How illicit tobacco trade undercuts effort to curb smoking
Potential for massive profit is behind the dramatic spike in black market trade in cigarettes, writes Corné van Walbeek
Tobacco and Heart Disease is the theme for World No Tobacco Day on Thursday. Although most people regard cancer as the disease commonly associated with tobacco use, more smokers die of tobacco-attributable heart disease than tobacco-attributable cancers.
While cigarette smoking in the western world is in decline, there are regional differences. Efforts to decrease tobacco consumption are undermined by the illicit trade in cigarettes.
Cigarettes acquired on the illegal market are cheaper, making it easier for people to start smoking and to smoke more — and more difficult for them to quit the habit. Many countries battle to curb the illicit trade in cigarettes, including SA.
Data in the February Budget Review strongly suggest that the illicit trade in tobacco is increasing in SA. Excise tax revenue from tobacco products decreased about 10% between the financial years 2016-17 and 2017-18, despite an 8% increase in the excise tax per pack of cigarettes. There had been a 7% decrease in revenue in the previous financial year — the first time in more than 50 years that nominal excise tax revenue decreased. An analysis of these numbers indicates that there has been a 20% decrease in the number of tax-declared cigarettes between 2016 and 2018.
This large decrease is a cause for concern. Although there has been a long-term decrease in cigarette consumption in SA, such a rapid decrease in the past two years cannot be explained by changes in people’s smoking patterns alone. Instead, it points to a significant increase in the illicit cigarette market.
The Tobacco Institute of Southern Africa (Tisa) has been arguing for many years that the illicit trade in cigarettes is high and increasing. While there was a spike in illicit trade in 2010, the evidence gathered suggests that the illicit market did not grow significantly from 2010 to 2015. But there has been a dramatic change since 2015.
Surveys in informal settlements indicate the illicit market is thriving there. In many places, cigarettes sell at 50c each, or R10 a pack. As the excise tax per pack is R15.52, it seems clear this is not being paid.
In the past, Tisa, which represents the large multinational companies, argued that small operators in the market were driving the illicit market. In 2010, when about 10% of the legal market was lost to the illicit market, Tisa and the multinationals complained and launched a well-orchestrated campaign to warn the public against illicit cigarettes. Surprisingly, over the past two years when the legal market decreased by 20%, the response from Tisa and the multinationals was subdued.
Since 2010 the average price of cigarettes sold at retail outlets has increased in line with inflation. However, from 1993 to 2010, the retail price increased substantially more than the inflation rate. The tobacco industry, which consisted almost exclusively of the multinationals at the time, saw that the government was rapidly increasing the excise tax.
These sharp increases were part of the government’s policy to reduce tobacco consumption. So the tobacco industry increased the retail price of cigarettes by much more than the increase in the excise tax. They sold fewer cigarettes, but made much more profit on each cigarette sold.
Every year since 1993 the government increased the excise tax and every year the tobacco industry increased the retail price by more than the increase in the tax.
Despite selling about 30% fewer cigarettes in 2010 than in the early 1990s, the turnover (net of excise taxes and valued-added tax) was substantially higher than in the early 1990s, even after the effect of inflation is removed.
To curb illicit trade, the government should start by ratifying the Illicit Trade Protocol of the Framework Convention on Tobacco Control, created specifically to remedy this issue
The high profits that the multinationals were earning attracted small, nimble new entrants into the industry. They were able to get in at the lower end of the market and take a substantial share of business away from the multinationals. The result has been a price war. According to Tisa, many of the new entrants do not pay excise taxes.
The chickens have come home to roost for the multinationals. For more than 15 years, British American Tobacco was able to use its near-monopoly power to sell cigarettes at increasingly higher retail prices and make massive profits. It created incentives for competitors to enter the market and undercut its prices. The result is a very fragmented and near-chaotic market.
To curb illicit trade, the government should start by ratifying the Illicit Trade Protocol of the Framework Convention on Tobacco Control, created specifically to remedy this issue. It should implement a track and trace system that would allow tobacco products to be identified from when they leave the factory to the time they are bought by the consumer.
The government should also force companies to affix high-technology tax stamps on individual cigarette packs. And it should revive the special units at the South African Revenue Service that target tax evaders.
The solution to the illicit trade problem is not to reduce the excise tax. Illicit trade has less to do with high excise taxes and more to do with a general decrease in tax morality. SARS has its work cut out.
Van Walbeek is the director of the Economics of Tobacco Control Project at UCT’s Southern Africa Labour and Development Research Unit and director of the World Health Organisation’s Framework Convention on Tobacco Control Knowledge Hub on Tobacco Taxation and Illicit Trade.