High cigarette taxes will encourage smuggling

Alcohol and tobacco are favorite cash cows of governments. Whenever a government wants to collect more revenues, it raises the excise taxes on liquor and cigarettes, the so-called “sin taxes” because alcohol and tobacco are presumed bad for the health and the high taxes are supposed to discourage people from consuming them. What’s more, there is no widespread anger and protests as when you raise the prices of fuel or the toll on roads.

The Philippine government is no exception to this. It also uses alcohol and tobacco as cash cows. It wants to raise sin taxes again. This time, the increase will be hefty, almost double the present rates.

Under House Bill 3465, the street price of local cigarettes could increase by 82.9 percent. Last year, manufacturers of sin products paid an aggregate amount of P67.2 billion, 22 percent above the P52.42 billion government target. (Correction: It is the consumers, not the manufacturers, who pay the taxes. Manufacturers simply add the taxes to the price of their cigarettes and liquor.) Other tax classifications—VAT (-18.9 percent) and income tax (-0.6 percent), failed to meet 2010 collection targets. With the proposed increases, the government expects to collect P60 billion more in sin taxes.

Wait a minute, not so fast. It doesn’t always work that way—increase taxes, collect more. Sometimes, more is less. When you become too greedy and impose very high taxes, you actually collect less because the people rebel. Many rebellions in the past, in the Philippines and elsewhere, were triggered by onerous taxes.

Very high taxes on liquor and cigarettes may just encourage smuggling and illicit trade. Taxes are simply passed on by business to consumers who ultimately bear the brunt of it. Consumers, however, will always seek the option of buying cheaper goods, irrespective of source. That’s where smuggling comes in, from which government derives no revenue.

And the Philippines is wide open to smuggling, with all its islands and isolated beaches. Remember the time when cigarette smuggling flourished here, when you can buy smuggled “blue seal” cigarettes at any street corner and smugglers became filthy rich?

Going back further in history, remember when Prohibition was imposed in the United States. Smuggling of liquor by gangsters flourished and even the Federal Bureau of Investigation was helpless. Forget the movie about Elliot Ness and the Untouchables, they were able to bag only one gangster, Al Capone, and not on smuggling but on tax evasion. The smugglers got away.

What I’m getting at is that we are no match for smugglers, as the past and present have shown. If there is a fresh wave of cigarette smuggling, the Philippine government would be helpless to stop it.

The experience of other countries shows the same relation between high taxes and smuggling and illicit trade. The higher the taxes, the more smuggling there will be.

Let us take Singapore as an example. It increased its excise duty by 135 percent between 2000 and 2005, the highest in Asia.

Revenues initially increased by 48 percent, from S$502 million in 2000 to S$743 million in 2003, but fell by -3 percent (SG$721 million) in 2005, to -16 percent (S$621 million) in 2006. Driven by the steep excise tax hikes, pack prices of premium cigarettes went up 70 percent between 2002 and 2005.

Although a tightly controlled country, Singapore failed to prevent smuggling from flooding the market to meet consumer demand for cheaper cigarettes. Total duty-paid industry volume dropped by 43 percent. The volume of illegal cigarettes seized by Singapore Customs increased from 8 million sticks of cigarettes to 106 million cigarettes in 2006, but the smuggling continued. Smoking in 2007 was virtually unchanged from 2001.

Speaking to legislators in 2006, Finance Minister Lee Hsien Loong said: “I seriously considered raising tobacco duties, but have reluctantly decided against it because we are already seeing revenues declining, not because people are smoking less but because smuggling has gone up.”

In neighboring Malaysia, excise duty increased from 2001 to 2009 at a compound annual growth rate of 21 percent per annum. This is almost 10 times higher than the inflation rate, which rose at just 2.3 percent a year. Excise revenue increased during this period but much lower than expected.

Reason: The steep and continued rise in prices led to the rapid emergence of smuggling, which exploded between 2004 and 2009, reaching an estimated 38 percent of the market, equivalent to 9 billion sticks.

This is the highest recorded level of illegal cigarettes in the history of Malaysia and probably the highest recorded anywhere in the world. Almost two out of every five cigarettes sold were smuggled. Smoking incidence was virtually unchanged.

Let us take New York State which has efficient law enforcement. In 2001 a 62 percent increase in state excise tax resulted in total federal and state excise taxes reaching $73 per thousand cigarettes. The excise taxes were raised again in 2002, 2008, 2009 and 2010. New York now has the highest cigarette tax rates in the US.

As a result, illicit trade increased dramatically as the tax differential between New York and neighboring states increased.

The best model to follow is that of Australia. Excise taxes Down Under are raised so predictably in line with the Consumer Price Index. As a result, Australia has increased excise revenues and reduced smoking considerably.

The Philippines needs an equivalent of the Australian excise tax system, not one that would raise the street price of cigarettes by 82.9 percent and induce smuggling.