Smoke detectors: The illegal cigarette trade deprives the government of tax revenue and has been linked to various other crimes, such as terrorism and human trafficking. Picture: THE HERALD
Smoke detectors: The illegal cigarette trade deprives the government of tax revenue and has been linked to various other crimes, such as terrorism and human trafficking. Picture: THE HERALD

In his medium-term budget policy statement speech last year, Finance Minister Pravin Gordhan announced that the Treasury would require an additional R28bn in the 2017-18 financial year.

So what tax options are available to Treasury? Personal income tax, the biggest tax source for the fiscus, has been mooted – especially for earners at the top end. However, personal income tax underperformed in the 2016-17 budget cycle, leading to the under-collection of receipts.

Value-added tax (VAT) is the next-biggest source of tax revenue and while a 1% VAT increase could raise as much as R15bn, this is likely to be a politically tough option.

According to the Reserve Bank, SA’s economic growth is expected to come in at 0.4% for 2016 and is projected to be 1.1% for the current 2017.

Treasury now has little option but to explore expenditure reductions and look for additional tax measures to limit growth of the budget deficit.

Based on some of the pre-budget commentary, Treasury’s emphasis seems to be on above-inflation increases in indirect taxes, such as excise duties and the fuel levy. But indirect taxes are regressive, hitting low-income earners hardest, and in 2016-17, they were R1.3bn below target.

There may therefore be a need to broaden the tax base and take a hard look at parts of the economy where the government is not getting its proper due.

Dealing with the trade in illegal cigarettes, for example, would be an easy place to start. It has cost the fiscus an estimated R4bn to R5bn in lost revenue each year, and about R24bn in the past five years.

Costing on average about R12 per pack and in some cases as little as R7 (compared to about R35 for the most popular brand on the market), it should be no surprise that the illegal trade is flourishing and accounts for a staggering 24% of the South African market. Growth in illicit trade can only serve to erode the tax base.

So, why does this matter? Some would argue that the legitimate tobacco sector’s loss to illicit traders is no big deal. The production and sale of illegal cigarettes, however, is not a victimless crime. Not only does the government lose out on substantial revenues that could be used to deliver vital public services, but the proceeds from the sale of illegal cigarettes are often used to fund drug smuggling, human trafficking and other crimes that blight communities.

Some smugglers even have links to terrorism. Combined, this "double whammy" of tax losses and increased crime (which requires yet more expenditure on police to tackle it) is having serious consequences in SA.

In theory, correcting this should be relatively easy. Tobacco products are manufactured or imported in a limited range of brands and excise is levied at a specific rate per thousand cigarettes (R662), due for collection at the point
of manufacture or import into the country.

An embossed diamond marking on the bottom of the pack is intended to provide a physical indication that tax has been paid.

Picture: REUTERS
Picture: REUTERS

Unscrupulous manufacturers and criminal networks, however, can and do regularly circumvent this process by issuing fraudulent paperwork that fails to fully declare what they produce and move out of their factories. The embossed diamond mark, meanwhile, can be easily copied by even the most unsophisticated fraudster.

So, in light of such significant tax losses and the widening budget deficit, how might Gordhan achieve the delicate balancing act of delivering the critical public services demanded by South Africans while maintaining SA’s investment-grade credit rating?

An effective step that could be taken to ease the government’s dilemma would be to tighten controls on and increase the monitoring of the cigarette-production process.

This could be achieved through two simple measures. The government could implement digital, tamper-proof verification technology on production lines that counts every pack made and reports this information directly to the South African Revenue Service so they can calculate exactly how much tax manufacturers should pay.

The government could also station customs officials at every site in the country where tobacco products are manufactured to monitor what goes in and what goes out, 24 hours a day.

These measures can be implemented quickly, at relatively low cost and are internationally proven ways for tightening control of unscrupulous manufacturers.

Eliminating the trade in illegal cigarettes is a low-hanging fruit and stakeholders across the legitimate tobacco value chain — including manufacturers — stand ready to support the government in implementing measures to help it reach these fruit.

Heshu is head of external affairs British American
Tobacco SA.

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