1. General excise environment and trends, affordability and excise linkage with illicit trade
Mirela Enasel
Manager Corporate Affairs CIS+ Region
Japan Tobacco International
ASE Bucharest, May 2013
Opinions presented are based on international experts views, researches and JTI international experience

2. Worldwide Spread of Excise Tax Structures
Of the 120 markets in the Tobacco Documentation Centre:
47 Purely Specific Excise Tax
20 Purely Ad Valorem Excise Tax (decline from 35 in 2007)
53 Mixed Excise Tax
The differences in tax base and structures means that there is an infinite possibility of excise structures
European Union allows only mixed excise tax structure

3. Excise Structure Design
2/23/2019
Excise Structure Design
Excise tax
Local Currency/’000
Minimum Excise Tax
Euro/000
Specific Euro/000
Ad valorem
% of RSP
Low Price
Mid Price
Premium
Retail price
Local Currency/’000

4. Effect of Different Excise Structures
Specific Excise
Ad-valorem Excise
Lower administration cost as only the volume of the products has to be known
Requires strong tax administration with technical capacity - i.e. higher administration cost
Tends to reduce price gaps between price segments
Wider price gaps between price segments
Better addresses health objectives
Encourages “trading down” to lower priced tobacco products due to large price differentials
Tax rates need to be regularly adjusted by inflation to maintain revenues in real terms
Manufacturer price increases raise state revenues without increasing tax rates. However, government suffers revenue loss in case of price decrease and consumer down trading to lower priced tobacco products
In fact always mixed structure due to VAT

5. Cigarette Affordability

6. What is Affordability and What does it tell us?
Consumer affordability is the measurement of a person’s capacity to buy a product
It will change with every variation in the price of a product and/or the consumer’s disposable income
Our preferred measure for cigarettes is:
the percentage of average per capita disposable income required to purchase one pack of cigarettes at market weighted average prices
Research shows that the level of consumer affordability is a key element to predict the probability that illicit trade will emerge in a country

7. There is a strong correlation between Cigarette Affordability and Illicit Trade
Source: Economist Intelligence Unit, KPMG Project Star report (2012), Industry Data

8. Economic drivers of Illicit Trade in tobacco
Consumer desire to save money usually caused by a sharp decline in cigarette affordability
Effects of economic crisis – lower incomes, increased unemployment etc. make consumers more price sensitive which leads them to seek cost saving opportunities
Easy access/availability of illicit products: a decline in consumer transportation costs and increased mobility across borders
Demand
Supply
Criminals desire to make money by tax avoidance driven by absolute amount of tax which gives incentives for smuggling
Weak enforcement, ineffective border control and comparatively less severe penalties
Easy access/availability of illicit products: a decline in transportation costs and low cost of production, shipment of illicit tobacco products

9. Particularity of poorer population segments
Evidence from academic literature suggests that smokers from low income groups are:
more responsive to changes in the price of cigarettes than those from other income groups
often less likely to quit smoking when faced by increased prices, choosing instead to switch to illicit product
Therefore it is interesting to examine the affordability for the poorest in society in addition to the average affordability

10. Cigarette Affordability for lowest-income consumers
Oxfords Economics defines cigarette affordability for lowest-income consumers as
the percentage of per capita poverty-risk disposable income required to purchase one pack of Value cigarettes
the Eurostat definition of the poverty-risk disposable income is “a person is at risk of poverty if their disposable income lies below 60% of the national median income”*
Oxford Economics applied this methodology in the analysis of tobacco taxation and affordability for Ukraine and Russia studies
2011 Cigarette affordability in Russia and Ukraine
*European Commission (2009) Portfolio Of Indicators For The Monitoring Of The European Strategy For Social Protection And Social Inclusion – 2009 Update.
Eurostat is EU’s statistical agency

11. Effect of excessive taxation on lower income groups
Tobacco taxes are highly regressive for the low income consumers who must spend a greater proportion of their income on tobacco
Excessive tax increase resulted in significant decline of mid-price and economy segments whilst premium segment remains resilient
Bulgarian cigarette market
Malaysian cigarette market
The new Member States’ experience shows that Research commissioned by ASH found that one in four of the poorest smokers buys smuggled tobacco compared to one in eight of the most affluent (source: ASH Fact Sheets, April 2011)
In Bulgaria, duty-paid market reduced by 48% and the value segment virtually disappeared into illicit, while Premium segment proved to be more resilient
In Malaysia illicit grew from 14% of consumption to 36% in 2010, mainly driven by low income smokers

12. EU Excise Tax harmonization: Large price and tax gaps
Weighted average prices of a cigarette pack in EU, January 2012
Cigarette excise gaps between the EU Member States
2012
Ireland
Latvia
Latvia
Source: European Commission
Regional Tax Harmonisation • Economic and sovereignty interests surrounding tobacco taxation 10

13. EU Cigarette Affordability and Illicit Trade
2011 non-domestic duty paid cigarette consumption in the EU reached 88.5 billion or 14.1% of total consumption resulting in over €10 billion in excise revenue lost (source: KPMG Star Report)
The major drivers are excessive excise yields driving lower affordability and large excise gaps
For the New MS’s €64 minimum required excise was too high and Old MS’s reached excessive tax levels relative to incomes IE
Non-Domestic Duty Paid DE FR BG AT FI NL EE BE PL UK RO GR SE ES DK IT CZ HU PT SK
% of daily PDI per capita
Source: EU Tables, Economist Intelligence Unit, KPMG Project Star report 2011 (2012)

14. G7 Cigarette Affordability and Illicit Trade
G7 countries experienced either stable tobacco excise development or sharp excise shocks, with clear differences in the consequences:
Tax shocks: UK, Canada, Germany, France - rapid excise and price increases resulted in affordability deterioration and illicit trade explosion
US, Japan and Italy - excise policy provided gradual affordability decline resulting in gradual, low (or negligible) level of illicit trade (Japan illicit consumption is negligible)
Evolution of cigarette affordability in selected
G7 countries,
Development of non-duty-paid market in
selected G7 countries,

15. Findings
Increasing excise levels without regard for consumers’ purchasing power
is detrimental to the tobacco market
undermines the sustainability of government revenues
results in the development of large, unregulated illicit markets
If cigarette affordability is taken into account, excise levels and revenues can be increased while consumption is reduced and the illicit trade is kept in check
The affordability of cigarettes for those on the lowest incomes must be closely monitored, as any negative changes in affordability will result in low-income consumers turning to the illicit market

16. EU Tobacco Tax System 16

17. EU Tobacco Tax Structure
Cigarettes
Tobacco tax must consist of excise tax and VAT
EU does not allow earmarked tobacco tax
Tax
% of Retail Sales Price
Minimum Excise Tax
fixed amount per 000’s
applied to all cigarettes
fixed amount per 000’s
Price
Price point above which mixed excise tax structure applied

18. EU Excise Tax Structure and Rates requirements
Cigarettes
Excise tax on cigarettes must consist of SPECIFIC and AD-VALOREM elements
SPECIFIC:
a fixed amount per 1000 cigarettes
between 5% and 76.5% of total tax (excise + VAT) on weighted average price (WAP*) until 1/1/2014
between 7.5% and 76.5% of total tax (excise + VAT) on WAP from 1/1/2014
AD-VALOREM:
a percentage of retail selling price (RSP)
25 Member States apply optional Minimum Excise Tax (MET)
*WAP is determined by the 1st March based on volumes and RSPs of the previous year calculated as = ∑(volume x price category)/∑volume

19. EU Minimum Excise Tax requirements
Cigarettes
Each country has to apply an overall minimum excise duty not less than:
€64 per 1,000 on all cigarettes (to be raised to €90 by 1/1/2014)
57% of the WAP (to be raised to 60% by 1/1/2014)
Member States with minimum excise duty of at least €101 per 1000 cigarettes on the basis of WAP do not need to comply with the 57% requirement (to be raised to €115 and 60% by 1/1/2014)
Transition period for Bulgaria, Estonia, Greece, Latvia, Lithuania, Hungary, Poland and Romania to reach the minimum requirements by 1/1/2018

20. EU Excise Tax Structure and Rates requirements
Fine-Cut Tobacco
EU Council Directive 2011/64: “It is necessary to bring the minimum levels for fine-cut tobacco intended for the rolling of cigarettes closer to the minimum levels applicable to cigarettes...”
The Directive sets the minimum incidence for fine-cut to 50% (2020) and for the minimum burden to be 60 €/kg (2018) - i.e. the chosen taxation relationship between fine-cut tobacco and cigarettes is 2/3
The obligation is to fulfill only one of the two requirements – minimum incidence OR minimum excise burden to be in line with the Directive. In addition Member States are free to choose if they want to apply a purely ad valorem taxation, purely specific taxation or a mixed structure

21. Latest trends in EU Structure changes
Cigarettes
Member States have the flexibility to set own tax structure
Acknowledging the benefits, Member States used the opportunity to increase specific excise
Gradual excise increase to reach € 90 by 2014 (MET)
Importance of affordability in determining the appropriate level of taxation is critical for the stability of tobacco markets and government tax revenues
To prevent an increase of ad valorem tax element with VAT increase, some EU countries automatically decrease ad valorem excise rate
EU illicit trade remains a significant problem reaching 10.4% of consumption in 2011 and resulting in revenue losses of over €11 billion a year (KPMG, Project Star 2012)

22. EU regulations allows freedom of tax structures
Cigarettes
EU mixed excise system allows for de facto specific or de facto ad valorem taxation as the specific component as share of the total tax can range from 7.5% to 76.5%
Ad valorem excise rate ranges from 1% (Sweden and Denmark) to 54% (Italy) – i.e. significant structural flexibility
Ad Valorem Rate
Specific as share of total tax (Excise + VAT)
76%
54%
74%
53%
72%
52%
50%
67%
63%
55%
52%
51%
52%
33%
31%
31%
41%
41%
42%
28%
38%
23%
22%
20%
20%
17%
16% 9%
12%
12% 3% 5% 1% 1% IT ES FR BE EE PL HU CZ BG DE GR RO UK IE NL DK SE IT ES FR BE EE PL HU CZ BG DE GR RO UK IE NL DK SE
Source: European Commission excise duty tables – July 2012c

23. Greater reliance on specific excise taxation
Cigarettes
With the implementation of the new Directive since January 2011, 19 countries have reduced their ad-valorem excise rates
Five northern EU countries have reduced ad valorem excise rate significantly
Denmark and Sweden have only 1% ad valorem excise – i.e. high reliance on specific excise tax
Netherland decreased ad valorem excise further compensating with specific tax increase to reach 76,5% of total tax (the maximum EU allowed) as of January 1, 2013
Country
Ad Valorem Excise Rate
January 2013
January 2010
Change in p.p. SE
1.00%
39.20%
(38.20) DK
20.80%
(19.80) NL
3.13%
20.52%
(17.39) IE
8.83%
18.25%
(9.42) UK
16.50%
24.00%
(7.50) GR
20.00%
58.43%
(38.43) PT
23.00%
(3.00) RO
22.00%
(2.00) DE
21.80%
24.66%
(2.86) SK
(1.00) SI
24.55%
44.03%
(19.48) MT
25.00%
50.00%
(25.00) CY
34.00%
44.50%
(10.50) LV
34.50%
(0.50) AT
42.00%
43.00% BE
50.31%
52.41%
(2.10) FR
51.75%
57.97%
(6.22) ES
53.10%
57.00%
(3.90) IT
54.35%
54.74%
(0.39)
Source: European Commission excise duty tables

24. Ad Valorem excise decrease to compensate specific increase
Examples of new EU Member States
Romania:
Government excise plan provides gradual increase over to reach EU minimum requirement of € 90 by 2018
Ad valorem excise decrease (from 22% in Jan 2011 to 14% in Jan 2018) compensated by specific excise tax increase
Bulgaria:
Ad Valorem decreased from 48% in 2006 to 23% in 2012
Specific excise as share of total tax increased from 16% to 54.2%

25. Thank you