BWorld 218, Tobacco taxation, smuggling and plain packaging

* This is my column in BusinessWorld on June 04, 2018.

“To cease smoking is the easiest thing I ever did, I ought to know because I’ve done it a thousand times.” — Mark Twain

On May 29, 2018, I attended the “Health for Juan and Juana” conference on universal health care (UHC) at the PICC, jointly sponsored by the DoH, ADB, PHAP, MeTA, Havas, AC Health, others.

It was a big event with many participants and high-powered speakers and facilitators from national and local governments, multilaterals, NGOs, academe and private players.

Listening to the health officials of Davao, Makati, Bataan, and South Cotabato, I got the impression that with the way they provide health care to their constituents, it is possible to abolish the DoH and realign its budget to LGUs.

The keynote speaker was Sen. JV Ejercito, Chairman of the Senate Committee on Health and Demography and he talked about his UHC bill, the public consultations, the financing including his proposal to further hike tobacco tax to P90/pack. It is a far-out number compared with P30/pack in 2017 under Sin Tax law of 2012 (RA 10351), to become P35/pack in 2018, P37.50 in 2019, then P40/pack in 2022 under TRAIN law (RA 10963).

Since corruption in government remains high, higher tax rates mean higher tax avoidance. Lots of cigarette smuggling occurred in 2015-2016 involving billions of pesos of avoided taxes. In February 2017 for instance, the Bureau of Customs estimated that some P50B of foregone taxes in 2016 were due to smuggling, about P16B of it was from cigarette smuggling.

If the numbers are correct and if we divide P16B over P29/pack excise tax in 2016, that was equivalent to 552 million packs of cheap cigarettes. Cheap cigarettes encourage more smoking and, as a result, higher tobacco taxes achieve an opposite result.

With higher tobacco tax this year because of TRAIN law, cigarette smuggling has continued.

For instance, a BusinessWorld report on May 01, 2018 said “DoF warns cigarette smuggling may be helping finance terrorism.”

DoF Secretary Sonny Dominguez was quoted, “Illegal money can end up funding terrorist activities” while Customs Commissioner Caesar Dulay said that “smuggled cigarettes are currently flooding the market.”

High taxation and explicit prohibitions are often two sides of the same coin. One policy done by governments abroad is the prohibition of displaying the tobacco companies’ names, logos, and brands via plain packaging policy. So all cigarette packs by all players, old and new, established or fly-by-night, will display similar designs and graphic warnings.

After implementing plain packaging policies since December 2012, illegal tobacco consumption in Australia has increased from an estimated 11.5% to 13.5% in 2012 to up to 15.0% in 2017 (source: KPMG, “Illicit Tobacco in Australia, Full Year 2017 Report,” April 20, 2018).

This because many new players, including those engaged in criminality and terrorism, have come in, produced cheap cigarettes since plain packaging is much easier to copy, and attracted more buyers and smokers.

The United Kingdom also enacted the plain packaging policy in May 2017 and after one year, (1) no significant decline in smoking incidence happened, partly or largely because (2) cheap counterfeit plain packs surfaced.

The counterfeits were found to have high tar, nicotine, and carbon monoxide than those allowed in UK, and in some cases, are found to contain heavy metals such as arsenic, cadmium, and lead, along with other toxic contaminants: asbestos, mold, dust, dead flies, rat droppings — and even human excrement. (Sources: The Times, “Illegal tobacco tainted by asbestos and rats,” May 16, 2017; Evening Standard, “Sniffer dogs with GoPro bodycams help uncover 30,000 fake cigarettes in Soho crackdown,” May 24, 2017).

Meanwhile, the World Justice Project (WJP) produces an annual study, the “Rule of Law Index” (RoLI) and score countries based on their performance on 8 factors and 44 sub-factors. The RoLI 2017-2018 Report involves more than 110,000 households as respondents and 3,000 expert surveyors in 113 countries and jurisdictions.

A summary is shown below, focused on Factor 6: Regulatory Enforcement (Government regulations are effectively enforced, applied and enforced without improper influence; Administrative proceedings are conducted without unreasonable delay, etc.)

So if Australia and the UK with better rule of law implementation have experienced high and rising incidence of illicit trade and smuggling of cheap cigarettes, how much more for developing countries like the Philippines?

If the Philippines will consider imposing higher tobacco taxes like the P90/pack proposal by Sen. Ejercito, and/or if it is to consider plain packaging policy, given its low rule of law culture and poor regulatory enforcement, a doubling of current extent of illicit trade and smuggling can be expected.

Which means more fake and cheap cigarettes will come in, and there will be more smoking and smokers, not less.

More government taxation and prohibitions create adverse selection problems; the law of unintended consequences always kicks in as nature abhors a vacuum.

Bienvenido S. Oplas, Jr. is President of Minimal Government Thinkers, a member-institute of Economic Freedom Network (EFN) Asia.

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See also:

BWorld 211, Intellectual property, innovation, and prosperity, May 20, 2018

BWorld 215, Urban mobility index and transport disruption, May 29, 2018 

BWorld 216, Positive and negative disruptions in the electricity market, May 31, 2018 

BWorld 217, Dutertenomics, TRAIN and high inflation, June 02, 2018

BWorld 200, IPR in the ASEAN and plain packaging in the West

* This is my column in BusinessWorld on March 27, 2018.

Last week, March 22, a global coalition of 62 market-oriented independent or nongovernment think tanks and institutes sent a letter to the World Health Organization (WHO) on the subject, “Five years of failure: Global coalition letter against plain packaging.” Three institutes from ASEAN countries were among the signatories: the Center for Indonesian Policy Studies (CIPS) in Jakarta, the Institute for Democracy and Economic Affairs (IDEAS) in Kuala Lumpur, and Minimal Government Thinkers (MGT) in Manila, my think tank.

The statement was circulated well in social media particularly by signatory-institutes. The paper noted,

“After Australia implemented the policy, other industries have been targeted around the world: alcohol, sugary beverages, fatty foods, even toys. These industries employ millions and any regulation that would deny key IP assets would have a devastating global economic impact. The trademark value alone of only twelve companies associated with these sectors is estimated to be more than $1.8 trillion.

The costs of plain packaging are enormous: the loss of the innovation incentive, the mutilation of established international IP law, the market carve-out to illicit actors, including terrorists. We urge the WHO and governments around the world to stop infringing on intellectual property rights with plain packaging policies.”

This coming April 18, IDEAS will hold a public forum on “Intellectual Property Rights in the ASEAN Economic Community: Challenges and Potentials” to be held at Intercontinental Kuala Lumpur. The forum will partly cover an emerging big issue in international trade — the proliferation of illicit products.

The proliferation of illicit trade and smuggling is ironic in a period of overall tariff reduction and trade liberalization in the ASEAN and many other regions in the world.

What explains this irony?

It is non-tariff barriers (NTBs) or non-tariff measures (NTMs). After all, these require additional permits, sanitary and phytosanitary measures (SPS), and technical barriers to trade (TBTs).

And, as mentioned in the letter, the emerging attack on IPR — plain packaging, abolition of trademark and logo, abolition of corporate branding, initially for tobacco products. Then advocates will move to other “unhealthy” goods like alcohol, sugary drinks, confectionery and candies, and so on.

Australia is the first country in the world to legislate and implement plain packaging or standardized packaging in December 2012. The estimated consumption of illicit and smuggled tobacco products was 12.2% of overall tobacco consumption in 2011 and 11.5% in 2012.

When plain packaging was implemented, the estimated illicit consumption went up: 13.5% in 2013, 14.5% in 2014, 14.1% in 2015, 13.9% in 2016 (source: KPMG, March 2017. “Illicit Tobacco in Australia, 2016 Full Year Report”).

Removing the trademark, logo and brand via plain packaging is less of an assault on tobacco companies with long years of corporate existence but more of an assault on a country’s tradition of protecting private property rights.

Below are some numbers showing average wealth and IPR protection in 15 economies, ASEAN + five in Northeast Asia. Data sources are (a) IMF’s World Economic Outlook (WEO) for GDP per capita, (b) Property Rights Alliance (PRA) International Property Rights Index (IPRI) 2017 Report, and (c) World Economic Forum (WEF) Global Competitiveness Report (GCR) 2017-2018.

The GCR is composed of 12 pillars and pillar #1 is about Institutions; among the sub-pillars there is IPR protection (see table).

These numbers show that countries with high per capita GDP whether in current or nominal prices or in purchasing power parity (PPP) values are also those with high scores and global ranking in intellectual property rights (IPR) protection. And countries with low per capita income also have low scores and ranking in IPR protection. The exception to this trend is Brunei in the IPRI Report, and South Korea in the GCR.

High and rising taxes and now plain packaging as measures to discourage smoking is successful only in reducing smoking of legal and branded tobacco products. Not mentioned by advocates is that these measures are highly favorable to producers and distributors of illicit, fake, non-branded, and cheap tobacco products.

Since brand and product differentiation is effectively abolished, producers and manufacturers, old and new players, will only compete in pricing. So more cheap tobacco will be introduced and this will encourage more smoking.

To further reduce smoking incidence, governments and NGOs should continue public education about the dangers of smoking. But almost all smokers already know the dangers of smoking, the same way that cliff and plane jumpers, high wall/rock climbers, motorcycle stunt drivers, extreme bicycle downhill riders, deep sea scuba divers, MMA/UFC fighters, etc. know the dangers of their sports and passion but they keep doing it anyway, repeatedly.

People own their body, not governments or health NGOs. There is a limit to state nannyism and very often, such nannyism results in adverse, unintended consequences.

Governments should instead focus on protecting private property as a way to encourage more economic prosperity. 

Bienvenido S. Oplas, Jr. is President of Minimal Government Thinkers, a member-institute of Economic Freedom Network (EFN) Asia.

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See also:
BWorld 197, Estimating electricity price hikes because of TRAIN, Part 2, March 22, 2018 
BWorld 198, Three levels of global disruption, March 24, 2018 
BWorld 199, Charity and giving should not be legislated, March 27, 2018

BWorld 161, The sin of smuggling and corruption in the Sin tax law

* This is my article in BusinessWorld last October 23, 2017.

The intent or purpose of higher taxation is to further penalize an act, work, or consumption, hoping to discourage them by making their prices higher while giving government and lobbyists more freebies and more money.

The unintended result of higher taxation is to encourage illicit trade, production of cheaper but lower quality goods and services while giving the corrupt and extortionists in government more money.

Such may be the experience of the Sin Tax law of 2012 or RA 10351. It has raised lots of money for government, benefitted the universal health care program of DoH-PhilHealth while enriching the smugglers, illicit traders and their government protectors.

Revenues from sin tax has significantly increased in 2013, the first year of implementation of the law. Tobacco tax in particular has more than doubled from P32B in 2012 to P70B in 2013. Meanwhile, estimates of cigarettes smuggling have also increased from 35 million packs in 2012 to 40 million packs in 2013 (see table).

The CRC estimates are partly derived from the Oxford Economics report in 2016, “Asia: Illicit Tobacco Indicators 2015.”

The rise in smuggling and illicit trade of cigarettes is also shown by the haul of the BoC and BIR in raids in November 2016 in Bulacan, Pampanga and Pangasinan where more than P1 billion worth of illegally produced cigarettes and counterfeits were discovered. In Pangasinan alone, an illegal factory was raided, which led to the discovery of fake stamps and cigarette making/packing machines that can produce up to 3.6B cigarettes a year.

So claims by the government and advocates of RA 10351 that “8 million Filipinos have stopped smoking since the passage of the law” or “at least 70,000 smoking-related deaths have been averted since 2013” and similar pronouncements may not be true after all? Or are these numbers exaggerated?

The numbers in the table and the huge number of discovered smuggled cigarettes by government raids mean one thing — demand and consumption for tobacco products remained high despite the tax hike. Consumers simply shifted from higher-price to lower-price products, and from legal to illegal or informal sources of tobacco and alcohol products. Like lambanog and tuba.

I made an informal, verbal survey of some small sari-sari stores in a rice farming village in Bugallon, Pangasinan when I went there last month, accompanied by a local. I asked the store owners, “Has smoking and drinking incidence by the people declined, stayed about the same, or increased?”

They replied that they do not have the numbers but they observe that smoking and drinking incidence did not drop or decline. Poor people simply shifted to cheaper brands as new brands with cheap products like Mighty sprouted. The well-off continued patronizing the established higher-price brands despite the rise in prices, they simply reduced their smoking by several sticks a day.

For alcohol products, San Miguel beer is literally wiped out in poorer villages because of its higher price but the consumption of Ginebra, Emperador, Red Horse, and other products has remained the same if not increased. Drinkers usually start with the high alcohol drinks and before going home or elsewhere, they wind down to Red Horse.

Sen. Manny Pacquiao introduced Senate Bill 1599 that aims to increase the unitary excise tax on tobacco products from P30 to P60 per pack, and the annual increase be raised from 4% to 9%. His goal is to parrot the goals of the Sin tax law of 2012 — more money for government, less smoking incidence by the people.

Given the above numbers and facts on the ground, what the boxer-Senator would achieve if his bill becomes a law would be more illicit trade and more corruption in government while gaining more political pogi points for his political plans in 2022.

Instead of introducing another round of higher sin tax, legislators and executive agencies should focus on strictly implementing the existing law and plug loopholes. The proliferation of counterfeit products and stamps mean there is proliferation of corruption in government that allowed such things to happen for several years.

There is a limit to state nannyism and government intervention on how people should run their own lives. Government should limit its unlimited itch to tax-tax-tax, regulate-regulate-regulate, spend-spend-spend.

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See also:
BWorld 158, Why a carbon tax is wrong, October 16, 2017 

BWorld 159, Electoral reforms and the President, October 19, 2017 

BWorld 160, A high carbon tax is irrational, October 25, 2017

Tobacco Tax 6: On Cigarette Smuggling

I posted my paper last February 23,  Tobacco Tax 5: Consumer Demand After Tax Hike and Smuggling, to some of my discussion yahoogroups, it attracted many good comments and counter-comments. I am posting them below. Get your favorite snacks, this is 11 pages long, cheers.
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Noy,

As usual I am amused by the graphical presentations. To begin with, it is quite amazing that anyone has been able to locate the curves at all in the x-y quadrant, when there have been no references made to previous reserach studies, that have computed for the coefficients of the cigarette demand or supply function, say in an urban setting. As you well know, slopes, inflections, and elasticities matter. Without these information, we will not know exactly where final prices and consumption will end up. Even granting the general directional shifts that you posit, without providing the precise location of the starting curves and their elasticities, one could arrive at any set of prices and consumption outcomes, and their ordinal relationships with each other, that would be different from the ones you concluded.

First off, there may be more lines in the graphical presentation than is necessary. If we limit movements to sin taxes alone on local cigarette manufactures and legit imports, there would be no reason for the demand curve to shift. One would think that final equilibrium price (and consumption) will just move along the original curve, not necessarily outside of it. Dont you agree? It will be the supply curve shifts that will determine the movement along the demand curve and the final outcomes wrt price and volume. . If this is true, then straightaways we can do away with or remove two cluttering lines from the chart.

Secondly, I agree that the supply curve will experience a shift, if the level of sin taxes change. As this will affect the marginal cost of making (legit) cigarettes available to the relevant market. But it will affect only those portions of the supply curve that represent the MC of local 'manufactures' and legit imports. I seem to recall from 101 that the supply curve is the MC envelop curve for all stocks made available to the market (i.e., in this case, local manufactures, legal imports, all the way up to contraband and smuggled). The 'stacking' or consumption order is from cheapest to most expensive. New sin taxes will certainly rearrange the original stacking order. But I doubt that the portion of the curve depicting contraband stuff will necessarily change. We are only sure of is that the final transaction or clearing prices in the relevant market will change.

Thirdly and lastly, the critical gap in the graphical presentation is the omission of the externalities ( social or health costs of smoking in a populated setting), which probably would impact the demand curve more since it is actual smoking that 'kills'. Like all pollution issues, this is the toughest nut to crack. But I think that only with these refinements, can discussions on sin taxes become more informative and productive. And that without them, we simply would remain in the dark, if not actually even be misleading.

Pardon this humble intervention but it has been a while since I last engaged. The real reason is I finally got a new internet connection with a cheaper provider. More power to you..

- Gary

Ahhh, the beauty of being criticized by Gary's wisdom. And that's the irony of it -- you won't draw him in unless you post something that is amusing to him, and I'm glad that I made one :-)

My additional points to your comments, Gary.

The graph is hypothetical, no assignment of figures and numbers. So P1 can be P5 per pack, or P22.25 or P49.50 or other random or estimated numbers that one can assign from some empirical studies out there. And yes, there can be as many supply curves and demand curves at different micro levels (demand curves by Mr. Smoker A, by Ms. Smoker B, byTherapist Smoker C, by Magician Smoker D, by Smokers ageing 15-19 yrs old, 20-24 yrs old, etc.). Likewise, Smuggler A will have his own supply curve different from the supply curves of Smuggler B, Smuggler C, and so on. But I limited the S and D curves to only 3 each for simplicity purposes. In fact I wrote that paper mainly for the various health NGOs and health professionals as my target audience, as they are the ones who are relatively active in pushing for really high tax rates for tobacco and alcohol products, mainly for public health reason, not so much for public finance. Thus, the need to simplify the graph.

It is possible that only the different supply curves will be moving and the demand curve will stay as is, and so the new equilibrium price will just lie along the original curve, I agree. But the probability of the demand curve moving rightwards or leftwards is larger than the probability of it staying in the same place. As Alex Magno wrote, if the tax is hiked from P2.70 to P30 and the retail price will go up to P100 per pack, then one option for him and other smokers is to totally quit smoking and so, DOF will collect not P30 but zero from each smoker who quit. And as I discussed in the paper, another option for smokers is to totally abandon the known brands that were hit by the tax hike and shift to lesser known cigarette brands that pay zero tax because they are entirely smuggled. The smuggler definitely paid bribes to certain government officials to make his smuggling easier, but the upward influence of bribes to the retail price is much lower than the upward tick due to the tax hike if the smuggler was a formal supplier.

The proposed larger state intervention via higher tax rate is supposed to address the social externality issue. About 7 of the 10 leading causes of death in this country are smoking related, directly or indirectly. It's good actually that we do not have elaborate and expensive welfare system that gives free hospitalization, free healthcare, etc. to people who abused their body and we ordinary mortals contribute for their healthcare so that they won't meet their creator much earlier than what they really desire.

Meanwhile, I am curious of the various simulations and elasticities. the major assumptions by the DOF in coming up with the magic number, P60 billion per year of additional revenue collections; ie, P60 B on top of existing tax collection from tobacco and alcohol products. Did they assume that tobacco smuggling is totally or partially curtailed?

- Nonoy

Noy,

I dont want to belabor this issue, but the actions of Alex Magno and his tribe (reacting solely to retail price signals) can very well be accomodated by, and along, one and the same demand curve. There is no real need for that curve to shift just because his group is constricting consumption due to market price changes. .Anyway, I get the drift of your argument and would now want to beg off this interesting debate. It may be well to remember that tax people feel it their duty to continually come up with measures that will keep tax revenue levels from falling, since expenditure levels are not within their immediate sphere of control. Thats within Congress's prerogatives. They know how unpopular that task is. So we can appreciate that they start off with really atorocious tax proposals, which they can then whittle down until it finally meets with public acceptance. You are doing a yeoman's job speaking for consumers. .

- Gary

Really? You assume that smuggling will ensue when we raise taxes on cigarettes? Even with the rate of tax hikes which brought Alex Magno to such fits of hilarity, cigarette prices domestically will still be much lower than those sold in other countries. When domestic prices are lower than international prices, what is the incentive to smuggle?

- Ms. H.