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

 2007 Johns Hopkins Bloomberg School of Public Health 2 Outline Financial incentives and the role of excise taxes Government responses to smuggling Other important factors that contribute to smuggling

 2007 Johns Hopkins Bloomberg School of Public Health 3 Source: adapted by CTLT from U.S. Department of Agriculture. (1999). Incentive for Illicit Trade: Price Difference Price difference/pack between U.S. export price and: High-income countries U.S. export price/pack USD, 1999 Average retail price for local brands USD, 1999 Average retail price for imported brands USD, 1999 Germany Cyprus Finland Spain Austria UK Price Differences: High-Income Countries

 2007 Johns Hopkins Bloomberg School of Public Health 4 Incentive for Illicit Trade: Price Difference Source: adapted by CTLT from U.S. Department of Agriculture. (1999). Price difference/pack between U.S. export price and: Low-income countries U.S. export price/pack USD, 1999 Average retail price for local brands USD, 1999 Average retail price for imported brands USD, 1999 Georgia Nicaragua Uzbekistan Ethiopia Cameroon India Bangladesh Price Differences: Low-Income Countries

 2007 Johns Hopkins Bloomberg School of Public Health 5 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?

 2007 Johns Hopkins Bloomberg School of Public Health 6 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

 2007 Johns Hopkins Bloomberg School of Public Health 7 * 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‡

 2007 Johns Hopkins Bloomberg School of Public Health 8 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

 2007 Johns Hopkins Bloomberg School of Public Health 9 Reducing Excise Taxes: Not a Solution Canadian government reduced tobacco tax rates dramatically in February, 1993

 2007 Johns Hopkins Bloomberg School of Public Health 10 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

 2007 Johns Hopkins Bloomberg School of Public Health 11 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

 2007 Johns Hopkins Bloomberg School of Public Health 12 Other Causes of Illicit Trade 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.

 2007 Johns Hopkins Bloomberg School of Public Health 13 Source: adapted by CTLT from Yurekli and Sayginsoy. (2006). Illicit Cigarette Trade Increases with Corruption!

 2007 Johns Hopkins Bloomberg School of Public Health 14 Source: adapted by CTLT from World Customs Organizations Report. (2004) Inability of Customs or Increasing Illicit Activities?

 2007 Johns Hopkins Bloomberg School of Public Health 15 Other Causes of Illicit Trade 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)

 2007 Johns Hopkins Bloomberg School of Public Health 16 Other Causes of Illicit Trade 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

 2007 Johns Hopkins Bloomberg School of Public Health 17 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

 2007 Johns Hopkins Bloomberg School of Public Health 18 Source: adapted by CTLT from Joossens and Raw. (2000). Smuggled Cigarette Market Share % 19995% 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%

 2007 Johns Hopkins Bloomberg School of Public Health 19 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

 2007 Johns Hopkins Bloomberg School of Public Health 20 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

 2007 Johns Hopkins Bloomberg School of Public Health 21 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)

 2007 Johns Hopkins Bloomberg School of Public Health 22 Source: adapted by CTLT from WCO database. (2004). More Counterfeits Are Seized Compared to Originals

 2007 Johns Hopkins Bloomberg School of Public Health 23 Source: adapted by CTLT from WCO Customs and Tobacco Report. (2004). Increasing Number of Seized Counterfeits

 2007 Johns Hopkins Bloomberg School of Public Health 24 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).

 2007 Johns Hopkins Bloomberg School of Public Health 25 *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

 2007 Johns Hopkins Bloomberg School of Public Health 26 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

 2007 Johns Hopkins Bloomberg School of Public Health 27 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