Increasing tobacco taxation is a rational and effective fiscal and health policy. The price incentive has prevented thousands of premature deaths and is responsible for thousands of teenagers not starting to smoke. However, despite recent steep increases, cigarettes are still more affordable than in the 1960s and it is necessary to "run to stand still" to maintain the price disincentive to smoke as incomes rise. ASH's primary concern is to ensure that the policy of above-inflation tobacco price rises through a steep excise duty escalator continues.

  Tobacco smuggling has reached serious proportion in the UK—accounting for about 16 per cent of the cigarette market and the majority of the hand-rolling tobacco market in 1999. The majority of cigarette excise fraud is not, as widely supposed, small-scale cross-Channel bootlegging. Three quarters of the cigarettes smuggled arise from large-scale fraud in which container-scale consignments are diverted from their supposed intended destination into an illegal distribution network by criminal gangs.

  The economics of container-scale fraud are driven primarily by the difference between taxed and untaxed prices and not by cross-Channel tax differentials. Some of the lowest tobacco tax jurisdictions have the highest levels of smuggling, for example Spain. Lowering or freezing tobacco taxation is an ineffective strategy in tackling large scale tobacco smuggling.

  Tobacco companies benefit from tobacco smuggling in at least four ways:

1.  The manufacturers still sell the cigarettes to the wholesaler and profit from the sale of products eventually sold illegally;

2.  Smuggling keeps cheap cigarettes on the market and insulates some smokers from the price incentive to quit;

3.  The tobacco industry can and does argue for lower taxes in the legal market—thus increasing legal demand;

4.  In some countries the tobacco industry has been shown to be orchestrating smuggling operations as part of marketing operations and to fight price wars.

  There should be no question of freezing or reducing tobacco taxes because of criminal activity. The appropriate response is revenue protection and prosecution of criminals.

  A freeze or anything but a very deep cut will have little impact on tobacco smuggling. Although smuggling is ultimately driven by high taxation, changes at the margin will have little impact on cross-border smuggling and none at all on container scale fraud. The scale of smuggling is primarily determined by the steady accumulated growth of distribution infrastructure and criminal participation, mitigated by the risk of prosecution and scale of penalties.

  A tax freeze or tax reductions will have no positive effects, but three negative effects:

1.  Revenue will fall. The effect of the price reduction in the legal market will more than offset revenue effects caused by extra smoking or reduced smuggling, which will in any case be negligible;

2.  Smoking will increase. Reduced or frozen prices in the legal market will stimulate demand, especially among the young;

3.  Criminal activity will have been rewarded. The UK will be held up by the tobacco industry as an example of the failure of one of the most important and effective tobacco control policies.

  Measures to tackle smuggling should include:

—  Resources: Substantial increases in Customs & Excise and police resources deployed—personnel, sniffer dogs, detection equipment etc. The £35 million Comprehensive Spending Review resources are just five pence in each £10 tobacco revenue lost;

—  Co-ordination: there must be an EU-wide response, extending to the accession states;

—  Responsibility: A "duty of care" regime in which responsibility for diversion fraud or selling to a fraudster is retained by the manufacturer and intermediaries in the distribution chain—this approach is used in the management of hazardous waste in the UK;

—  Tracking: all movements of duty upaid tobacco should be logged centrally and arrival confirmed and checked. Packs, cartons and cases should be uniquely encoded at the place of manufacture and tracked through the distribution chain;

—  Licensing: all participants in the distribution chain, including cash and carry wholesalers, would need a licence to handle tobacco products and would lose this if implicated in excise fraud;

—  Legal status: tax-paid security markings to indicate whether the products are sold legally and to indentify the origin of the product;

—  Disincentives: Penalties should be set at a level that creates a meaningful economic disincentive;

—  Policing: police should be required to intervene on street-level illegal distribution, car boot sales etc. It should not be allowed to become an "acceptable crime";

—  Challenges: make it easier to challenge the bootlegger's "personal use" excuse;

—  Politics: UK should invest effort in persuasion of EU partners to raise taxes to UK levels (rather than, for example, campaigning to "save" duty free).

Scale of UK tobacco fraud

  Treasury and Customs & Excise estimates tobacco tax losses (including VAT) of £2.5 billion. These figures imply that smuggled tobacco accounted for about 16 per cent of volume in the UK in 1999.

  *Container-scale diversion fraud—the balance betwen total and other types of fraud.

  This is part of a growing worldwide pattern. Comparisons of world cigarette imports and exports for 1996 suggest that over one third (400 billion pieces) of exports (1,107 billion) do not reappear as imports (707 billion). In 1980, 21 per cent of traded cigarettes (69 billion) "disappeared" in this way, but trade was only about one third of current levels.i

HM CUSTOMS AND EXCISE CONSULTATION ON FISCAL MARKING OF TOBACCO PRODUCTS

Proposal

  The proposal is to add a marking to packaging of cigarettes and hand-rolling tobacco as follows[8]:

  The marking would be printed on the pack during manufacture or prior to importation. Every pack sold legally in the UK would have to display this marking.

Summary of Response

  Overall, we believe the proposal is far too weak to constitute an adequate or proportional response to the enormous problems of tobacco smuggling. Our concerns are set out in the attached note, but they are, in summary:

—  The UK Duty Paid pack marking does not actually mean duty has been paid and this will be ineffective against many types of "diversion" or large scale fraud. Tax stamps, which do indicate that duty has been paid are far better;

—  The marking is easily counterfeited—and this may create a perverse incentive for smugglers to seek counterfeit product;

—  The proposal contains no markings for tracing tobacco products through the distribution chain—thus assisting in detection and prosecution. We would like to see secure, unique identification markers placed on every pack;

—  The penalties are far too weak. The fines should be proportional to the gains that may be made and, given that the distribution chain has shown itself to be incapable of controlling smuggling, a licensing system should be introduced with the power;

—  The markings are not embedded in a secure system for tobacco distribution in which each level of distribution, up to and including the tobacco companies, has a "duty of care" not to sell to organisations that may ultimately sell to smugglers;

—  We welcome the proposal for dealing with forestalling. A tax stamp—which implies an earlier duty point—should also be time limited, for the same reasons;

—  We are concerned about the apparent willingness to be led by the tobacco industry in this area—evident in this consultation and in the Alcohol and Tobacco Fraud Review. It is important that Customs and Excise recognise that the tobacco industry gains substantially from tobacco smuggling, and has been involved in its facilitation in a number of jurisdictions.

"UK Duty Paid" marking

  The proposed pack marking "UK Duty Paid" does not actually mean that duty has been paid—it is simply printed on the packet during manufacturing. Conceptually it is no different to printing "intended for legal sale in the UK" on a pack, though it sounds much more authoritative. Tobacco products bearing such marks may be illegally diverted from the duty-suspended distribution chain and, through a variety of routes, enter the illegal distribution chain without duty being paid. This is a common form of fraud against which the marking is ineffective.

  There appears to be nothing to stop tobacco products bearing these marks being legally exported from the UK without duty being paid. Consignments could then be illegally reimported, perhaps described as a completely different product. This is not unlike the practice of some manufacturers of exporting UK manufactured tobacco products with UK health warnings—an approach that facilitates illegal re-import and subsequent resale.

  There appears to be nothing to stop cigarettes with these markings being exported to Belgium and sold at Belgian duty-paid outlets near the Channel ports that currently supply the "white van" bootlegging trade.

  Overseas tobacco manufacturers could print the "UK Duty Paid" markng on packs supposedly intended for legal UK import, but a wholesaler could sell the consignment to a different country or divert it from the duty-suspended distribution chain and illegally import it into the UK without paying duty.

  The marking is very easy to counterfeit. If the marking does somehow inhibit the smuggling of legally manufactured brands, it may have the perverse effect of placing a premium on counterfeit product—on which the marking can be easily forged and made available to smugglers seeking a supply of packs that have the UK Duty Paid marking and a long sell-by date.

  There is no reconciliation of the number of packs printed with the marking and the amount of duty actually paid by the manufacturers. In our view, the tobacco companies should be accountable for duty for every pack on which the marking is placed.

  The reason given for not introducing tax stamps—ie markings that mean that duty has been paid—is that it would take the tobacco industry too long to comply. The source given for this analysis is the tobacco industry. In our view, it is totally unacceptable for the Government to rely uncritically on advice from the tobacco industry. The tobacco industry benefits enormously from smuggling and smuggling is a central plank of its extensive campaign to have tobacco taxes reduced.

Anti-forestalling "Sell-by" date

  The date-limited component of the proposal is welcome. It is clear that forestalling has been a source of considerable lost revenue and has worked to undermine the health impact of Government's previous commitment to raise duties by 5 per cent per year in real terms. Forestalling is caused by strategic behaviour by tobacco companies to avoid duties. We believe this will also assist retailers, for whom the glut of pre-budget cigarettes on the market in the post-budget months can create serious pressures. As the wholesale supplier Booker explains in its annual report.

The timing of the tobacco duty increase affected our retailer customers' liquidity in the critical pre-Christmas trading period. Retailers bought tobacco stocks in advance of the duty increase but, following its implementation, consumers switched to buying price-marked packs of economy brands which continued to be available at the pre-budget price for several weeks. Until these ran out at the wholesalers, retailers were unable to sell the regular packs at the new increased price and in addition had to buy further stocks of the price-marked economy packs. Consequently they suffered a cash squeeze which reduced their spending on higher margin non-tobacco products. (Booker plc, Annual report and financial statements 1997. Page 3. 1998).

Offences

  The proposed fines appear to be small compared to the gains that can be made by excise fraud. While we recognise that other offences may be relevant to excise fraud we believe that the courts should have the power to levy fines that are proportional to the scale of the offence.

Major omissions from the proposal

  The proposal falls far short of what could be done and what is needed—it simply is not a proportional response. We believe that fiscal markings should be part of a system that aims to create a secure "custody chain" for tobacco products. It should be noted that high value pharmaceuticals (such as morphine) move through distribution without large scale losses. The approach taken to movements of hazardous waste (which can leave legal transit and be passed to fly-tippers) is to have a "duty of care" in which each person handling the material is responsible for the conduct of the person that they send the material to. Such principles should underpin a rethink of the tobacco distribution system. The practical elements of such a system would be:

—  Tax stamps that indicate that duty really had been paid—these should be secure-printed to avoid counterfeiting;

—  Tax stamps should be time limited to avoid forestalling;

—  Each pack, carton, case and container should be coded with a unique machine-readable identifier—like a serial number;

—  The identifier should be used for tracking products through the distribution chain; identifying the source of smuggled product; detecting fraud; gathering evidence for prosecutions and deterring potential smugglers;

—  Anyone handling tobacco in manufacturing, wholesale or retail distributions should be licensed and risk losing the licence if implicated in fraud.

Tobacco industry influence

  We are very concerned that the proposal appears to have been excessively influenced by the tobacco industry. The tobacco companies benefit from smuggling in three ways: they are still paid by wholesalers for cigarettes that are eventually smuggled; smuggling ensures a supply of cheap cigarettes on the market which helps to keep wavering smokers hooked; and, most importantly, the tobacco industry can, and does, argue for reduced taxation (and therefore increased consumption) in the legal market.

  The only argument advanced against the much more effective approach of introducing tax stamps is "the Government has so far accepted the arguments of the tobacco industry that tax stamps would take longer to introduce because of the need to acquire new machinery" [9] (para A7.1).

  In the Alcohol and Tobacco Fraud Review tax stamps were dismissed as ineffective and too costly:

". . . the introduction of tax stamps would not in themselves make a significant contribution to the prevention of fraud and smuggling",

"Given the costs for Customs and for the trade involved in the introduction and use of tax stamps we do not recommend that any further consideration is given to their use . . ." (ATFR para 8.8.2)

  No cost benefit analysis was presented to justify this argument, and given that tax stamps operate in other jurisdictions, it is a claim made without foundation. If Customs believes tax stamps to be ineffective against fraud, the proposed markings would be more ineffective. In our view, the comfort of the tobacco industry must not be a major consideration when there are excise losses of £2.5 billion. Very large expenditures can be justified to protect the legal distribution chain from fraud.

9   Joossens, L, for WHO Framework Convention on Tobacco Control Technical Briefing Series Paper 2. Improving public health through an International Framework Convention on Tobacco Control. 1999. Back