ECONOMICS OF TOBACCO CONFERENCESCHOOL OF ECONOMICS, UCT

16-18 JULY 2014

Illicit trade in South Africa: Can we trust the industry rhetoric?

Corné van Walbeek and Lerato ShaiSchool of Economics, University of Cape Town

Some background information

This study was made possible by funding from the Bill & Melinda Gates Foundation

It was recently published in Tobacco Control

This presentation was prepared for a workshop on illicit trade, hosted by the Deputy Minister of International Relations, but (as it turns out subsequently) funded by the tobacco industry The presentation was excluded from the programme at

the last minute

Illicit trade in South Africa and the region

Is illicit trade bad for government revenues and public health?

YES

Should the government take illicit trade seriously?

YES

Is the problem as bad as the tobacco industry makes it out to be?

Let’s look at the evidence from a number of angles

Cigarette consumption

Total cigarette consumption has two components: Legal consumption Illicit consumption

Legal consumption can be tracked quite easily through the National Treasury’s records

Illicit consumption has to be estimated

The crucial question: Do the tobacco industry’s estimates of the illicit market

make intuitive and logical sense?

Legal consumption

Financial year

Total revenue

(R million)

(nominal)

Excise tax per pack

(nominal)

Legal consumption (million

packs)

Percentage change

2006 6 784 R5.56 1 220 2.2

2007 7 665 R6.16 1 245 2.0

2008 8 659 R6.82 1 270 2.0

2009 9 188 R7.70 1 193 -6.0

2010 9 368 R8.94 1 048 -12.2

2011 10 172 R9.74 1 044 -0.3

2012 10 978 R10.32 1 064 1.9

2013 11 461 R10.92 1 050 -1.3

The situation in 2009 and 2010

2009 2010

Percentage change in legal consumption -6.0% -12.2%

GDP growth -1.5% +3.1%

Percentage change in the nominal price of the most popular brand of cigarettes

16.1% (from R19.17 to

R22.26)

11.5% (from R22.26 to

R24.83)

Inflation rate 7.1% 4.3%

Approximate percentage change in the real price

9.0% 7.2%

Can the decrease in legal cigarette consumption be explained by “economic fundamentals”?

Yes No

Percentage change in excise tax 12.9% (from R6.82 to R7.70)

16.1% (from R7.70 to R8.94)

Illicit consumption

Year Percentage

2008 8%

2009 10%

2010 21%

2011 26%

2012 30%

2013

Relative share of the illicit market, based on data provided by TISA

Source: Presentation to National Treasury, September 2013

Total cigarette consumption

Year Percentage change in legal consumption

Percentage change in illicit consumption

Approximate percentage

change in total consumption

2008 2.0%2009 -6.0% 2% -4.0%

2010 -12.2% 11% -1.2%

2011 -0.3% 5% +4.7%

2012 1.9% 4% +5.9%

2013 -1.3%

If the tobacco industry’s estimates are correct, we have the following situation (approximately):

Can this alleged increase in total cigarette consumption be

explained?

An increase in smoking prevalence? No, adult smoking prevalence in 2012 was between

20% and 21%, according to three independent surveys (AMPS, NIDS and South African National Health and Nutrition Examination Survey), down from 24% in 2003 (AMPS)

Strong economic growth? No, GDP growth in 2011-2013 averaged only 2.7%

The tobacco industry’s estimates of the illicit market

Year TISA numbers quoted in numerous

articles at the time

December 2010 article in Business

Report (BATSA)

June 2012 presentation to

National Treasury (BATSA)

May 2013 presentation to authors (TISA)

2006 20% - - 21%

2007 20% - - 11%

2008 20% 11.0% 7.9% 8%

2009 20% 16.6% 10.4% 10%

2010 20% 23.1% 21.0% 21%

2011 25% - 26.0% 26%

2012 30% - 27.8% (30%) 30%

What can we conclude?

The spike in the illicit market in 2010 is real

The alleged large increases in illicit trade in 2011 and 2012 are not supported by other data

The tobacco industry has a record of rewriting history in order to create the impression that the problem is particularly pressing right now

If previous estimates were incorrect, are the current estimates credible?

ADDITIONAL SLIDES

The industry’s role in determining the value of the excise tax

How the excise tax is set in South Africa: Total tax (excise tax plus VAT) should be 52% of the

recommended retail price of the most popular price category of cigarettes

National Treasury passively responds to the pricing strategy of the dominant player in the tobacco industry

This policy has been in place since 1994 (with an increase in the target tax burden from 50% to 52% in 2004)

Bottom line: The industry sets the quantum of the excise tax

Example: How this works in practice

In February 2009 the RRP of Peter Stuyvesant was R19.40, consisting of the following components: VAT (14%, but 12.3% of VAT-inclusive price): R2.38 Excise tax: R6.82 Net-of-tax price: R10.20

National Treasury wants a total tax burden of 52% = R10.08 (R2.38 VAT and R7.70 excise) Increases excise tax from R6.82 to R7.70 (12.9%)

If there is 100% pass-through of the tax, the retail price increases by R0.88 + 14% VAT = R1.00

But the tobacco industry increases the RRP from R19.40 to R22.50 (i.e. R3.10 or 16%) between February 2009 and February 2010 The net-of-tax price increases from R10.20 to R12.04 (18%)

Example (continued)

In February 2010 the RRP of Peter Stuyvesant is R22.50, consisting of the following components: VAT: R2.76 Excise tax: R7.70 Net-of-tax price: R12.04

National Treasury wants a total tax burden of 52% = R11.70 (= R2.76 VAT and R8.94 excise) Increases the excise tax from R7.70 to R8.94 (16.1%)

And so the process continues….

The increase in the net-of-tax price (and the RRP) in the previous year is directly responsible for the increase in the excise tax in the current year

Trends in the real net-of-tax price and the excise tax

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Excise tax Net-of-tax price

Real

excis

e t

ax a

nd

net-

of-

tax

pri

ce p

er

pack

(2

01

2 p

rices)

What this graph indicates

During the 1970s and 1980s the real net-of-tax price remained largely constant Tobacco industry wanted to grow the market There were no legislative impediments to this growth

The landscape changed dramatically in the early 1990s Anti-tobacco legislation passed in 1993 and 1999 Using its near-monopoly power BAT increased the net-of-tax prices This was good for profitability and good for public health

The net-of-tax price increases were overdone by about 2010 Entrance of nimble, low-cost producers into the market (FITA-aligned

firms) A competitive situation is being presented as a pure illicit trade problem

CIGARETTE CONSUMPTION AND

REAL PRICES

Aggregate cigarette consumption and the real price of cigarettes

19

61

19

63

19

65

19

67

19

69

19

71

19

73

19

75

19

77

19

79

19

81

19

83

19

85

19

87

19

89

19

91

19

93

19

95

19

97

19

99

20

01

20

03

20

05

20

07

20

09

20

11

0.00

5.00

10.00

15.00

20.00

25.00

0

500

1000

1500

2000

2500

Price per pack, constant 2012 prices Cigarette consumption, million packs

Avera

ge p

rice p

er

pack

, 2

01

2

pri

ces

Cig

are

tte c

on

su

mp

tio

n (

mil

lio

n

pack

s,

tax-p

aid

on

ly)