Written evidence from Jonathan Isaby, TaxPayers Alliance [TOB02]

1. The TaxPayers’ Alliance fights to reform taxes, cut spending and protect taxpayers, and has over 75,000 supporters across the United Kingdom. The illicit trade has a direct impact on UK tax revenue and therefore not only on rates of taxation on tobacco products, but also on other taxes which may be raised to recoup lost revenue.

2. The Committee asks what could and should be done (i) to reduce tobacco smuggling; and (ii) to disrupt the illegal trade in tobacco within the UK.

3. Your Committee chairman was utterly correct to highlight in the call for evidence on tobacco smuggling that the UK has “one of the highest rates of tobacco duty in the EU” and to link this to the fact that this makes our country “one of the most lucrative markets for smugglers”.

4. Measuring tax gaps is HMRC’s annual report looking at how much tax revenue is lost to the black market and in the most recent edition[1], it estimates that up to £11.6 billion of tax revenue (in duty and VAT) was lost through illicit sales of cigarettes between 2006-07 and 2010-11, while as much as £4.3 billion was lost through illicit sales of hand-rolling tobacco over that same period. It is worth noting that this annual report almost always underestimates the losses in revenue, which are more often than not then revised upwards in the following year’s edition. The 2012 report estimates that the black market in cigarettes could now account for as much as 16 per cent of the total market, with illicit sales of hand-rolling tobacco representing at the very least one third of the total market and potentially up to 44 per cent of the entire UK market.

5. At £5.40 per pack of twenty, the UK has the second highest tax burden per packet of cigarettes in the EU, lagging slightly behind Ireland[2]. The Irish Office of Revenue Commissioners released a report in February 2011[3] that modelled the cigarette market in Ireland, which acknowledged that when the price rises, rather than consumption falling, smokers simply switch to the illicit market. It should therefore be a salutary lesson to British politicians that in his Budget for 2010, the then Minister for Finance, Brian Lenihan, froze the duty on cigarettes, saying[4]:

“I have decided not to make any changes to excise on tobacco in this Budget because I believe the high price is now giving rise to massive cigarette smuggling. My responsibility as Minister for Finance is to protect the tax base.”

6. The speech was a frank acknowledgement that the high duty on cigarettes had not necessarily curbed consumption but had led consumers to purchase substitute illicit goods instead.

7. There are plenty of other studies looking at the effect of price on the consumption of cigarettes and its relation to illicit trade. For example, Cullum and Pissarides found that:

“The increased complexity of the market for tobacco products means that earlier studies of the UK duty-paid segment of the market… struggle to predict the impact of price changes on demand. Normally, price increases would lead to reduced consumption. However, more recently the effects of higher prices have become more uncertain as consumers may switch their consumption to other sources or lower quality cigarettes.”[5]

8. In a 2010 Australian study, PricewaterhouseCoopers found that the most common reason for using illegal tobacco was cheaper prices.[6] Geis, in another Australian study, acknowledged World Bank research that suggested tax increases bring more revenues and reduce smoking even with high rates, but went on to say that such research leaves:

“[unanswered] questions about the consequences for smuggling… what results might ensue if the tax reached what the public believes is an unacceptable level.”[7]

9. Gabler and Katz, meanwhile, carried out a study in Canada and their findings were stark:

“Contraband cigarettes are perceived to be a near-perfect substitute for lawfully purchased cigarettes. As such, contraband tobacco use neutralises the deterrent effect of higher taxes”.[8]

10. They also highlighted that previous governments in Canada had been aware of these effects, with varying results:

“This dynamic was recognised by government officials in the mid-1990s, and tobacco excise taxes were reduced in order to weaken incentives to purchase, manufacture, distribute, and smuggle contraband tobacco. But the federal government began to raise tobacco taxes again in the early 2000s. Predictably, the higher taxes stimulated trade in contraband tobacco, resulting in a flourishing black market that now constitutes an estimated 27 per cent share of the overall tobacco market”.[9]

11. It is therefore indisputable, as demonstrated by hard facts and international evidence – as well as academic research – that high taxes increase the extent of outright tax evasion. A larger shadow economy is part of the price that all taxpayers pay for the high taxes and burdensome regulations imposed by politicians, and this is clearly the case as far as the tobacco trade is concerned. The significant loss of revenue resulting from the illicit market in tobacco inevitably leads to higher taxes elsewhere for ordinary families as a way of making up the shortfall.

12. As far as disrupting the illegal tobacco trade goes, the introduction of standardised packaging would be a gift to counterfeiters and smugglers, and therefore a further blow to both the taxman (through additional lost revenue) and taxpayers (through higher taxes elsewhere to recoup that lost revenue).

13. The boost to the illicit trade that plain packaging would bring is backed up by former senior law enforcement officials. Roy Ramm, former Commander of Specialist Operation at New Scotland Yard, is unequivocal about the effect that plain packaging would have on the illicit trade. He wrote in article published on the Huffington Post website that:[10]

“It would be easy to say dealing with this situation is one that just requires increased law enforcement, monitoring and intelligence operations, and that there is no connection between a potential increase in smuggling and the government's plans for plain packaging of cigarettes. But this is not the case. First, plain packaging will be easier to counterfeit than branded packs. Once you've forged one packet with the name of the product on it, you've forged them all. Secondly, if it is easier to fake the packet, then it will be encouragement for organised crime groups to produce more and more fake tobacco to contain within them. If there is a natural barrier put on the numbers of cigarettes you can fake, because of the multiple numbers of brands in the marketplace that need to be counterfeited, then there is no limit put upon smugglers and organised crime groups if the carton – and content – are [sic] the same.”

14. Existing police officers are also sceptical about plain packaging, according to a poll conducted by Populus. When asked whether standardised packs would make it easier to produce or sell counterfeit cigarettes, 86 per cent said it will. 68 per cent said that plain packs would lead to an increase in black market cigarettes. 70 per cent of the officers asked said that they believe the Government would lose tax revenue and 60 per cent even said that plain packs would cause children to turn to the black market.[11]

15. Multiple brands with different packet designs are a costly barrier for counterfeiters wishing to replicate them. Plain packs would be far easier to copy. Official seals or embossed ‘duty-paid’ symbols may be of use to a customs official, but if they are roughly copied on counterfeit tobacco products it is unlikely that consumers – or even retailers – would be able to tell the difference. Indeed, this is a point that has been made by Brandon Lewis MP (then a backbencher, now a member of the Government) in a Westminster Hall debate:[12]

“I am not a cigarette smoker, but surely one potential problem with plain packaging is not whether experts and officials can check a code to see whether the product is illegal but whether the public who buy the packs can spot it easily.”

16. Roy Ramm echoed this sentiment:[13]

“It would be disastrous if the government, by introducing plain-packaging legislation, removes the simplest mechanism for the ordinary consumer to tell whether their cigarettes are counterfeit or not.”

17. Research by Transcrime has found that brands are far harder to counterfeit than deterrents which have already been put in place:

“The presence of pictorial health warnings has not to date discouraged counterfeiting, and health warnings are easier to counterfeit than specific brands and features.”[14]

18. Contraband and counterfeit cigarettes are a significant threat because the informal economy in general is so large and very adaptable. Recent research found that it is likely to make up around 22 per cent of global GDP.[15]

19. Schneider has also produced influential literature on the informal economy. In a paper from 2011, for example, he concluded that “the most influential factors on the shadow economy and/or shadow labor force are tax policies and state regulation, which, if they rise, increase both.”[16]

20. In a 2013 paper for the Institute of Economic Affairs, Schneider and Williams found that the shadow economy constitutes around 10 per cent of GDP in the UK. Given that tax policies are the main driver of the shadow economy, there is significant scope to reduce the tax burden and bring more trade back into the formal economy.[17]

21. At a time when politicians are especially looking for the economy to grow and reduce unemployment, it is also worth remembering that many jobs are lost as a result of the illicit trade in cigarettes and hand-rolling tobacco. Frontier Economics released a report which estimated that 2.5 million jobs have been lost in the G20 countries alone because of the illicit trade.[18]

22. This adds to pressure on the budgets of various public sector bodies including local authorities. According to the Local Government Group, 87 per cent of all English councils surveyed were undertaking activities related to illicit tobacco. An estimated 4,300 premises were visited by councils across England in 2010-11 in relation to illicit tobacco products.[19] This means that local authorities already spend a significant amount of time and resources dealing with illicit tobacco. If the trade were boosted further by the introduction of plain packs then even more money would be spent to try and curb that trade, at a time when councils should be looking to prioritise their frontline services.

23. We believe that the law enforcement agencies and customs officers are already over-burdened by the amount of illicit tobacco in circulation and the number of smugglers they are trying to track. This has been made worse in recent years by continuous above-inflation tax hikes, and the introduction of plain packaging would stretch officers even more as it would be far easier to imitate legitimate brands.

24. The focus of politicians should be on making the work of those responsible for enforcing the rules easier, not harder. So in trying to ascertain what would reduce tobacco smuggling and disrupt the illegal trade in tobacco, they should bear in mind that imposing ever higher taxes on tobacco and/or the introduction of plain packaging would only be to encourage the illicit trade, giving succour to the smugglers and making life even harder for the authorities charged with trying to deal with them.

Relevant recent pieces of TaxPayers’ Alliance research from which this submission is drawn include:

Tax Gap: How cracking down on illicit trade could fund a 1p cut in the basic rate of Income tax, April 2012
http://www.taxpayersalliance.com/taxgaps.pdf

The Single Income Tax, Final report of the 2020 Tax Commission, specifically Section 7.1.1. Higher taxes lead to a larger black market and broadly increase tax evasion, May 2012
http://2020tax.org/2020tc.pdf

First, do no harm: How politicians can make tax evasion worse, October 2012
http://www.taxpayersalliance.com/firstdonoharm.pdf

Jonathan Isaby, TaxPayers Alliance

20 August 2013

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