-17 forecast. So use of different underlying forecasts, absent any policy change, doesn’t seem to be the most likely explanation for the $19.5 billion discrepancy between the PBO’s estimate and Treasury’s estimate. Grattan Institute The most likely source of difference between the revenue estimates is differing assumptions about how increases in tobacco excise will reduce demand for cigarettes. Past increases in tobacco excise rate have clearly reduced tobacco consumption. Grattan Institute As Treasury has noted before, estimating how people will respond to changes in taxes is notoriously difficult, especially in the long term. It’s hard to isolate the impact of tobacco excise on the level of smoking. For example, changes to policy – plain packaging reforms or the many expansions of smoking bans – and to social norms have occurred at the same time as excise increases. Comparing the estimates To see whether differences exist between the behavioural assumptions in the Treasury and PBO costings, we compared the forecast increase in revenue to the planned increase in the excise rate. If there were no change in behaviour, every 10% increase in the excise rate would lead to a 10% increase in revenue. But if people are assumed to smoke less or quit as a result of the increase, a 10% rise in the excise rate will generate a smaller increase in revenue. In the third year after the tobacco excise hikes begin (2019-20), the PBO costing expects each 10% rise in the excise rate to increase excise revenue by 7.8%. By comparison, Treasury expects excise revenue to rise by just 5.6% in that year. So the Treasury estimates clearly assume that the tobacco excise hike will have a larger impact on consumption than has been assumed by the PBO. Shadow Finance Minister Tony Burke told the ABC that: We used the long-held Treasury assumptions that had previously been used. Those were the assumptions determined by the Parliamentary Budget Office and they go through to previous assumptions used by Treasury. However, a similar increase in tobacco excise was costed by Treasury for the former ALP government and published in the previous government’s 2013 Economic Statement. In the third year after the 2013 tobacco excise hikes began, the Treasury expected each 10% rise in the tobacco excise rate to lead to a 5.4% increase in revenue. This suggests the Treasury is using a very similar behaviour change assumption in 2013 to the one it used when costing this year’s budget. Grattan Institute Treasury confirmed at Senate Estimates last Friday that the behavioural assumption used in the 2016-17 Budget costing was a “minor variation” from the 2013 estimate. Treasury’s assumption is based on the range of estimates published by the World Health Organization. Treasury has the final say Treasury is responsible for estimating the budgetary impact of revenue policy changes according to the Charter of Budget Honesty. If elected, an ALP government would have to rely on Treasury’s estimate of the revenue gain from its tobacco excise policy when preparing the budget. Shadow Treasurer Chris Bowen has already pledged to accept the Treasury estimates over those produced by the PBO. Labor has played down the impact the discrepancy will have on their spending plans. Asked about the revised figure of $28.2 billion in tobacco tax revenue produced by Treasury modelling, Burke told the ABC that: … if you go through the commitments Labor has so far announced, we were already well south of even that revised figure. We have already more than the improvements to the budget bottom line to pay for everything we have put forward. Verdict It is true that there’s a $19.5 billion discrepancy between Labor and Treasury’s revenue estimates. The Parliamentary Budget Office, which costed Labor’s plan, said the tobacco tax hike would rake in $47.7 billion. Treasury estimated the tobacco excise increase would bring in just $28.2 billion. $47.7 billion - $28.2 billion = $19.5 billion. Treasury estimates clearly assume that the tobacco excise hike will have a larger impact on cigarette consumption than has been assumed by the PBO modelling. Even though it has relied on independent costings from the PBO, the ALP now has to accept its tobacco excise policy is predicted to raise nearly $20 billion less revenue over ten years than it had expected. However, Labor has said that it can comfortably budget for the lower Treasury forecasts. – Brendan Coates Review This FactCheck provides a sound overview of tobacco taxation in Australia. It correctly identifies that the likely main difference between the Federal Treasury estimate and the Parliamentary Budget Office estimate of tobacco revenue relates to the assumption made around behavioural change resulting from the increased tobacco excise rates - what economists call the “demand elasticity”. The author makes a fair judgement that the difference between the two costings is likely to mean that Labor will have $20 billion less revenue over the next ten years. – Ben Phillips. Have you ever seen a “fact” worth checking? The Conversation’s FactCheck asks academic experts to test claims and see how true they are. We then ask a second academic to review an anonymous copy of the article. You can request a check at checkit@theconversation.edu.au. Please include the statement you would like us to check, the date it was made, and a link if possible.