2007 Johns Hopkins Bloomberg School of Public Health Section B Causes of Illicit Trade.

2007 Johns Hopkins Bloomberg School of Public Health

Section BSection B

Causes of Illicit Trade

2 2007 Johns Hopkins Bloomberg School of Public Health

Outline

Financial incentives and the role of excise taxes

Government responses to smuggling

Other important factors that contribute to smuggling


Source: adapted by CTLT from U.S. Department of Agriculture. (1999).

Incentive for Illicit Trade: Price Difference

Price difference/pack betweenU.S. export price and:

High-incomecountries

U.S. export price/packUSD, 1999

Average retail price for local brands USD,

1999

Average retail price for

imported brands USD, 1999

Germany 0.21 2.67 2.69

Cyprus 0.21 1.17 1.92

Finland 0.22 3.55 3.84

Spain 0.32 1.12 2.18

Austria 0.32 3.29 3.87

UK 0.33 5.92 5.92

Price Differences: High-Income Countries


Incentive for Illicit Trade: Price Difference

Source: adapted by CTLT from U.S. Department of Agriculture. (1999).

Price difference/pack betweenU.S. export price and:

Low-incomecountries

U.S. export price/packUSD, 1999

Average retail price for local brands USD,

1999

Average retail price for

imported brands USD, 1999

Georgia 0.16 0.04 0.76

Nicaragua 0.21 0.77 1.09

Uzbekistan 0.24 0.65 2.56

Ethiopia 0.24 1.72 1.72

Cameroon 0.35 0.06 1.25

India 0.35 0.67 1.13

Bangladesh 0.38 0.47 1.26

Price Differences: Low-Income Countries


Illicit Trade and Tax Policy

Price difference Most widely used argument against policy on excise tax

increase by governments and industry

Is tax difference responsible for the price difference among countries?


Source: Alexander Wiedow. (September, 2006). Hungary Tax Seminar.

Pre- and Post-Tax Price Level

Pre- and post-tax price level in EU financial incentive already exists under pre-tax price Average pre-tax

price among EU member countries in 2004 in EUR/1000


* Source: IMF Country Report; †Source: Personal communications with the Ministry of Finance of the

Kyrgyz Republic, ‡Source: Personal communication with the Ministry of Finance of Uzbekistan.

Governments’ Response to Illicit Trade

Governments often think reducing excise taxes will halt smuggling activities

Reducing excise taxes (evidence from developing countries) Georgia: excise taxes reduced by half in 2002* Kyrgyz parliament discussed reducing excise taxes

during budget discussions in 2004† Uzbekistan: excise rates were changed from ad valorem

to specific and the rates were reduced‡


Source: Nordisk Tobaksstatistik. (1970–2002); author’s calculation.

Tax Decrease in Sweden

Seventeen percent reduction due to fear of smuggling in 1998 Between 1997 (pre-tax reduction) and 1999 (pro-tax

reduction) period: Public health lost since consumption increased by 18% Government lost since revenue did not reach 1997

level! By 2000 consumption increased more than 20%

(revenue reached 1997 level) Outcome: public health and government lost due to lower

excise taxes

The government ignored the long-term cost of increased consumption by concentrating only on short-term revenue gains


Reducing Excise Taxes: Not a Solution

Canadian government reduced tobacco tax rates dramatically in February, 1993


Reducing Excise Taxes: Not a Solution

After the tax reduction Countries still face smuggling Cigarettes become affordable and consumption

increases Revenues are not necessarily increased as much as

expected Long-term costs have been ignored for short-term gains


Other Causes of Illicit Trade

Level of risks associated with smuggling and the corruption level in the country

Inability of customs to detect and halt smuggled goods due to lack of: Up-to-date technology at customs and communication

between customs Collaboration with the World Customs Organization Judicial and legal systems supporting customs’ activities

In many countries, customs and tax administrations are aware of smuggling, but they have no technical capacity, manpower, and strong laws to support their action

Moldova Turkey Some Latin American countries



Irresponsible exporting and accountability of the industry and exporters Industry’s involvement to illicit trade in the U.S. and the

EU: Court cases against industry in many countries

Brazilian cigarettes re-exported illegally back to country—irresponsive exporters

Lack of political commitment by the government Lack of implementation and enforcement of controlling

illicit trade Many factories established near the Brazilian

border in Paraguay are the main sources of smuggled cigarettes to Brazil*

*Source: Roberto Iglesias. (2005). Mercosur study from Brazil.


Source: adapted by CTLT from Yurekli and Sayginsoy. (2006).

Illicit Cigarette Trade Increases with Corruption!


Source: adapted by CTLT from World Customs Organizations Report. (2004)

Inability of Customs or Increasing Illicit Activities?



Trade restrictions Smokers’ positive perception of foreign brands

Partly because of the lack of variety and appealing domestic brands (under the state or private monopoly)

Low household income and high prevalence among poor population Evidence shows that cheap cigarettes are smuggled

more into countries with high poor-smoker populations (e.g., Ukraine, Uzbekistan)



High percentage of youth population Future smokers-to-be:

Take risks in terms of tobacco-associated diseases and deaths

Are a price-sensitive but brand-cautious population

Increasing the purchasing power of population and female employment Economic independence and sophisticated appearance


Source: Unofficial U.S. Department of Agriculture data in attaché reports. (2003).

Government’s Commitment: China

In 2002, State Tobacco Monopoly Agency (STMA) and the Ministry of Public Security jointly launched several major crackdowns on illegal cigarette activities Hired 24,000 people to investigate counterfeit

production in the country Inspected 320,000 cases of suspected illegal cigarettes Confiscated 4.97 billion counterfeit cigarettes Closed down 2,476 illegal manufacturing operations Seized 1,375 pieces of equipment used in these illegal

operations Arrested 4,075 people


Source: adapted by CTLT from Joossens and Raw. (2000).

Smuggled Cigarette Market Share

1995 15%

1999 5%

Government’s Commitment: Spain

How? Choked off container supply, by intelligence activity and

cooperation, technology, anti-smuggling legislation, close cooperation among five countries plus the European Anti-Fraud Office (OLAF)

Not by reducing taxes, arresting street sellers

1997: sales of legal cigarettes rose 78 billion and tax revenues increased 25%


Agreement between EU and Philip Morris

2004: European Commission and Philip Morris International signed a twelve-year agreement to combat contraband and counterfeit cigarettes

The EU agreement requires Philip Morris to implement several measures to combat cigarette smuggling; these include: Improved tracking, tracing, labeling, and record-keeping

requirements to help law enforcement determine the source and track the path of contraband cigarettes

Better monitoring of its sales and distribution practices and vendors to ensure they are in compliance with legal requirements

Establishment of additional monetary penalties Philip Morris must pay if its cigarettes continue to be smuggled in large quantities


Agreement between EU and Philip Morris

Payments under the agreement The agreement also includes an initiative whereby PMI

has agreed to make payments in the event of future seizures in the European Community of its genuine products above defined quantities

These payments will be made without regard to fault or wrongdoing by Philip Morris International

If other member states sign the agreement, including the new member states, they will also be entitled to receive these payments

The European Community and 10 member states will receive substantial payments over a number of years

The amount of Philip Morris International’s payments under the agreement will vary based on a number of factors and could total approximately $1.25 billion


Counterfeit Production and Trade

Is this an emerging new threat or newly recognized threat?

Counterfeit cigarette factories were destroyed in Poland, Germany, Russia, and Dubai In Russia

2005: six million counterfeit cigarettes were destroyed 2004: 40 million counterfeit cigarettes were destroyed

In Dubai In 2003: 3.8 million counterfeit cigarettes were seized

Counterfeit cigarettes reached Canada through trade: 2003: seized 43,000 cartons of counterfeit cigarettes (worth

$2.6 million)


Source: adapted by CTLT from WCO database. (2004).

More Counterfeits Are Seized Compared to Originals


Source: adapted by CTLT from WCO Customs and Tobacco Report. (2004).

Increasing Number of Seized Counterfeits


Evidence from Economic Studies

An increase in tax and enforcement level would fit both governments’ and public health advocates’ objectives for: Reducing smuggling activities Reducing global cigarette consumption Increasing government tax revenues

The enforcement level plays a significant role in controlling the worldwide smuggling activities and also reduces global consumption

Source: Yurekli and Sayginsoy. (2006); Merriman, et al. (2000).


*Source: Yurekli and Sayginsoy. (2006).

Evidence from Economic Studies

A 10% increase in average retail and import prices and 10% increase in law enforcement (lower corruption), assuming no change in income, will: Decrease smuggling activities by 5.4% Reduce global consumption by 2.3% Increase governments’ tax revenues by 7.8% despite

4% total tax revenue lost due to smuggling


Summary

What can be done about illicit cigarette trade? Existing evidence suggests that government commitment is

the key for success

What can governments do? Require manufacturers to put tax-paid markings/stamps on

packages End duty-free sales, including cigarettes produced in duty-

free zones Require license and detailed records for all cigarette

exporters, manufacturers, and distributors; require a unique identifying code on all cigarette packs and a chain of custody information so that smuggled cigarettes can be traced

Require export-bonds from exporters until the cigarettes reach their final legal destination


Summary

Enhancing customs officials Technical, financial, legal capacity as well as human

resources for detecting and prosecuting Ensure official communication and collaboration with

other customs and the WCO

Prosecute and impose high penalties for those-actual-players who are responsible for smuggling Not targeting to street sellers only

2007 Johns Hopkins Bloomberg School of Public Health Section B Causes of Illicit Trade.

Documents

price difference source

price differences

average retail price

tax policy price difference

posttax price level

excise tax increase

excise taxes evidence

lower excise taxes