A high tax on e-cigarettes will bring evasion and illegality
The finance minister’s recent budget was SA’s most important in years. Tito Mboweni faces a tricky balancing act. Spending and economic pressures from the pandemic have caused government debt to soar to 80% of GDP in 2020/2021, up from 66% the year before.
The economy cannot grow fast enough for the inflated fiscal deficit to dissipate of its own accord. Spending cuts and more revenues are needed to pay back the country’s escalating debt. But premature fiscal consolidation risks harming economic growth and delaying the recovery.
Mboweni is therefore looking for new sources of cash. One area that has been mooted is a new excise on e-cigarettes. Because only VAT is levied on e-cigarettes, a new excise would undoubtedly bolster the public purse. But there are salutary lessons from the EU, where member states are still grappling with how best to tax e-cigarettes, that the SA authorities would do well to consider.
The first challenge is avoiding the temptation of setting the new excise at too high a rate. Fewer than half of the EU member states — 13 out of the 27 EU countries — have any excise at all on e-cigarettes. And the countries that do have set them at relatively low levels — between 2% and 12% of the excise on traditional cigarettes.
There are good reasons for this. Portugal and Italy both found, to their cost, that an excessive e-cigarette excise led to widespread tax avoidance and evasion. Tax receipts were well below what was expected. And a year ago Hungary more than halved its e-cigarette excise to reduce the incentive for consumers to import cheaper, illegal vapour products.
The trouble is that it is easy for people selling and buying e-cigarettes to evade paying taxes because the e-cigarette industry is far more fragmented than the traditional tobacco sector. In Italy, for example, close to 19,000 different e-cigarette products are sold by more than 200 manufacturers and importers. And in the UK more than 500 manufacturers and importers supply 34,000 different products.
In contrast, about 40 cigarette brands are supplied in SA by nine manufacturers through a well-established system of bonded warehouses. In principle, this makes it easier to monitor and audit what comes out of the cigarette supply chain and ensure the right taxes are being paid, than it is for e-cigarettes. Consequently, experience shows that when the excise on e-cigarettes makes it worthwhile for unscrupulous suppliers to evade the official channels, they can relatively easily do so undetected.
One common way to do this is through e-commerce, as Italy and Portugal found to their cost. When large numbers of e-cigarettes are purchased online in small consignments it is difficult for postal authorities, courier companies and customs officials to identify and intercept tax-evading products. This is why an illegal e-cigarette market commonly emerges with lower taxes than tends to create an illicit cigarette problem.
This raises the question of how SA can hope to administer and enforce an excise on e-cigarettes when it already has one of the worst illicit cigarette problems in the world. Even before the onset of the Covid-19 pandemic, illicit cigarette sales comprised between a third (according to a recent University of Cape Town study) and half (according to manufacturers) of cigarette sales in SA. After the 2020 sales bans, the problem has worsened.
A moderate approach to e-cigarette taxation might therefore be a prudent way to kick things off in SA. This would also play well against the health policy agenda. A growing body of evidence from independent experts (who are, in many cases, part of the anti-tobacco lobby) shows that e-cigarettes are far less harmful than cigarettes. Some studies find e-cigarettes are 95% less harmful than smoking tobacco. Consumers switching from smoking to e-cigarettes may, consequently, enjoy significant health benefits.
The Italian and Portuguese authorities certainly, at least in part, explained their tax cuts on vapour with reference to potential health benefits. And the UK certainly thinks health policy is important regarding e-cigarette taxes. In 2018, the UK secretary of state for health & social care called for proportionate regulation and tax of e-cigarettes based on their reduced risk profile. He endorsed the UK levying no excise duties on e-cigarettes.
This is still the UK’s approach. As SA considers taxing e-cigarettes, Europe delivers some valuable lessons. Not least that starting with a prudent approach can pay dividends.
• Raponi is an honorary professor of European tax law at Brussels Business School. An independent international tax consultant, he has previously worked as head of the excise department at the European Commission.
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