Monday, 4 February 2019

In denial about the black market

As covered by City AM (and no one else, as far as I can see), the World Bank has produced a report about the illicit tobacco trade.

If you thought a UN agency would ask a disinterested economist to investigate this topic, you'd be sadly mistaken. Instead, they got Sheila Dutta, a 'public health' professional, to put the document together and so the top line is that the rise of black market tobacco has got next-to-nothing to do with economic incentives, ie. high tobacco taxes... 

The tobacco industry commonly argues that higher taxes and prices (as well as other tobacco control measures), will motivate customers to buy illegal products rather than smoking less or quittin, and that this will impact tax revenue without a decline in tobacco use. Numerous empirical analyses, across a diversity of countries - including the case studies presented in this report - refute this argument.

This bald (and bold) assertion is watered down slightly a few pages later when she says:

Tobacco taxes play only a minor role in illicit trade

The suggestion that increasing tobacco duty does not lead to more black market activity does not reflect bitter, real world experience and is not even borne out by the report itself. It is fitting that the first chapter looks at Australia which had a negligible illicit trade in tobacco ten years ago but now has an endemic problem thanks to exceptionally high taxes. Contrary to the top line of the report, the authors of that chapter acknowledge that tobacco tax rises may 'heighten incentives for criminals to expand the illicit tobacco market’ and ‘can work to stimulate the trade in illicit tobacco products by decreasing the affordability of tax-paid tobacco and increasing profitability for those undertaking illegal activities.’ This should be obvious.

Similarly, in the chapter on Ireland, it says: ‘A high rate of tobacco excise, and the consequent high price of tobacco products, make Ireland attractive to those involved in the illicit tobacco trade.’No kidding.

The chapter on the UK notes that: ‘Following a series of tax rises, the illicit tobacco trade increased rapidly in the 1990s.’ The authors go on to claim that the illicit trade was brought under control in the first decade of this century by increased enforcement. Whilst enforcement doubtless played a part, a more likely explanation is that tobacco duty was frozen in real terms from 2001 until 2008.

In recent years, however, there have been large, above-inflation tax rises and, unsurprisingly, the share of the illicit market has grown. What a coincidence.

Incredibly, the authors portray Britain as a success story because the size of its black market declined after the boom year for booze cruises of 1999 (the impact on legal cigarette sales of that little splurge can be clearly seen below).

According to HMRC, the UK government lost between £1.7 billion and £3.2 billion of tax revenue in 2016/17 thanks to black and grey market tobacco sales. This is considerably more than was lost in 2010/11 and is only slightly less than was lost in 2005/06, despite there being far fewer smokers around today. If this is a success, I’d hate to see what failure looks like.

Nevertheless, the report says:

The UK experience underlines that eradicating smuggling is an issue of enforcement. Cutting tobacco taxes is not an effective method of reducing the illicit trade.

The idea that the UK has any lessons to teach about 'eradicating (!) smuggling' is genuinely laughable. It has one of the biggest - if not the biggest - problems with illicit tobacco in Europe.

As for the notion that cutting taxes would not reduce the illicit trade, imagine if cigarettes in the UK cost the same as they do in, say, Spain (around £4). Would British smokers still go to Spain to buy their cigarettes? Would they still buy cigarettes from a man down the pub for £5? Obviously not. The idea is ludicrous.

It is delusional to deny the relationship between price (driven by tax) and illicit activity. Money is literally the only incentive for buying and selling illicit cigarettes.

This is not to say that there are not things governments can do to alleviate the problem, but the problem wouldn't exist at all without sin taxes. There is a strong and consistent relationship between the magnitude of tobacco taxation and the size of the illicit market. In the EU, countries such as Britain and France, which have the most punitive taxes, have the biggest black markets. In New York, which has the US’s highest tobacco taxes, more than half of the cigarettes smoked are bought out of state.

You already know this, of course, because you are not an idiot. Who does Ms Dutta think she's kidding?

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