Tobacco Taxes: A Smuggler’s Boon?

From: Business Today Egypt

As the government raises taxes on cigarettes hoping to deter smokers, is an illegal tobacco market growing in Egypt?

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.

Banking on uptraders
As an international player in the market, Refaat doesn’t mind a fair game. What bothers him is the ability of illegal brands to attract upscale smokers. “A consumer who […] is considering upgrading to [our] brand finds another pack that looks like [an] international [brand] but [is] cheaper,” he says. “The problem with this pack is that it does not respect the standards issued by the Egyptian Organization for Standards and Specifications (EOSS), which means you have no control on the degree of tar or nicotine in the cigarettes.”

Cigarette producers are bound to EOSS specifications and undergo periodical inspections by government labs. Should they be found non-compliant, they could face very aggressive measures, which Refaat did not share, but BAT has not been in that position since they started operating in the market 10 years ago.

In light of the two excise hikes, Refaat says, “We have seen our volumes continue to increase, which means that people like our brands, and we have seen our market share solid and fighting. But we think we could have grown better and that we are losing what we call an uptrading opportunity.”

Most smokers that have fallen through the cracks into the illicit market have been attracted from the lower end of the market, which is mainly dominated by local producer Eastern Tobacco Company.

Direct marketing ban
Egypt’s 1977 anti-smoking campaign began with the prohibition of tobacco advertising and a decision to place health warnings on cigarette packs. In 1981, the campaign culminated in a law banning smoking on public transport.

The graphic health warnings that now cover approximately half a pack have been long in the making and have also been met with resistance from the tobacco industry. “Tobacco companies are against any decision that would lower demand for their products,” El-Awa says. “For example, they were against the graphic health warnings on cigarette packs.”

The warnings are relatively mild compared to those on cigarette packs in North America or Europe, for example, which show cancer-infected lungs or yellowing teeth.

“We didn’t go straight for the diseased body parts because a field study carried out by the Ministry of Health showed that people on the street did not understand what the organs were,” El-Awa explains. Nevertheless, Egypt has adopted a system of changing the warnings on the packs every six months, and El-Awa promises that the next batch will be more sternly worded.

While tobacco companies like BAT honor the ban on direct marketing, many find ways around it. El-Awa points to a few examples of indirect marketing that are more evident: from sponsored tobacco kiosks to brand-sponsored cafes and restaurants and social campaigning tactics to attracting shifting smokers.

Responsible smoking
Illegal packs are easy to identify as they do not have the graphic health warnings imposed by the Ministry of Health and they do not bear the label that prohibits selling cigarettes to smokers under 18. While acknowledging that it’s a controversial issue, Refaat comments on how BAT is respecting choices and how it does not encourage people to smoke.

“We know [this is] a controversial business so we want to do it in a responsible way by not selling to underage people and not selling outside the law,” he says, describing BAT’s stance on public smoking. “We launched the ‘Respecting the Choices’ campaign, which promotes respecting the choices of smokers and non-smokers.”

Run a couple of years ago in cooperation with the Tourism Promotion Authority, the campaign places signs and leaflets in a number of hotels across the country. BAT also assists hotels, restaurants and cafés that want to allow public smoking by subsidizing the necessary ventilation and installations that respect the choices of smokers and non-smokers.

“We do recognize that tobacco selling does entail health risks and we do insist that our tobacco selling campaigns be linked to a very simple formula: we will sell cigarettes to people who are already smokers, we will not encourage anyone to start smoking, we will not incite anyone to smoke, we will not do anything that can even remotely be labeled as encouraging smoking, even if in some countries encouragement or media or advertising is allowed, BAT does not do that.”

Without a doubt, there is a growing tobacco consumption trend in the region that cannot be pinned on one specific reason. However, El-Awa blames it on the absence of a comprehensive strategy throughout the region and the failure to systematically apply the laws.

“Our ‘Global Youth Tobacco Survey,’ which is carried out across the region every four years, has found that the age for starting smoking is actually less than 13 in all the countries in the [Eastern Mediterranean],” she says.

Currently, adult Egyptian women are a very small segment of the tobacco market, but statistics show that younger women are the bigger consumers. In 10 years, the consumption level among adults will increase.

“If trends continue at this rate, the adult consumption among women will increase and the difference between male and female consumption levels will be bridged,” El-Awa says.