13.12 Future directions for reform of tobacco taxes

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Tax levels in Australia have not increased in real terms since the reforms instituted as part of the move to the New Tax System between 1999 and 2001.

With its ratification of the international Framework Convention on Tobacco Control which came into force on 27 February 2005, Australia is obligated to provide rates of taxation for tobacco products in periodic reports to the conference of Parties.50 The Convention also states

2. Without prejudice to the sovereign right of the Parties to determine and establish their taxation policies, each Party should take account of its national health objectives concerning tobacco control and adopt or maintain as appropriate measures which may include:

a. implementing tax polices and, where appropriate, price polices, on tobacco products so as to contribute to the health objectives aimed at reducing tobacco consumption.

WHO Framework Convention on Tobacco Control50, Part III, Article 6

This section outlines some of policies relevant to tobacco taxation that might be considered.

13.12.1 What is the 'right' level of tobacco taxation?

The most significant issue that governments must face in considering taxation as a tobacco control policy is in deciding on an appropriate level for tobacco taxes. There are several possible approaches.

13.12.1.1 Recouping social costs

Many economists would argue that the 'correct' level of tobacco taxation is that which ensures that revenue from tobacco taxes is at least equal to the costs likely to be imposed on society resulting from tobacco use (that is, those costs not borne voluntarily by smokers themselves).243 While theoretically this seems like an attractive proposition, in practice governments attempting to set tax levels on this basis would face several difficulties.

Quantification of costs have been established for Australia, as for elsewhere, but the most comprehensive of these are estimates of current costs based on past tobacco consumption rather than estimates of future costs based on consumption by current smokers.[64] It doesn't seem very just to expect current smokers to bear costs associated with smoking by previous generations of smokers over whose smoking they had no control. If taxes were set to cover the costs associated with past consumption, then remaining smokers would have to contribute the same total amount of revenue, regardless of the total quantity of tobacco smoked, and regardless of how many smokers managed to quit.

Some studies have attempted to project future costs associated with smoking by current smokers, however because most health effects occur only after many years of use, and because medical treatments change rapidly, it is extremely difficult to quantify such costs with any accuracy. Gene therapies, for instance, could revolutionise the treatment of many cancers and cardiovascular problems over the next 10 to 15 years. The future population costs of treating virus-related conditions such as cervical cancer could be drastically reduced through investment in vaccination programs and other preventive measures over the next few years.

A further challenge would be to ensure that all the relevant costs were being included. For many of the health problems caused by smoking, the extent of mortality and morbidity has yet to be quantified. Also, there are many health conditions which scientists suspect may be caused or worsened by smoking, but where insufficient research has been conducted yet to ascertain causality. Further, current costs are based on average treatment costs. The cost of treating diseases in people who smoke are likely however to be higher than average due to problems such as slower healing of fractures and a greater incidence of post-operative complications.244 Authors of economic studies acknowledge that current estimates are likely to significantly underestimate the true costs for all these sort of reasons.245 If tax rates were to be set on the basis of likely future health care costs, then a mechanism would need to be established for more comprehensively and regularly updating estimates of the health burdens associated with tobacco use.

When thinking about recouping the social costs of tobacco use, one should always remember that it is smokers and their families who will bear the greatest proportion of the costs associated with smoking. In addition to costs borne by business and costs borne by government, costs borne non-voluntarily by smokers themselves and by their immediate families are a third, very large component of Collins and Lapsley's estimate of total tangible costs—$9,871.2 million or more than 50% of the total $19,609.3 million estimated tangible costs attributable to smoking for Australia in 2004–05. In addition to almost $10 billion in tangible costs, smokers and their families bear 100% of the intangible costs attributable to tobacco use, $19,459.7 million in 2004–05. Collins and Lapsley's estimate of intangible costs included an estimate of the value to individuals of a year of life lost in 2004–05, but they did not attempt to quantify the pain and suffering of those who grieve for smokers who die early. And as well as these economic costs, addicted smokers spent more than $10 billion in 2004–05 on tobacco products, which included more than $6 billion in excise and customs duty and GST on sale of tobacco products.[65]

13.12.1.2 Pricing products out of the reach of young people

Another approach to establishing the optimal level of tobacco taxes is to attempt to price tobacco products out of the reach of young people.

A packet of 30 cigarettes in Australia in April 2007 cost about $12.60, about as much as going to the cinema246 or renting a couple of new-release movies on DVD.247 This is equivalent to just over one-third of the average pocket money that 15-year-olds received each week in 2005—see Table 13.11. If, instead, a packet of cigarettes in Australia cost, say, as much as buying a new-release video (about $30),248 just under the amount that the average 15-year-old has each week 'to spend on themselves', then many fewer children would be motivated to go without everything else they enjoyed for a whole week in order buy cigarettes, and most would simply opt not to use them. For adults not addicted to tobacco-delivered nicotine, cigarettes costing $30 a pack (or about one dollar per stick) would be something to be consumed only on special occasions, like a cognac or a cigar after a special meal.

Theoretically one could go further and price cigarettes out of the reach of all but the most cashed-up young person, at higher than the pocket money received by, say, 90% of 15-year-olds. Because some young people receive very high levels of pocket money (even as much as $50 a week), setting taxes to result in these sorts of prices would impose considerable hardship on those addicted smokers unable to dramatically reduce their consumption. It may also result in the development of black markets to supply remaining users.

While it may not be feasible to price young people out of the tobacco market altogether, making cigarettes less affordable to young people should be an important consideration in setting tax levels.

13.12.1.3 Frequent price rises to discourage tobacco use

A more practical approach to setting tobacco tax levels is to apply price increases frequent and large enough to discourage uptake and to encourage serious quitting attempts by remaining smokers. Based on this logic, the World Health Organization51 and the World Bank2 recommend that the price of all tobacco products should rise by at least 5% per year in real terms.

Table 13.23 shows the recommended retail price, in actual dollars, of a packet of Peter Jackson 30s in Australia since 1999 compared to the price, in actual dollars had the real price increased by 5% per year since that time.

As can be seen from Table 13.23, cigarette prices in 2002 fell below the level that would have been in place had the WHO/World Bank recommendations been adopted in 1999. Prices have not recovered since that time.

Because many smokers dependent on tobacco-delivered nicotine will be unable to quit even with the encouragement of regular price increases, it is essential that tax increases be just one part of a comprehensive strategy to discourage smoking and support quitting.243, 249

Enormous costs caused by tobacco use are borne by smokers themselves and substantial poverty results from and is perpetuated by spending on tobacco products. Tax revenue from smokers easily exceeds the costs to government—if not to the rest of the community—associated with smoking. Given these factors, the World Health Organization recommends that when government revenue increases from increases in tobacco taxes, extra funding should be provided for services and treatment to help smokers to quit.51 This recommendation is based on considerations of health, economic efficiency, social justice and political acceptability.

13.12.2 Removal of tobacco from the CPI?

Modern economic management puts great store by a country's official Consumer Price Index or CPI. It is regarded as a key indicator of economic performance and is taken into account when establishing international credit ratings. CPIs are also often used to determine increases in national social security payments and increases in wages covered by national awards. Because increases in tobacco taxes increase tobacco prices, tax increases can lead to unwelcome increases in the CPI and this can be in conflict with the inflation-control policies set by central banks and international lending agencies.

This problem, and the falling proportion of many populations who smoke, has led many in tobacco control to suggest removal of tobacco from the basket of goods used to calculate the CPI. Indeed, in 1992, Tasmanian Democrat Senator Robert Bell presented a Bill that proposed just such an approach in Australia.250

The Australian Bureau of Statistics and most economists have opposed the exclusion of tobacco from the CPI on technical grounds. The integrity of the index relies on a very high degree of consistency over time and with other jurisdictions internationally.

A way around the problems of concern to health groups would be to use the CPI which excludes tobacco and alcohol as the index used for wage increases and indexation of pension and benefits. This has been done in Luxembourg (1 January 1991), France (1 January 1992) and Belgium (1 January 1994).251 In this way, increases in the price of cigarettes are not offset by increases in those wages, benefits and pensions that are regularly increased in line with the CPI.

In Australia, the CPI is reviewed regularly to take account of changing patterns of consumer spending,[66] and the sub-indices are re-weighted accordingly after each review.252 The impact of tobacco price increases on the CPI is declining in recent years as the Cigarettes and Tobacco Sub-group makes up a declining percentage of the overall CPI. The changing weightings of the Cigarettes and Tobacco Sub-group are set out in Table 13.24.

At the latest weighting255, the price of cigarettes and other tobacco products would have to increase by at least 400% in order to cause the overall Australian CPI to increase from 4% to 5%.

13.12.3 Measures to reduce legal and illegal circumvention of tobacco taxes

Section 13.7 describes three forms of evasion that have been significant in Australia. There are many ways in which taxes on tobacco products are being circumvented in different countries around the world. This section outlines strategies for protecting tax revenue (and the effectiveness of tobacco taxes as a means of discouraging consumption) in the face of emerging and potential new threats.

Joossens, Chaloupka, Merriman and Yürekli (2000) provide a useful set of distinctions between: legal and illegal circumvention of taxes; of products for personal use versus commercial resale; and of products in small versus large quantities.197 They describe:

1. Legal circumvention including

• legal cross-border shopping
• legal tourist shopping and
• legal duty-free sales

2. Quasi-legal circumvention including

• sales through the internet and
• grey-market sales involving export of cigarettes to wholesalers in one country who import them back to the country of origin, exploiting differences in taxes applicable to cigarettes destined for export and those destined for domestic consumption256 and

3. Illegal circumvention including

• bootlegging by individuals and small gangs purchasing tobacco products in low-tax jurisdictions in amounts that exceed limits set by customs regulations, and re-selling them in high-tax jurisdictions and
• large-scale, organised smuggling, involving the illegal transportation of large consignments of stock, often by highly organised criminal gangs usually evading payment of all taxes.[67]

13.12.3.1 Moves to discourage legal circumvention

Removal of duty-free status of sales to travellers

Had duty been paid on all the products that were sold duty-free in Australia in 2001, revenue is estimated to have totalled more than $130 million.257 However, without duty-free status, sales would undoubtedly have been much lower, so it is unclear how much extra revenue the government would gain if duty-free sales were to be abolished.

The main justification for banning duty-free sales of tobacco products is that it provides scope for evasion of revenue. Advocates have also argued that government willingness to grant duty-free status to such products 'sends the wrong message' and may cause consumers to underplay the health risks of smoking. It is also a regressive tax break in that higher-income people are likely to have better access to duty-free shops (in airports for example) than low-income people.

The Framework Convention on Tobacco Control highlights the problem of duty-free sales as a key element of tobacco tax policy. It states in Part III, Article 6 that Parties should

…adopt or maintain as appropriate measures which may include:

…b. prohibiting or restricting, as appropriate, sales to and/or importations by international travellers of tax and duty-free tobacco products.

13.12.3.2 Moves to discourage quasi-legal circumvention

Discouraging internet selling

Surveys of smokers in Australia reveal very few cases yet of people reporting purchasing of cigarettes via the internet258 however there are several internet sites with Australian domain names that do sell cigarettes—see Chapter 11, Section 11.6.5 for further details. Overseas studies indicate that people who purchase cigarettes through the internet are primarily motivated by lower prices which are possible because online vendors rarely pay excise taxes. One survey of US smokers who had purchased online found that consumption by such smokers increased compared to purchasers paying full-price for cigarettes from bricks-and-mortar retail outlets. Internet sales thus have the capacity to undermine the public health benefit of higher cigarette prices.259 Given the difficulty of collecting local taxes from suppliers based in overseas jurisdictions, many tobacco control advocates have called on governments to ban the advertising of such products to Australian internet users.[68] Other proposals to disrupt internet trade in cigarettes have included preventing the vendor from hosting a website (by seizing relevant domain names),260 preventing the vendor from receiving payment (by banning credit card payments for cigarette purchases over the internet) and preventing shipments (by restricting local mail carriers and delivery services).261

In the United States, several credit card companies have voluntarily refused to provide service to such vendors.262

13.12.3.3 Measures to reduce illegal circumvention of tobacco taxes

Article 15 of the Framework Convention on Tobacco Control (FCTC) in force since February 2005 recognises that eliminating illicit trade in tobacco products including smuggling, illicit manufacturing and counterfeiting, are essential components of tobacco control.

Section 13.7.2 described the considerable investment by the Australian Taxation Office to tackle the problem of illegal diversion of roughly processed smoking tobacco. In Australia however, there has been much less attention on the problem of smuggling and counterfeiting of cigarettes.

Article 15 of the FCTC obliges ratifying countries including Australia to

… adopt and implement effective legislative, executive, administrative or other measures to ensure that all unit packets and packages of tobacco products and any outside packaging of such products are marked to assist Parties in determining the origin of WHO Framework Convention on Tobacco Control tobacco products, and in accordance with national law and relevant bilateral or multilateral agreements, assist Parties in determining the point of diversion and monitor, document and control the movement of tobacco products and their legal status.50

Article 15 goes on to state:

In addition, each Party shall:

(a) require that unit packets and packages of tobacco products for retail and wholesale use that are sold on its domestic market carry the statement: "Sales only allowed in (insert name of country, subnational, regional or federal unit)" or carry any other effective marking indicating the final desitnation or which would assist authorities in determining whether the product is legally for sale on the domestic market; and

(b) consider, as appropriate, developing a practical tracking and tracing regime that would further secure the distribution system and assist in the investigation of illicit trade.

3. Each Party shall require that the packaging information or marking specified in paragraph 2 of this Article shall be presented in legible form and/or appear in its principal language or languages.

4. With a view to eliminating illicit trade in tobacco products, each Party shall:

(a) monitor and collect data on cross-border trade in tobacco products, including illicit trade, and exchange information among customs, tax and other authorities, as appropriate, and in accordance with national law and relevant applicable bilateral or multilateral agreements;

(b) enact or strengthen legislation, with appropriate penalties and remedies, against illicit trade in tobacco products, including counterfeit and contraband cigarettes;

(c) take appropriate steps to ensure that all confiscated manufacturing equipment, counterfeit and contraband cigarettes and other tobacco products are destroyed, using environmentally-friendly methods where feasible, or disposed of in accordance with national law;

(d) adopt and implement measures to monitor, document and control the storage and distribution of tobacco products held or moving under suspension of taxes or duties within its jurisdiction; and

(f) adopt measures as appropriate to enable the confiscation of proceeds derived from the illicit trade in tobacco products.209

World health Organization,
Framework Convention on Tobacco Control.50 p13

 

The Framework Convention includes the following footnote to Article 15.

There has been considerable discussion throughout the pre-negotiation and negotiation process concerning the adoption of an early protocol on illicit trade in tobacco products. The negotiation of such a protocol could be initiated by the International Negotiating Body immediately following the adoption of the FCTC, or at a later stage by the Conference of the Parties.50

Since the Convention came into force, the Framework Convention Alliance, an alliance of more than 250 international, regional and national non-government organisations from more than 90 countries, has been calling for the development of a protocol to combat illegal trade. It states that the following should be part of such a protocol:263

• licensing of all exporters and importers with licences empowering tax authorities to keep track of all traders and transactions
• a tracing and tracking system that made it mandatory to
  • identify country of export, the final country of destination and the first customer
  • print overt and covert markings on packs, cartons and master cases which made it easier for companies and government officials to detect counterfeit stock
  • track stock using machine-scannable codes
  • keep and on request provide computerised records of all shipments
• a strict liability and compensation system whereby the producer is liable for all taxes and duties until the products reach the final destination and all due taxes are properly paid[69]
• criminalisation of counterfeiting of and contraband in tobacco products, as well as the removal and alteration of markings
• anti-money laundering measures, so that proceeds derived from illicit trade in tobacco products can be confiscated.

Additional measures might include campaigns to raise public awareness of the problems of cigarette smuggling, and efforts to coordinate tax rates among neighbouring countries.

Several jurisdictions have already begun to adopt such measures.

France and Singapore require licences for at least some of those involved in the cigarette manufacturing and distribution chain.

Hong Kong employs sophisticated computer-tracking systems to monitor the movement of stock. As in many countries and many industries, in Australia tobacco companies have for some years now been routinely machine-scanning tobacco packages as a means of controlling stock and recording sales. In 2004, British American Tobacco Australia (BATA) installed laser bar codes to enable much faster tracking of stock. Laser bar codes are difficult to counterfeit and allow much more detailed accounting of stock from production to retail sale.264

In the United States, the Prevent All Cigarette Trafficking Act[70] will, if enacted, lower the threshold for a cigarette smuggling violation from 60,000 to 10,000 cigarettes and increase powers and resources of the Bureau of Alcohol, Tobacco and Firearms to investigate and enforce US laws prohibiting illicit trading in cigarettes.194, 215 [71]

A regional anti-tobacco smuggling alliance was established in 2004 to exchange information and coordinate efforts to fight smuggling within the Asia Pacific region.265

So far in Australia, no action has been taken on any of the five areas above.

Extensive amendments to the Customs Act 1901 in 2001 were aimed at modernising the way the Australian Customs Service manages the movement of cargo in and out of Australia. Reforms were intended to

• create the legal foundation for an electronic business environment for cargo
• establish a new approach to managing compliance that recognises that 'one size doesn't fit all'
• improve control over cargo and its movements where there has been failure to comply with regulatory requirements.266

Amendments do not specifically mention tobacco but were intended to address the problem of products bound for export being diverted to the domestic market without payment of excise duty.267 Further amendments in 2006268 were intended to strengthen controls over imports of those classes of products that, when manufactured and sold in Australia are subject to excise duty (so-called excise-equivalent goods). The amendments require improved accounting to the Customs Service up until the time of excise liability is established for those goods used in the manufacture of tobacco products.269

The 2004 and 2006 amendments to excise legislation described in Section 13.7.2 above do give authorities power to require additional reporting by companies where there are suspected problems with compliance. However the 2006 amendments to excise regulations270 also relax requirements for packaging and marking of tobacco products. Part 11, (Division 1) and Divisions 6 to 8 of the regulations61 were abolished because 'compliance of these requirements was no longer actively enforced and these regulations were not required as they were overly prescriptive and inconsistent with best practice regulation'.271