Frank J. Chaloupka Distinguished Professor, UIC

1. Tax Avoidance & Evasion An Overview Frank J. Chaloupka Distinguished Professor, UIC Director, WHO Collaborating Centre on the Economics of Tobacco and Tobacco Control Society for Research on Nicotine & Tobacco Toronto, Ontario, Canada, 18 February 2011

2. Overview • Tobacco taxes, tobacco use, and government revenues • Types of tax avoidance & evasion • Measuring tax avoidance & evasion • Determinants of tax avoidance & evasion • Policy options for curbing tax avoidance & evasion

3. Impact and Variability of Tobacco Taxes

4. Taxes, Prices and Tobacco Use • Increases in tobacco product taxes and prices: • Induce current users to try to quit • Keep former users from restarting • Prevent potential users from starting • Reduce consumption among continuing users • Young, low SES most affected • Increase government revenue from tobacco taxes • Create incentives for tax avoidance and evasion

5. Cigarette Taxes and Prices Globally

6. State Cigarette Excise Tax Rates – 2010 WA VT MT ME ND OR MN Chicago$3.66 NH ID WI MA NY SD WY MI RI PA IA CT NV NE NJ OH IL NYC $5.85 IN UT DE CA WV CO VA MD KY KS MO D.C. NC TN AZ OK SC NM AR ≥ $3.00 per pack GA MS AL $2.00-$2.99 per pack LA TX $1.50-$1.99 per pack AK FL $1.00-$1.49 per pack Anchorage $3.45 HI 50-99 cents per pack <50 cents per pack CDC, Office on Smoking and Health. State Tobacco Activities Tracking and Evaluation (STATE) System. 6

7. Definitions

8. Tax Avoidance & Evasion • Many terms used: • Illicit trade, contraband, smuggling, bootlegging, counterfeit, etc. • Tax Avoidance • Legal methods for avoiding tobacco taxes • Tax Evasion • Illegal methods for avoiding tobacco taxes

9. Tax Avoidance & Evasion • Individual tax avoidance • Reservation, Internet and other direct, duty-free, and cross-border purchases • Generally not illegal, but states require local taxes to be paid • Brand/product switching, carton purchases, use of cheaper outlets • Bootlegging • Small scale purchasing of cigarettes in low-tax/price jurisdictions for resale in high tax/price jurisdictions

10. Tax Avoidance & Evasion • Large scale, organized smuggling • Illegal transportation, distribution and sale of large consignments of tobacco products • Generally avoids all taxes • Counterfeit • products bearing a trademark without the approval of the trademark owner • Often involved in organized smuggling

11. Tax Avoidance & Evasion • Illegal Manufacturing • Unreported or under-reported manufacturing, distribution and sale of large consignments of tobacco products • Generally avoids all taxes • Often involved in organized smuggling • Brand Repositioning • Industry changes in pricing, packaging, product design, etc. that change tax rate applied to product

12. Measurement

13. Measuring Avoidance & Evasion • Difficult to measure given illegality • Variety of approaches used • Each captures different pieces • None fully captures all tax avoidance and evasion

14. Measuring Avoidance & Evasion • Comparing recorded exports of tobacco products to recorded imports • Difference reflects leakage into black markets • Recent estimates suggest 20-30 percent of exports do not appear as imports • 4-10 percent of global consumption • Will be largely organized smuggling

15. Extent of Illicit Trade Source: ECOSOC Trade Database: Ayda Yurekli

16. Measuring Avoidance & Evasion • “Expert Opinions” • Customs officials, tobacco industry representatives, tax authorities, and others • Potential bias in some sources • Widely varying estimates across countries • Recent estimates 10-12% • Again, largely reflecting organized smuggling

17. Tax Avoidance and Evasion Source: Tobacco Atlas, 3rd edition

18. Measuring Avoidance & Evasion • Individual tax avoidance a bit easier to assess • Econometric analyses of tax paid sales that account for various factors, including: • tax/price differences • population density • travel patterns • Distance • US estimates suggest up to 12.5% of total consumption in early 2000s

19. Measuring Avoidance & Evasion • Individual tax avoidance – self-reported data • International Tobacco Control Policy Evaluation Study • Tobacco Use Supplement to the Current Population Survey • European Survey on Economic Aspects of Tobacco Use • Others

20. Measuring Avoidance & Evasion • Individual tax avoidance – self-reported data • Tobacco Use Supplement to the Current Population Survey • Periodic state representative, cross-sectional samples • Includes questions on price paid, whether or not purchased in own state, other state or through other channels (e.g. Internet or phone) – 2003 and 2006/07 surveys only • Does not pick up in-state tax avoidance (e.g. reservation purchases) • 2003: 5.63% 2006/07: 5.19%

21. Tax Avoidance – United States Source: Tax Burden on Tobacco, 2008 and TUS-CPS

22. Tax Avoidance – United States Source: Tax Burden on Tobacco, 2008 and TUS-CPS

23. EU Tobacco/Economics Survey Pack Inspection B10) Please, could you show me the latest pack of cigarettes or hand rolling tobacco that you bought? No 1 Yes 2 INTERVIEWER: COLLECT ALL THE FOLLOWING INFORMATION FROM THE PACK. IF IT IS NOT POSSIBLE TO SEE THE LATEST PACK BOUGHT, THEN ASK THE INTERVIEWEE TO PROVIDE THE INFORMATION REQUIRED If you do not have it with you, could you remember the following information on your last pack of cigarettes or hand rolling tobacco? b) Health warnings Health warnings in [country specific]language 1 Health warnings in foreign language 2 Lack of health warnings 3

24. EU Tobacco/Economics Survey

25. EU Tobacco/Economics Survey Pack Inspection B10) Please, could you show me the latest pack of cigarettes or hand rolling tobacco that you bought? No 1 Yes 2 INTERVIEWER: COLLECT ALL THE FOLLOWING INFORMATION FROM THE PACK. IF IT IS NOT POSSIBLE TO SEE THE LATEST PACK BOUGHT, THEN ASK THE INTERVIEWEE TO PROVIDE THE INFORMATION REQUIRED If you do not have it with you, could you remember the following information on your last pack of cigarettes or hand rolling tobacco? c) Tax stamp (banderole) [Country specific] stamp1 Foreign stamp 2 Stamp removed or destroyed 3 Lack of stamp/Duty-free pack 4

26. EU Tobacco/Economics Survey

27. Measuring Avoidance & Evasion • Combining methods • Expert Opinions • Potentially most comprehensive • Econometric modeling • Cross-border shopping, bootlegging • Self-report and pack inspection • Mix of individual avoidance and bootlegging/smuggling • Littered pack collection • Mix of all activities, but may overstate problem

28. Determinants

29. Determinants of Avoidance & Evasion • Tax and price differentials • More important for individual tax avoidance and bootlegging • Larger scale efforts avoid all taxes

30. Tax Avoidance – United States Source: Tax Burden on Tobacco, 2008 and TUS-CPS

31. The illicit cigarette market share (%) and the average cigarette pack price($) in high, middle and low income countries in 2007. Source: WHO & IUATLD, 2009

32. Determinants of Avoidance & Evasion • Corruption • Weak tax administration • Absence of tax stamps; weak or non-existent physical controls; unlicensed manufacturers, distributors, retailers; weak customs authorities • Poor enforcement • Limited resources for border patrols, customs authorities, etc; low penalties

33. Smuggling and Corruption

34. Determinants of Avoidance & Evasion • Presence of informal distribution channels • e.g. Street vendors, unlicensed distributors • Presence of criminal networks • e.g. Organized crime, terrorist organizations

35. Policy Options

36. Impact of Avoidance & Evasion • IARC Handbook 14: • Sufficient Evidence that tax avoidance and tax evasion reduce, but do not eliminate, the public health and revenue impact of tobacco tax increases

37. Does NOT Eliminate Health Impact of Taxes Source: Tax Burden on Tobacco, 2008 and TUS-CPS

38. Does NOT Eliminate Revenue Impact of Taxes

39. Impact of Avoidance & Evasion • World Bank Policy Report: • Rather than forego tax increases, appropriate response is to crack down on illicit trade • IARC Handbook 14: • Strong evidence that a coordinated set of interventions that includes international collaborations, strengthened tax administration, increased enforcement, and swift, severe penalties reduces illicit trade in tobacco products

41. WHO FCTC • Article 6: Price and tax measures to reduce the demand for tobacco • “The parties recognize that price and tax measures are an effective and important means of reducing tobacco consumption by various segments of the population, in particular young persons.” • “….each Party should…adopt or maintain, as appropriate, measures which may include: • “implementing tax policies and where appropriate price policies on tobacco products so as to contribute to the health objectives aimed at reducing tobacco consumption; and • Prohibiting or restricting, as appropriate, sales to and/or importations by international travellers of tax- and duty-free tobacco products.” • Guideline development in early stages

42. WHO FCTC • Article 15: Illicit trade in tobacco products • The Parties recognize that the elimination of all forms of illicit trade in tobacco products, including smuggling, illicit manufacturing and counterfeiting, and the development and implementation of related national law, in addition to subregional, regional and global agreements, are essential components of tobacco control. • Each Party shall adopt and implement effective legislative, executive, administrative or other measures to ensure that all unit packets and packages of tobacco products and any outside packaging of such products are marked to assist Parties in determining the origin of tobacco products, and in accordance with national law and relevant bilateral or multilateral agreements, assist Parties in determining the point of diversion and monitor, document and control the movement of tobacco products and their legal status. In addition, each Party shall…… • Protocol negotiations ongoing

43. WHO’s Best Practices in Tobacco Taxation • Simpler is better • Complex tax structures more difficult to administer • Greater opportunities for tax evasion and tax avoidance under complex tax structures • Where existing structure is more complex, simplify over time with goal of achieving single uniform tax

44. WHO’s Best Practices in Tobacco Taxation • Rely more on specific tobacco excises as the share of total excises in prices increases • Greater public health impact of specific excises given reduced opportunities for switching down in response to tax/price increases • Sends clear message that all brands are equally harmful • Where existing tax is ad valorem, adopt a specific tax and increase reliance on specific tax over time

45. WHO “Best Practices” for Tobacco Excise Taxes • Adopt comparable taxes and tax increases on all tobacco products • Maximizes public health impact of tobacco tax increases by minimizing opportunities for substitution

46. WHO’s Best Practices in Tobacco Taxation • Eliminate tax or duty free sales of tobacco products • As called for in Article 6 of FCTC • Reduces opportunities for individual tax avoidance • Maximizes public health and revenue impact of taxes/tax increases

47. WHO’s Best Practices in Tobacco Taxation • Adopt new technologies to strengthen tobacco tax administration and minimize tax avoidance and evasion • Sophisticated tax stamps • Tracking and tracing technologies • Production monitoring technologies

48. WHO’s Best Practices in Tobacco Taxation • Strengthen tax administrators’ capacity by licensing all involved in tobacco product manufacturing and distribution • Facilitates identification of those engaged in illegal trade • Enhances ability to penalize those engaged in illegal trade • License suspension, revocation

49. WHO’s Best Practices in Tobacco Taxation • Ensure certain, swift and severe penalties for those caught engaging in illicit trade in tobacco products • Increased the expected costs of engaging in illicit trade • Administrative sanctions coupled with licensing

50. WHO’s Best Practices in Tobacco Taxation • Strengthen tax administrators’ capacity to monitor tobacco product markets and evaluate the impact of tobacco tax increases • “Trust but verify” • Monitoring of tobacco production and distribution • Physical control over tobacco products • Periodic audits • Capacity to estimate impact of tax changes on consumption, revenues