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By K. L. S. de Silva
Over the past decade, Sri Lanka has engaged in a war on tobacco, with government bodies and non-profit organisations working together to increase regulation and taxation measures on the tobacco industry. However, most of these measures have been aimed at curtailing the legal tobacco industry, which has had an inadvertent impact on boosting illegal cigarette trading in the country.
In 2017, we have a seen an alarming growth in the number of smuggled cigarettes entering the country. The first six months of 2017 saw law enforcement agencies confiscating 40.5 million illicit cigarettes, compared to the four million sticks seized during the full year 2016. Unfortunately, law enforcement authorities are successful in detecting only one in 10 sticks smuggled into the country, meaning that around 315 million sticks of illicit cigarettes have permeated into the market. At this rate, the illicit market in Sri Lanka has been projected to grow to 1.2 billion sticks in 2017.
The illegal cigarette trade is not just a local phenomenon; it is a serious global issue, which occurs on every continent and is prevalent in both high and low income countries. 11.6% of the global cigarette market is illicit, equivalent to 657 billion cigarettes a year and $40.5 billion in lost revenue. If the global illicit trade were eliminated, governments would gain at least $31 billion, and from 2030 onwards would save over 160,000 lives a year.1
The illegal trade of tobacco is a popular criminal activity because of the profit margins available to suppliers and the demand from consumers who prefer to buy an illegal product at a lower price than a legal, duty paid product. The greater the expected profits from trading in illegal tobacco, the greater the criminal incentive.
According to the Financial Action Task Force, high taxes on tobacco stimulate illegal trade in tobacco. When a country has high cigarette prices, it encourages criminals to engage in the illicit trading of cigarettes.
Cigarettes remain one of the most commonly traded products on the black market due to factors such as high profit margins, relative ease of movement across borders, low detection rates and inadequate penalties. If all other factors are equal, tax increases on legal cigarettes will increase the demand for illegal trade to take place. Further, it tends to be the affordability of cigarettes (prices and tax rates relative to what people earn) that drives the demand for illegal cigarettes, not just the price by itself.
Differences in prices and tax rates with neighbouringcountries also matter, because high prices and taxes in the destination country allow the criminal to buy cheaply and sell high, whilst still undercutting legal cigarette prices. In fact, most governments and academic research into the subject have confirmed that high taxes are one of the incentives for illegal trade in tobacco to flourish.2 Sudden tax hikes such as those seen in Sri Lanka in recent years, are highly likely to lead to the emergence or growth of smuggled cigarettes.
In addition, tax rises on legal cigarettes are further good news for criminals who already view Sri Lanka as a smugglers’ paradise and do not care about the age of their customers.
Introducing measures to improve enforcement should reduce the expected profits that can be earned from illegal trade and thus, reduce the scale of the problem. One to way to develop effective enforcement is to make improvements to the system of tracking criminals and stopping their activity, thereby increasing the likelihood of criminals being caught.
Moreover, stricter penalties must be imposed on criminals caught trading in illicit cigarettes. Consistent education and public awareness campaigns to warn against the harmful effects of illegal cigarettes can also be an effective measure in countering this problem.
Another measure would be to ensure that prices of legally-manufactured cigarettes are maintained at an affordable level to ensure that smokers are not pushed into buying cheaper illegal products. If the profitability of engaging in illicit trade is greater than the risk of doing so due to the exorbitantly high taxes on legal cigarettes, criminals will still seek to trade illegal cigarettes because in many cases, the demand for cigarettes remain the same.
Policymakers must understand that tax rate increases, which result in widening price differentials lead to an increase in the consumption of illegal cigarettes and therefore take necessary action to reduce this gap.
We need not look too far to see how over taxation of legal cigarettes can trigger an influx of illicits. A closer look at countries like Malaysia and Pakistan where illicit trade is thriving makes it evident that the driving force behind illicit trading of cigarettes is the price gap between legal and smuggled products.
In Malaysia, the Government increased the taxes on legally manufactured cigarettes by 110% over a span of five years. This included four massive increases including an unprecedented 40% increase in November 2015. Consequently, the legal cigarette sales declined significantly whilst illegal cigarettes rose to make up more than 40% of the market.
For smugglers, the current high price of legal cigarettes in Sri Lanka (Rs. 50 a stick) presents an excellent opening to make a profit and the unscrupulous are clearly making the most of the opportunity presented. It is time for policymakers to take serious note of what is happening and take measures to avoid a repetition of the Malaysian situation in Sri Lanka.
In a study of the illicit market of the European Union (15 countries in Western Europe), it was found that a reduction in the affordability of legal cigarettes was accompanied by an increase in the consumption of illegal cigarettes. The main driver of the reduction in legal cigarette affordability was an increase in tax rates.3 The results from the study were consistent with the notion that legal cigarettes being less affordable may be associated with higher levels of illegal cigarette consumption.
Similar studies conducted in Eastern Europe, the Middle East and Africa over the last decade also showed that consumption of illegal cigarettes tends to be higher in countries in which legal cigarettes are less affordable. The studies also showed that an increase in illegal cigarette consumption was always accompanied by an increase in taxation on cigarettes (in real terms) but not always a reduction in the affordability of legal cigarettes.
In studies conducted on several countries in the Asia Pacific region, there was found to be a stronger relationship between changes in the consumption of illegal cigarettes and changes in legal cigarette affordability. This suggests that cigarette affordability does contribute to the illegal cigarette problem, but that other factors also explain cross country differences in the rate of illegal cigarette consumption. On average, illegal cigarette consumption has increased by 1.6% a year in this region, between 2008 and 2013. The largest absolute increase was in Pakistan, where illegal cigarette consumption increased from 14.7 billion to 18.3 billion sticks between 2008 and 2013.4
The same can be said for the Americas, where a decrease in the affordability of legal cigarettes, due to higher taxes, increased demand for illicit cigarettes. Illicit trade also grew at an alarming rate due to the increase in profitability of selling cigarettes on the black market, again because of the huge price differentials. Brazil had the highest level of illegal cigarette consumption by 2013 not only in absolute terms at 35.2 billion sticks but also as a proportion of total consumption, at 31.9% of total cigarette consumption. The lowest level of illegal cigarette consumption in 2013 was Chile, at 360 million sticks.5
The illicit cigarette trade robs governments of tax revenue and increases tobacco-related deaths. Cigarettes are an especially attractive product to smugglers because tax is a high proportion of price, and evading tax by redirecting tobacco products into the illicit market (where sales are largely tax free) generates a significant profit margin for all those involved. The availability of cheap cigarettes increases consumption and thus tobacco-related deaths. Eliminating or reducing the illicit cigarette trade will reduce consumption, save lives, and increase tax revenue to governments.
In Sri Lanka, illegal cigarettes are available in the market for as low as Rs. 20-30 per stick.As it stands, illegal trade of cigarettes destabilises government health objectives, because the availability of cheaper, black market cigarettes increases consumption – smugglers don’t comply with any laws including selling to under-aged youth. Further, the consumption of such products has higher health risks as illicit cigarettes are not subject to product standardisation and other safety regulations followed by legal manufacturers.
The growth of an illegal cigarette market can make the implementation of health policies, more difficult and also result in a loss of tax revenues. Illicit trade can also negatively impact legal retailers’ businesses, diverting profits instead to organised crime, while placing additional pressure on the criminal justice system.
1Joossens L, Merriman D, Ross H, Raw M. How eliminating the global illicit cigarette trade would increase tax revenue and save lives. Paris: International Union Against Tuberculosis and Lung Disease; 2009.
2The Financial Action Task Force, 2012.
3Project Sun – A study of the illicit cigarette market in the European Union, KPMG, 2013
4Illicit tobacco in Pakistan – 2013 Full Year Report, KPMG, April 2014
5Tobacco in Brazil – Industry Overview, Euromonitor, November 2014
(The writer is President, Tobacco Retailers' Association.)
