EXECUTIVE SUMMARY

  The Wine & Spirit Association represents shippers and importers, who are most severely affected by smuggling and cross-border shopping.

  WSA's relationship with HM Customs & Excise is good and the Alcohol and Tobacco Fraud Review has been conducted well, with good consultation within its stated aims, which are mainly directed at diversion fraud. However, on the question of smuggling, it is less successful because it does not tackle the key question of the level of excise duty rates compared with our neighbours in the single market.

  Excise duty rates are massively higher than those in France and many other continental countries and the result is growing cross-channel shopping and smuggling. In 1997, at least 10½ per cent of UK wine sales and 5 per cent of spirits came from the cross-channel market. The growth has paused with the ending of duty-free, but may now be expected to resume with increased vigour. The asymmetry of response means that once people have switched to cross-border shopping or smuggling, it is much less easy to bring them back to the UK market. The erosion of the excise duty base can be expected to climb strongly from its present level.

  The possibility of deterring cross border shopping by reducing duty rates in exchange for a ferry tax on the lines of the passenger tax at airports should be investigated.

  Cross-border shopping naturally leads to smuggling and organised crime. It also negates the efforts of the trade to promote the sensible drinking message and to avoid sales to minors.

  The efforts to control smuggling (through the Alcohol and Tobacco Fraud Review) are inadequate and could produce a public reaction if applied too insensitively.

  The solution must be to review the whole question of the level of excise duties in the UK. In Switzerland, excise duty rates were cut to match the duty levels of their neighbours; the result a doubling of the taxable revenue—producing roughly the same revenue as before, but without the continuing decreases.

  We therefore call on the Government to fulfil its pledge to carry out its previous commitment to a fundamental review of excise duty and indirect taxes.

The WSA

  The Wine and Spirit Association (WSA) represents UK traders in wines and imported spirits, which have a retail turnover of approximately £9 billion and provide £2 billion of duty revenue (in addition to VAT of £1.4 billion)—over a third of the total alcohol excise duty raised in the UK. Our members include major traders (wholesalers and retailers), including many who trade a large proportion of the whisky, gin and vodka sold in the UK. We also include a large number of small enterprises as members. Our strength is in the bringing of alcoholic drinks onto the UK market—precisely the activity that raises excise revenue. In addition we represent UK winegrowers and the producers of British wines.

  UK traders are disadvantaged by cross-border shopping and smuggling more than producers—a manufacturer will generally get a benefit from a sale, whether it is in the UK or in France, while the UK trader loses everything if a product is sold outside the UK. The exception is the producers of English and Welsh wines who are faced with growing cross-border shopping and smuggling from their heartland (much of the industry is concentrated in Kent and Sussex) and for whom exporting to France in order to sell to day-tripping British customers against cheap French wines is not economically viable.

Relations with HM Customs & Excise

  In general, the WSA has found Customs to be helpful in handling problems and open in consulting about changes to the system. A good example is the Alcohol & Tobacco Fraud Review (ATFR), which is concerned with drawing up a series of measures, mostly designed to eliminate the problems of "diversion fraud" (under which, duty-free drink which is destined to go abroad is diverted onto the home market without paying any duty). The review has been conducted openly and the WSA has co-operated totally in working out practical ways of implementing the recommendations. We believe that the main problems are being overcome and we acknowledge HM Customs & Excise's realism in tempering the recommendations to practicalities. This is important because what may be practicable for a manufacturer (eg lot marking) may be far less acceptable for a trader, who has to handle a large number of different products from producers all round the globe.

  In this submission, the emphasis is on smuggling (from overseas), together with the related question of legal cross-border shopping, as opposed to diversion fraud. We believe that the problem of diversion fraud is a temporary one, which will become much less when a computerised system of tracking cargoes across Europe is implemented. However, there are two points which must be made:

—  The measures which have been announced will add significantly to the costs of traders, yet the primary beneficiary will be HM Customs & Excise.

—  There is always a danger in setting targets for individual Customs Officers that they will take the easy way out and serve maximum fines on legitimate traders who have small errors in their paperwork, rather than tackling the real criminals. There was some evidence of this at one time but, since we drew HM Customs & Excise's attention to the problem, we believe that it is now much less serious.

  We believe that the right measures are being taken to combat diversion fraud and we look forward to seeing the problem lessen. However, the same cannot be said for smuggling duty paid goods from abroad (at lower duty rates) to resell within the UK without paying the extra UK duty. We believe that HMC&E is not putting as much emphasis on this and that the correct question to be asked is the one which was ignored by the Anti-fraud Review—"are Excise duties in the UK simply too large in relation to our neighbours?". This question was specifically excluded from the ATFR. It affects legitimate cross-border shopping as well as smuggling, each of which are outside the trade's control and cause damage to the trade as well as losing massive amounts of excise revenue.

  In the next three sections we shall examine excise duty in general, the pattern of smuggling and cross-border shopping, the links with crime and HM Custom & Excise's response.

Excise duty in general

  Although there has been tax on Alcohol since the 13th Century, it has only been an important revenue raiser since Excise Duty was imposed on it in the 17th Century. At that time, strong alcoholic drink was seen as a potential health hazard if available cheaply to ordinary people. Another justification for taxation of alcohol in more recent years has been that wines and spirits have been seen as a luxury for the rich. However, nowadays, spirits and wine—consumed by 65 per cent and 68 per cent of all adults respectively, compared with 64 per cent for beer—are seen as part of everyday consumption by ordinary consumers, whilst recent published works suggest that red wine and other alcoholic drinks are beneficial to health if taken in moderate quantities. Alcohol misuse is still a problem, but it is being tackled in different ways—the WSA has contributed to the National Alcohol Misuse Strategy and supports the work of the Portman Group against misuse of alcohol by education, codes of conduct and publicity. Excise duty is therefore simply being used as a means of raising revenue; and because of its high level it inevitably leads to distortion and inefficiency in allocation of resources.

  An analysis of elasticities by the Institute for Fiscal Studies (IFS) in 1999 concluded that the duty level on spirits was near to the revenue maximising level and could even be above it, whilst the duty on wine was close, but below the revenue maximising level. This means that consumer resistance to duty increases on spirits is such that any further increases in duty could produce a decrease in revenue while from wine the gain would be minimal. It also means that there is a strong incentive for consumers to obtain their purchases from overseas, either in person through cross-border shopping or indirectly through smuggling. The consequences of this are the subject of the next sections.

Cross-border shopping and the end of duty-free

  Ever since the opening of the single market in 1993, consumers have taken advantage of the opportunity to travel abroad (particularly for day trips to France) to purchase wines and spirits at lower rates of excise duty for their own use. The difference in excise rates between the UK and France is staggering (see Appendix) and the effect on people's behaviour is dramatic. There is no legal bar to this and such purchases have risen continually over time, particularly in the case of wine, where the latest statistics (for 1997) show an increase of 40 per cent in the revenue lost to the UK over the previous year, to £140 million. In all, the loss in UK revenue from legitimate purchases of all alcoholic drinks amounted to £245 million in 1997 and has continued to grow. However, this is not the end—there is also the loss of revenue from British jobs in distribution and retailing and associated industries like packaging and bottling. The damage to traders has been serious, but it is difficult to estimate, because the trade was anyway in a period of flux because of the increasing market share being taken by the supermarket chains.

  In July 1999, duty free shopping on intra-EU journeys came to an end. Initially, the effect of this is to increase UK revenue, since some who had purchased duty free will now purchase in the UK; in addition, the higher fares charged by ferries following the end of the cross subsidy from duty-free sales deter cross channel shopping and hence promote duty-paid sales in the UK. These gains to the UK trade will do something to offset the substantial loss from the closure of duty-free shops, particularly in airports.

  However, in the medium term we expect there to be a new surge in cross-border shopping which will cut further down on the tax base. Competition is forcing down fares again and the ferries are equipping themselves with shops to sell alcohol and tobacco (and other goods) at French duty-paid rates, with the aim of replacing the high margins previously gained from duty-free by higher quantities at French tax rates. Spirits are being sold at the same price as the former duty-free (but without the limit of 1 litre per person) and beer and wine at prices similar to those in Calais. Shoppers can shop at French prices without even leaving the ferry—in one case pedestrians and coach parties can purchase on board and have their goods delivered to their cars or to the coach at Dover. Moreover, the ferries, with their strong UK bases, will be able to market the new services heavily in the UK. Similar opportunities are offered on other ferry routes. In effect, the ferries are becoming powerful new retailers of wines and spirits at French prices. This will take a little time, since many of the necessary investments have still to be made and the public has not yet adjusted to the new opportunities, but in the end we expect renewed growth of cross-border shopping.

  The initial increase in ferry fares because of the ending of duty free was not enough to outweigh the attraction of buying in France to overcome the extremely high UK excise duty. Nevertheless, it was a disincentive and could have deterred some. A possible way to tackle the problem would be to reduce duty rates, and to replace the revenue by a tax on all ferry movements on the lines of the airport tax, providing a double disincentive to shopping abroad. This would need to be worked on in detail but we believe that such an approach is the only way to reduce cross-border shopping without losing revenue.

  If nothing is done to reduce excise duty, the share of the wine and spirit market that is taken by cross-border shopping will continue to increase. Simple models that suggest that the market will quickly reach an equilibrium that depends on the excise duty difference are missing the dynamic elements of the market:

—  Cross-Channel shoppers take time and investment to learn the appropriate ways (for them) to travel, where to shop, what to buy, (not just alcoholic drink, but also cheap petrol, French food etc). However, once they have found out how to do it, the savings of a journey are much greater and the enjoyment of a family day out in France (especially if there are children) is such that a much lower incentive is needed to keep them going again in future. There is therefore an asymmetric effect—once "converted" to cross-channel shopping, a consumer is less likely to stop.

—  As cross-channel shopping grows, it becomes more convenient, since suppliers and ferry companies can afford to invest in better facilities. The shops in Calais have arranged their displays to attract the British buyer and many British retailers (Sainsburys, Tesco etc) have set up shops in France and are planning to expand. Moreover, advertising and direct mail by retailers and ferry companies give simple instructions on how to shop in France and the savings to be obtained. This process can be expected to continue as the ferries begin serious marketing of duty-paid drinks.

  The comparison is with long-term shifts like that towards own brands in supermarkets. It suggests that we are nowhere near equilibrium and that any increase in duty rates would accelerate the trend and raise the final level. The published figures are not up to date and are distorted by confusion with smuggling, but they suggest that growth is continuing. We believe that the ending of duty-free will, after a pause, contribute to this growth and hence threaten the revenue base. However, it is hard to quantify until the post-duty-free system has settled down and the research data have been analysed. It would be sad if wines and spirits were to go further down the road towards the position of tobacco.

The links between Cross-Border shopping, smuggling and crime

  Cross-border shopping creates manifest unfairness by allowing those who are in a position to spend a day in France to benefit lawfully whilst others cannot do so. This brings the law into disrepute and creates the atmosphere that "buying some extra for a friend" is considered by many to be neighbourly rather than illegal. Breaking the law is seen by some as fun rather than a crime, and such an attitude creates the opportunity for real criminals to move in, just as they did in the days of prohibition in the USA.

  And serious criminals have indeed moved in. Smuggling has taken off and HM Custom & Excise is quoted as saying that drug traffickers are drawn to alcohol and tobacco by high returns and the less severe punishment available to the courts. From this, the criminals are branching out into other forms of fraud and not just cross-channel smuggling. The seizures of HM Custom & Excise have doubled and may still only be the tip of the iceberg.

  Social consequences of smuggling and other forms of fraud go way beyond giving consumers cheaper drinks at the expense of HM Customs & Excise. The WSA supports measures taken by the government to promote sensible drinking and reduce alcohol misuse, but they will not work if a significant part of the supply is coming through smuggling by criminals. The limitations on behaviour observed by good retailers are flouted by such people as drug dealers, who often target schools. Reports of 10-year-old schoolchildren playing "chicken" with traffic on the Ashford by-pass when under the influence of strong bootlegged lager are an indication of a growing menace. Moreover, such flouting of the law encourages other types of crime, including violence and intimidation (again parallel to prohibition)—clashes with police in Dover are a sign of this.

  Measurement of smuggling is difficult for obvious reasons. HM Customs & Excise estimates that, in 1997, 10½ per cent of all wine consumption and 5 per cent of spirits were collected by shoppers going abroad, including smuggling in cars and vans, but excluding the rapidly increasing crime of smuggling in HGVs and containers. Even if we accept their estimates, this is an enormous figure and we believe it to be rising rapidly (see the previous section).

  The progress of cross-channel shopping and smuggling is worrying for the trade. We believe that present models are inadequate to describe the long-term loss to the revenue base that is taking place. Not only is the market share currently taken away from UK suppliers a serious drain, but also the investment in distribution facilities across the channel and on the ferries represents a challenge for the future. We believe that the government is not taking this threat seriously enough and that an analysis of the longer-term trends is required before control is lost completely. We would be happy to invite the Committee for a visit to Calais to demonstrate just what is happening.

HM Customs & Excise's response

  As stated earlier, the main emphasis in the Anti-Fraud Review has been on diversion fraud. Nevertheless, there have also been strong increases in the powers of HM Customs & Excise to punish smugglers. However, with the comparatively small resources devoted to the problem, combined with the difficulty of identifying at the port whether a consignment is a case of legitimate cross-border shopping or not, the powers are not in place to stem the tide. The review on its own is not the answer to the growth of smuggling and fraud (nor of course will it affect the damage to the trade from the rapid growth in legitimate cross-border shopping). Smugglers and fraudsters will invent ways of getting round regulations as fast as they are imposed. As long as the pressure from tax differencies persists, trying to stop the flood is reminiscent of Canute's attempt to stop another form of cross-channel flow. Other countries with similar problems (notably Denmark and Switzerland) have seen the need to reduce excessive duty rates before the cross-border traffic became too large to bear.

  The experience of Switzerland is instructive: pressure of cross-border shopping caused the Government to reduce excise duties by 50 per cent earlier this year, making them equivalent to their neighbours; the result was that the incentive for cross-border shopping and smuggling disappeared and internal sales doubled, keeping the total revenue take roughly constant and halting the continual reduction that had been seen previously.

  Relying too much on policing by HM Customs & Excise could produce a public reaction. Tough powers could easily catch the comparatively harmless while the real villains go free. Many of the proposed measures are so strong that a legitimate trader who fills in a form wrongly is liable to heavy penalties, whilst cross-channel shoppers could find that what they see as a harmless purchase of "a little bit for the neighbour" may result in heavy fines, confiscation of their vehicles, imprisonment, loss of social security &c. A few hard luck cases could bring the whole policy into disrepute. The WSA supports the crackdown on smuggling, but it should be combined with a reduction in the excise duty levels which provoked the smuggling in the first place.

Conclusions and recommendations

  The efforts by HM Customs & Excise to control the inflow of smuggled goods are failing. One merely has to look at the experience of traders trying to sell modest wines to restaurants in the South-East—hardly feasible in many areas to a legitimate trader—to realise that much more radical thinking is needed. The current allocation of resources to combat smuggling is inadequate and tends to be aimed at tobacco. Anyway, it does not tackle the problem of legitimate cross-border shopping, which is steadily increasing and eroding the Excise duty tax base.

  Economic modelling is needed on the future course of smuggling and cross-border shopping if there is no general decrease in taxes. We believe that the expansion in the market sector supplied by duty-paid sales in France and elsewhere is continuing to grow and will reach a much higher level than at present. HM Customs & Excise are watching their tax base shrink and far less revenue will be collected in future if nothing is done. However, waiting to cut duty rates until the market has adjusted will be too late. The asymmetry of conversion is going to make it much more difficult to decrease the number of cross-channel shoppers than it was to persuade them to start.

  The solution to these problems is to cut duty rates on alcohol speedily. We believe that the same approach which was so successful in direct taxes—to eliminate most of the exceptions and to lower the general level of income tax—could have a parallel here. Limiting the differences between the indirect taxes on different products would reduce the distortions in consumer decision and would limit the growth of cross-border flows.

  Before the last General Election, the Labour Party announced that it would carry out a fundamental review of excise duty, but this has not taken place. We call on the Government to implement such a study now.

11 October 1999

Notes:

  This does not include VAT, which is 20.6% in France and 17.5% in the UK.

  Strength: Intermediate products (including fortified wines) are 15-22% vol; Sparkling wines are 8½-15% vol; still wines are 5½-15% vol.

  Exchange rate: Assume Ffr10.3=£1.00.