1. ECONOMICS OF TOBACCO CONFERENCE SCHOOL OF ECONOMICS, UCT 16-18 JULY 2014 Illicit trade in South Africa: Can we trust the industry rhetoric? Corné van Walbeek and Lerato Shai School of Economics, University of Cape Town

2. Some background information This study was made possible by funding from the Bill & Melinda Gates Foundation It was recently published in Tobacco Control This presentation was prepared for a workshop on illicit trade, hosted by the Deputy Minister of International Relations, but (as it turns out subsequently) funded by the tobacco industry  The presentation was excluded from the programme at the last minute

3. Illicit trade in South Africa and the region Is illicit trade bad for government revenues and public health? YES Should the government take illicit trade seriously? YES Is the problem as bad as the tobacco industry makes it out to be? Let’s look at the evidence from a number of angles

4. Cigarette consumption Total cigarette consumption has two components:  Legal consumption  Illicit consumption Legal consumption can be tracked quite easily through the National Treasury’s records Illicit consumption has to be estimated The crucial question:  Do the tobacco industry’s estimates of the illicit market make intuitive and logical sense?

5. Legal consumption Financial year Total revenue (R million) (nominal) Excise tax per pack (nominal) Legal consumption (million packs) Percentage change 20066 784R5.561 2202.2 20077 665R6.161 2452.0 20088 659R6.821 2702.0 20099 188R7.701 193-6.0 20109 368R8.941 048-12.2 201110 172R9.741 044-0.3 201210 978R10.321 0641.9 201311 461R10.921 050-1.3

6. The situation in 2009 and 2010 20092010 Percentage change in legal consumption-6.0%-12.2% GDP growth-1.5%+3.1% Percentage change in the nominal price of the most popular brand of cigarettes 16.1% (from R19.17 to R22.26) 11.5% (from R22.26 to R24.83) Inflation rate7.1%4.3% Approximate percentage change in the real price 9.0%7.2% Can the decrease in legal cigarette consumption be explained by “economic fundamentals”? YesNo Percentage change in excise tax12.9% (from R6.82 to R7.70) 16.1% (from R7.70 to R8.94)

7. Illicit consumption YearPercentage 2008 8% 2009 10% 2010 21% 2011 26% 2012 30% 2013 Relative share of the illicit market, based on data provided by TISA Source: Presentation to National Treasury, September 2013

8. Total cigarette consumption YearPercentage change in legal consumption Percentage change in illicit consumption Approximate percentage change in total consumption 2008 2.0% 2009 -6.0% 2%-4.0% 2010 -12.2% 11%-1.2% 2011 -0.3% 5%+4.7% 2012 1.9% 4%+5.9% 2013 -1.3% If the tobacco industry’s estimates are correct, we have the following situation (approximately):

9. Can this alleged increase in total cigarette consumption be explained? An increase in smoking prevalence?  No, adult smoking prevalence in 2012 was between 20% and 21%, according to three independent surveys (AMPS, NIDS and South African National Health and Nutrition Examination Survey), down from 24% in 2003 (AMPS) Strong economic growth?  No, GDP growth in 2011-2013 averaged only 2.7%

10. The tobacco industry’s estimates of the illicit market Year TISA numbers quoted in numerous articles at the time December 2010 article in Business Report (BATSA) June 2012 presentation to National Treasury (BATSA) May 2013 presentation to authors (TISA) 200620%--21% 200720%--11% 200820%11.0%7.9%8% 200920%16.6%10.4%10% 201020%23.1%21.0%21% 201125%-26.0%26% 201230%-27.8% (30%)30%

11. What can we conclude? The spike in the illicit market in 2010 is real The alleged large increases in illicit trade in 2011 and 2012 are not supported by other data The tobacco industry has a record of rewriting history in order to create the impression that the problem is particularly pressing right now If previous estimates were incorrect, are the current estimates credible?

12. ADDITIONAL SLIDES

13. The industry’s role in determining the value of the excise tax How the excise tax is set in South Africa:  Total tax (excise tax plus VAT) should be 52% of the recommended retail price of the most popular price category of cigarettes  National Treasury passively responds to the pricing strategy of the dominant player in the tobacco industry  This policy has been in place since 1994 (with an increase in the target tax burden from 50% to 52% in 2004) Bottom line: The industry sets the quantum of the excise tax

14. Example: How this works in practice In February 2009 the RRP of Peter Stuyvesant was R19.40, consisting of the following components:  VAT (14%, but 12.3% of VAT-inclusive price): R2.38  Excise tax: R6.82  Net-of-tax price: R10.20 National Treasury wants a total tax burden of 52% = R10.08 (R2.38 VAT and R7.70 excise)  Increases excise tax from R6.82 to R7.70 (12.9%) If there is 100% pass-through of the tax, the retail price increases by R0.88 + 14% VAT = R1.00 But the tobacco industry increases the RRP from R19.40 to R22.50 (i.e. R3.10 or 16%) between February 2009 and February 2010  The net-of-tax price increases from R10.20 to R12.04 (18%)

15. Example (continued) In February 2010 the RRP of Peter Stuyvesant is R22.50, consisting of the following components:  VAT: R2.76  Excise tax: R7.70  Net-of-tax price: R12.04 National Treasury wants a total tax burden of 52% = R11.70 (= R2.76 VAT and R8.94 excise)  Increases the excise tax from R7.70 to R8.94 (16.1%) And so the process continues…. The increase in the net-of-tax price (and the RRP) in the previous year is directly responsible for the increase in the excise tax in the current year

16. Trends in the real net-of-tax price and the excise tax

17. What this graph indicates During the 1970s and 1980s the real net-of-tax price remained largely constant  Tobacco industry wanted to grow the market  There were no legislative impediments to this growth The landscape changed dramatically in the early 1990s  Anti-tobacco legislation passed in 1993 and 1999  Using its near-monopoly power BAT increased the net-of-tax prices  This was good for profitability and good for public health The net-of-tax price increases were overdone by about 2010  Entrance of nimble, low-cost producers into the market (FITA-aligned firms)  A competitive situation is being presented as a pure illicit trade problem

18. CIGARETTE CONSUMPTION AND REAL PRICES

19. Aggregate cigarette consumption and the real price of cigarettes