Tobacco Taxes and the Threat of the Illicit Market: Latin America

Five years ago, we launched the Think Tanks Project to build a local evidence base on the economics of tobacco and tobacco control in low- and middle-income countries. The research topics we pursued with our think tank partners were guided by six research core competencies (presented below as questions). This framework ensured that our findings were relevant and timely for policy makers.

We are diving into each research core competency by region (Asia, Latin America, and Southeastern Europe) in this blog series. So far, we have covered research core competencies 1 through 5. Below, we focus on Research Core Competency 6 in Latin America.

# Research Core Competency Questions
1 How do consumers of tobacco respond to tobacco taxes, and how would consumers respond to tax increases and other structural reforms to fiscal policies?
2 How would a given fiscal policy affect the price of tobacco products, and how would this change in price affect government revenues, consumption, and health outcomes?
3 How would the fiscal policy affect the poor?
4 What are the health and economic costs of a given unhealthy behavior and how can the fiscal policy address these costs?
5 How would the fiscal policy affect employment and economic growth?
6 To what extent is the fiscal policy related to illicit trade of tobacco products?

Our think tank partners examined the illicit tobacco market across Latin America. Often, the tobacco industry strongly and vocally opposes tobacco tax increases by claiming that such policies would lead to an uptick in illicit trade. The studies highlighted below dispel these myths using the methods described in the Tobacconomics Toolkit on Measuring Illicit Trade in Tobacco Products in addition to other validated methodologies. These scientific analyses can be used to inform policies related to tobacco tax systems and administration.

In Paraguay, CADEP compared the supply of cigarettes with domestic tobacco consumption. While tobacco consumption decreased between 2008 and 2019, supply has increased resulting in a wide gap. During that time, the net supply was seven times higher than estimated domestic consumption. This oversupply suggests that illicit cigarettes are being exported to neighboring countries in the region.

Research from FUNCEX in Brazil examined the country’s production of cigarette inputs and the illicit cigarette market. Over the last decade, available raw tobacco in Brazil has increased, while legal cigarette production decreased begging the important question of where this tobacco leaf goes. In 2017, Brazil accounted for 35% of the market share of Paraguay’s cigarette inputs, such as raw tobacco, specific types of cigarette paper, and materials for filters, which significantly exceeded Paraguay’s domestic demand for licit cigarettes (this oversupply is discussed above). Estimates also suggest that taxed cigarette consumption was 10 billion sticks per year lower than expected between 2016 and 2018. These findings—consistent with other research— indicate the presence of a significant illicit market in Brazil, likely originating from Paraguay.

UCB also explored the illicit market in Brazil. Currently, the country’s illicit cigarette consumption is higher around the borders of Paraguay and Peru. For example, the Brazilian States of Paraná and Rio Grande do Sul border other countries, yet illicit consumption is almost 18% higher in Paraná, which borders Paraguay, compared to Rio Grande do Sul, which borders Uruguay (60.2% and 42.9%, respectively). The researchers simulated the effect of a 10% reduction in the illicit market under three tax reform scenarios across Brazil. The transition to the licit market would reduce consumption as consumers would face higher prices. At the same time, the government would be able to collect tax revenue on the remaining licit cigarette consumption. Across the country, tobacco tax revenue would increase by around 8.5% or 1.5 billion BRL. This increase would differ by state due to the variation in the existing size of the illicit market. The results support the importance of increasing tobacco taxes while implementing systems to reduce cigarette smuggling.

In Peru, IEP analyzed the evolution of the demand for cigarettes and the legal supply of cigarettes following the implementation of tobacco control policies and a new tax strategy in 2010. The demand for cigarettes declined significantly following these changes. Further, demand fell at a faster pace than supply, by 66% and 41%, respectively, suggesting a reduction in the illicit market. Unlike industry claims, this evidence shows that tax increases do not lead to an uptick in the illicit market, while effectively reducing consumption. 

Across Latin America, more research is needed to understand the flow of illicit trade between countries. Improving coordination between and among countries will reduce the size of the illicit market. At the same time, governments should continue to raise tobacco taxes and strengthen their tobacco control efforts to reduce consumption and collect additional tax revenue. These policies will not increase illicit trade despite the myths perpetuated by tobacco companies.

Our final blog in this series explores the illicit market in Southeastern Europe!