November 11, 2019

Increasing Tobacco Taxes ≠ Increasing Illicit Trade: A Look at Brazil’s Working Group

In response to growing concerns about illicit trade, the Brazilian government formed a working group in March of this year to determine whether reducing tobacco taxes would solve the problem. Although formed in response to industry arguments that tobacco taxes were the cause of increasing illicit trade, within six months, this group concluded that reducing taxes not only would not reduce illicit trade, but would, instead, have negative fiscal, tax, and health implications. In order to curb illicit trade, the group concluded, better coordination between Ministries of Finance, Health, and Foreign Affairs as well as the police force, is necessary for more effective tobacco control.

This recent conclusion is supported by the global evidence. The illicit cigarette market is relatively larger in countries with low taxes and prices, while relatively smaller in countries with higher cigarette taxes and prices. In fact, higher taxes are often associated with stronger tax administration, which includes higher levels of monitoring and penalties for illicit trade. Non-price factors are much more important determinants of the size of the illicit tobacco market. These are strength of governance, tax administration, and regulatory framework; the extent of corruption; government commitment or willingness to control illicit activities; social acceptance of illicit trade; availability of informal distribution networks; and to some extent geography.

Despite the presence of an illicit cigarette market, Brazil has also been successful in reducing tobacco consumption using higher tobacco taxes as the primarily tool. Until the last tax increase, in December 2016, the tobacco excise tax has been increasing faster than inflation, which has resulted in an increase in real cigarette prices. This has been accompanied by the implementation of a track and trace system and other administrative measures to curb illicit cigarette trade. As a result, the consumption of both legal and illegal cigarettes has declined, and smoking prevalence has declined from 15.6 percent in 2006 to 10.8 percent in 2014. At the same time, the size of the illicit cigarette market in Brazil fluctuates: 28.6 percent (2012), 28.8 percent (2014), 42.8 percent (2016), and more recently, 31.4 percent (2018). The decline of the size of illicit trade in the last couple of years has occurred as tax administration and enforcement efforts have been strengthened.

Other country experiences also illustrate the lack of connection between illicit trade and tobacco tax increases. In 2016, Vietnam increased the ad valorem cigarette tax rate from 65 percent to 70 percent. A study after the tax increase showed that illicitly traded cigarettes accounted for 13.7 percent of the total market for cigarettes, while in 2012, when taxes were lower (65 percent rate from 2008-2016), the illicit market share was 20.7 percent.

The conclusions of Brazil’s working group are confirmed by the global evidence. Increasing excise taxes on tobacco products as part of a comprehensive tobacco control policy is an effective way to help reduce smoking prevalence and raise government revenue. Moreover, tax increases do not significantly affect illicit trade. When tobacco tax increases are backed by effective governance, incentives for tobacco consumption, both illegal and legal, are significantly reduced.