2. The illicit trade argument

25 Jun 2013

Even more common than the “golden goose” argument is this variant: Any significant tobacco tax increase will lead to runaway illicit trade in tobacco products, leading not only to a decline in government revenue, but also defeating the goal of reducing tobacco use by causing cheaper, illegal products to flood the market.

Typically, industry lobbyists will claim that a large tax increase in some foreign country led to a big spike in smuggling, with dire consequences in terms of law and order. Canada and Mexico are frequently abused examples in this regard.

Responses:

The brief response to the illicit trade argument is:

  • Many countries rely on industry figures to estimate the size of the illicit trade market, and the industry typically inflates these figures. The industry has a vested interest in exaggerating the size of the market because it increases pressure to lower taxes.
  • Smuggling can be, and has been, adequately controlled, even with large tax differentials, such that both revenue and health goals are met.
  • High taxes, and high tax differentials between countries, are not the only or even the major factor behind tobacco smuggling. Other factors that successfully predict tobacco smuggling are the pre-existence of successful smuggling routes and networks, the level of corruption in a country, level of penalties for smuggling, and level and type of enforcement efforts.17
  • The tobacco industry itself has been implicated in smuggling efforts, and it is well-documented that smuggled products are seen as part of industry strategies to break into new markets.

The industry is currently using Hong Kong as an example of out of control smuggling. ASH New Zealand has produced a useful document discussing the Hong Kong situation (among other countries), offering other estimates of the problem, and more nuanced interpretations of the reasons for the problem.18

Tax revenue: Tobacco tax increases almost invariably lead to increases in tax revenue, even if some smuggling occurs. (The main exceptions involve very small tax increases, or countries with tax structures that allow smokers to switch to cheaper products taxed at lower rates.) On the other hand, tobacco tax decreases, even when they are followed by a drop in illicit trade, invariably cause a decrease in tax revenue. For example, when Canada slashed its taxes in 1994, in part because of industry-backed campaigns claiming competition from smuggling was putting retailers out of business, revenues dropped by at least 25 percent, for a five-year revenue loss of CD$4.8 billion (see “Figure 20. Canada: Decreased tax revenue and increased industry profits following the 1994 tobacco tax cuts.” ).19

Consumption: Tobacco tax increases also result in declines in consumption, even when smuggling is taken into account. (Figures 17 & 18)

 

When taxes go up, consumption goes down – even if there’s some increase in smuggling:

Figure 17. The black line shows per capita tobacco consumption in France, including cross border purchases (contraband estimate). Even taking illegal consumption into account, consumption dropped as prices increased (red line).20
 

Tobacco industry attack on taxation: A Mexican version

Mexico increased its tobacco tax by 7 pesos (approximately US$0.60) per pack in 2010. In the lead-up to the decision, the industry predictably made an all-out effort to link higher taxes to smuggling, using Canada as an example. The articles below appeared on the same day in two major papers, clearly not a coincidence.
The headlines reflect typical industry arguments and mistruths designed to grab the emotions of parents, enforcement and revenue authorities, and fearful citizens alike:
“ [TAX] RAISES ON CIGARETTES WILL FURTHER DETONATE UNDERWORLD [TRADE]¨:

  • Organized crime holds 33 percent of the market in Canada
  • In Mexico, adolescents are the main target
  • Money generated is sometimes used to fund terrorist activities
  • Black market in tobacco worth 16,250 million Mexican pesos
  • And, in “La Reforma”: Pirate tobacco gains ground.

Above: El Sol de México, 13 September 2010. Below: La Reforma, 13 September 2010.

 

When taxes go down, smoking goes back up:

Figure 18. Canada. Smoking prevalence among youth continued to drop through 1993, despite a tobacco industry estimate that at least one-third of all tobacco consumed was smuggled.

 

 

Jurisdictions that resist tax rollbacks have better health outcomes:

Figure 19. Canada: The provinces that maintained high provincial tobacco taxes in the face of a dramatic federal tax cut in 1994 saw much lower per capita consumption in 1998 than the provinces that cut their taxes.

Figure 20. Canada: Decreased tax revenue and increased industry profits following the 1994 tobacco tax cuts.

Figures 19 to 20 show the results of a tragic natural experiment conducted in Canada. In 1994, taxes were cut in half in most provinces of Canada as a response to successful lobbying by tobacco companies, fuelled by smuggling arguments. These figures show that a decades-long decline in tobacco use among adults and youth was reversed, that per capita consumption was much higher in provinces that reduced taxes, and that governments lost C$5 billion in tax revenue while tobacco industry profits increased by C$1.3 billion.21

Successful anti-smuggling strategies: A number of countries have implemented comprehensive anti-smuggling strategies that have reduced smuggling levels while continuing to increase their tobacco tax levels. The three best-documented cases of this are the United Kingdom,22 Spain23 and Italy24. Graphs showing prices and taxes rising in the UK and Spain while contraband is falling can be found in Appendix 1.

Successful anti-smuggling strategies typically look for the most effective ways to increase costs, reduce profits and increase risks for major participants in the illegal tobacco market. This can include:

  • Increased penalties for large-scale smuggling;
  • Investment in enforcement, particularly at borders and in ports;
  • Licensing and more secure tax stamps or fiscal markings;
  • Legal action against manufacturers that continue to supply the black market, for example by exporting large quantities to countries where there is no legitimate market for their brands; and
  • Implementing full-scale tracking-and-tracing systems, to make it easier to detect the point at which shipments of tobacco products are diverted into the illegal market.

All of these measures have costs, but they can be more than paid for by recovery of tobacco tax revenue and by further increases in tobacco taxes. Also, particularly in the case of tracking-and-tracing systems, costs can be recouped from the industry via licensing fees or other mechanisms.

Of course, the Protocol to Eliminate Illicit Trade in Tobacco Products (commonly known as ITP, for Illicit Trade Protocol), which was adopted by the WHO FCTC Conference of the Parties in November 2012, includes a wide range of measures that countries can take if they are worried about illicit trade.

Tobacco industry role in tobacco smuggling. There are numerous sources documenting involvement of the tobacco industry in smuggling. A good starting point is the Center for Public Integrity. Industry documents obtained through litigation show that in the 1980s and 1990s, the major multinationals used smuggling as a tool to break into closed markets, to force down taxes, and to grab market share.

In Canada, which saw a large surge of smuggling in the early 1990s, police investigations and civil litigation eventually led to guilty pleas by all major Canadian manufacturers (the subsidiaries of British American Tobacco, Philip Morris and Japan Tobacco, respectively) as well as civil settlements, reached in 2008-2010.25 The European Union also investigated the involvement of tobacco industry multinationals in the 1990s and early 2000s, and settled lawsuits against several companies out of court.26

Back to the “golden goose argument”

Proceed to the employment argument

 17 Merriman D. Understand, measure, and combat tobacco smuggling. Tool 7, Smuggling, in World Bank Economics of Tobacco Toolkit, Yurekli A. & de Beyer J, Eds. World Bank: Washington, DC, 2000. Available on-line.

18 Paynter J, U E, Joossens L. Illicit tobacco trade: monitoring and mitigating risk in New Zealand. Auckland: Action on Smoking and Health New Zealand, June 2010. Available on-line.

19 Canadian Cancer Society, Non-Smokers’ Rights Association and Physicians for a Smoke-Free Canada. Surveying the Damage. 1999.

20 Hill, C. Prix du tabac en France et conséquences sur les ventes et sur la consommation. [Tobacco price in France and impact on sales and consumption.] Bulletin épidémiologique hebdomedaire. 25 mai 2010, no. 19/20:222-224.

21 Canadian Cancer Society et al, op. cit.

22 HM Revenue & Customs. Tackling Tobacco Smuggling – building on our success. April 2011. Available on-line.

23 Joossens L. Report on smuggling control in Spain. Tobacco Free Initiative Success Stories series. World Health Organization. No date. Available on-line.

24 Joossens L, Raw M. Progress in combating cigarette smuggling: controlling the supply chain. Tob Control 2008;17:399-404. Available on-line.

25 Canada’s settlements are available on-line.

26 For example, see EU agreement with Philip Morris from 2004, available on-line.

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