Tobacco Taxes: A Smuggler’s Boon?

By the end of 2011, taxes on cigarettes reached 71% of their retail price following the latest tax increase in July of last year. The figure surpassed the guidelines that were outlined in the March 2011 World Health Organization’s (WHO) report.

The report, titled “The Economics of Tobacco and Tobacco Taxation in Egypt,” had estimated raising the average tax on cigarettes to 70% of the retail price would prevent over 600,000 premature deaths in current and future smokers. While this may be a welcome development for the state budget and WHO’s outlook, it has also resulted in a flourishing illicit trade market.

Taxes are a basic and commonly used economic tool for the government to raise funds. In the recent past, the Egyptian government has raised taxes on cigarettes twice. First in July 2010, when there was an 84% tax increase that led to a 48% increase in prices. In July 2011, taxes were raised by another 37%, pushing prices up 21%. Overall, the price of cigarettes has gone up nearly 80% in less than a year.

The budget for the 2011/12 fiscal year shows that tax from tobacco and cigarettes will amount to LE 18 billion, which is the second-highest source of tax revenue. Instead of blocking a new tax under the premise that it would be an additional financial burden on the lower-income consumer, Parliament insisted that the tax be applied across the board, not only on imported brands. Fatimah El-Awa, regional advisor on WHO’s Tobacco Free Initiative, points out that this latest round of taxes is different than any other. “When taxes were raised on tobacco before, it was simply a fundraising tool for the government,” she says. “This time, the tax increase has a health benefit behind it, which is why it was approved by the last Parliament.”

Increase in black-market trading
Common sense dictates that with price increases, smokers would be deterred from smoking. Instead, the increase in prices has been a boost for illicit tobacco trading. “What happened was that the market size did not shrink, but instead there was a heavy increase in the illicit trade of tobacco because there weren’t enough measures in place to safeguard the market from infiltration by illicit traders,” says Karim Refaat, head of Corporate Affairs for North Africa at British American Tobacco (BAT).

According to Refaat, the illicit tobacco trade accounted for a mere 0.01% of Egypt’s 81 billion stick market (the common measurement in the industry) in the first quarter of 2010 and now jumped to 7%, with the possibility of moving toward the 10% mark. Refaat blames pricing dynamics for allowing illegal brands to gain a wider market share.

“The cheapest pack prior to the [2010 and 2011] excise taxes was Cleopatra […], which was being sold for LE 2.75,” he says. “So for an illicit trader to manufacture a pack outside Egypt, ship it, clear it, pay retailers an incentive to sell something that is illegal and to cover all costs and still be able to sell under LE 2.75 is extremely difficult — almost impossible.”

With the Cleopatra pack now at LE 5, illicit traders can make a bigger buck and still sell below that price.

Research by the Tobacco Free Center shows that illicit cigarettes are sold up to 90% cheaper than legal ones in Canada, 50% less in the UK and 25% cheaper in China. The center’s research also shows that in 2007, China had the highest number of illicit cigarettes at about 214 billion sticks, Brazil 38 billion and Turkey 12 billion.

It’s true that tobacco companies have not seen their market share grow, but what bothers the cigarette makers is that they didn’t lose market share to another competitor; they lost to 62 brands of illegal cigarettes, some of which are made and shipped over from the UAE’s Jebel Ali industrial zone.

According to research, the size of the illicit cigarette market in the Middle East and North Africa is 10–15%, whereas it has reached 27% in Brazil and the UK and more than 30% in Hungary.

According to these numbers, the government is losing LE 1.7 billion per year of the targeted tax revenue. Over five years, with the illicit trade market at 10% at the end of 2011, the government would lose LE 8.5 billion — 50% of the health insurance bill.

Raising taxes might seem like a bad idea, but El-Awa says trial and error in other countries has proven that growth of illicit trade has little to do with pricing and more to do with border control. She recounts that Spain saw illicit trade increase when tobacco prices were decreased whereas tobacco smuggling activities increased when the price was brought down.

“This means that the price is not the only factor affecting illicit trade — there are other security measures that need to be taken to reduce illicit trade,” she says.