Economic, social, and security impacts of tobacco excise duty harmonization in the EU

Líberální Institut Conference, 20 September 2006 Prague

Costs and benefits of tax harmonization – experience and expectations: Hungary

Zoltan Fekete Director BGA Hungary

Background

Since 1995, BGA Hungary is the prime forum of the FMCG businesses in Hungary.

Its main activities include legislative lobbying, fighting against abusive trade practices, and promoting the case of brands and branding for consumers and policy-makers.

IPR infringement, counterfeiting, piracy, smuggling are topical issues for the industry.

In 2005, to better tackle these issues, BGA Hungary started new activities: Budapest Economy Round-table, a series of discussions by state,

industry and experts on black market, grey trade, smuggling etc; BGA package of regulatory amendment proposals for better

regulation and effective enforcement in the above issues. Tobacco industry is heavily affected by illicit trade, smuggling, and, to a

lesser extent, piracy, hence the common agenda with other packaged goods manufacturers.

Illicit tobacco trade by region

Total: 20,1% 2005 Region 5: 39,3%

Region 4: 30,0%

Region 3: 4,9%

Region 1: 10,3%

Region 2: 8,5%

In 2004: 19,1%

Romania

UkraineSlovakia

Austria

Serbia

Croatia

Slovenia

Most affected regions are along the Eastern borders.Source: BAT Hungary

Illicit tobacco trade by country of origin

Country of origin by regionIllicit trade

75%

55% 50% 53% 52%

91%

7%

8%28%

47%

6%

3%7%

2%

15%

0%

26%

2%4%

14%

0%0%

4%

1%3%

6%

7%0%

4%

2%4%14%

0% 0%8%

1%

N=1871 N=520 N=322 N=251 N=315 N=463

TOTAL Region 1 Region 2 Region 3 Region 4 Region 5

others

Romania

Germany

Austria

Hungary

Ukraine

Q8 and examination of the cigarette packs after pack swap.Base: Respondents in the particular category and region.Single response. Spontaneous response.

Incidence-based

Country of origin by regionIllicit trade

72%64%

77%

54%

39%

91%

7%

0%

10%

0%24%

1%

3%

0%

3%

18%9%

0%

2%

4%

0%

0% 5%

1%2%

6%

0%

9% 3%

0%14%26%

10%18% 22%

7%

N=402 N=55 N=31 N=12 N=96 N=207

TOTAL Region 1 Region 2 Region 3 Region 4 Region 5

Others*

Romania

Germany

Serbia

Austria

Ukraine

Q8 and examination of the cigarette packs after pack swap.Base: Respondents in the particular category and region.Single response. Spontaneous response.

Incidence-based

* Others = Not identifiable; France, Croatia; Egypt; Denmark; USA

2004 2005Ukraine 75% 72%Austria 7% 7%Germany 4% 2%Romania 3% 2%Serbia 0% 3%Others 11% 14%

Country of origin

Growing illicit trade, growing inbound from Serbia.

2004 2005

Source: BAT Hungary

N=402 100%Priluki Oszoblivi 209 52%Next 34 9%L&M 29 7%Ronson 22 5%Prima Optima 16 4%Marlboro 13 3%Raquel Slims 11 3%Memphis 8 2%LD 7 2%Pall Mall 7 2%Vision 5 1%Vogue Superslims 4 1%Golden Gate 3 1%Davidoff 3 1%Saint George 3 1%Slim Agenda 3 1%Fort 2 1%Vikend 2 1%

Examination of the cigarette packs af ter pack swap.

Base: All respondents and respondents in the particular category .

UkraineSerbia

Denmark

Illicit TradeBrand family2005

Illicit tobacco trade by brands

N=350 100%Priluki 189 47%L & M 20 5%Ronson 18 4%Marlboro 15 4%Raquel Slims 11 3%Prima Optima 11 3%Berkut 8 2%Multifilter 8 2%Pall Mall 7 2%Next 7 2%West 6 2%Vogue 5 1%P20 4 1%

Brand family2004

Illicit Trade

Growing illicit brand portfolio.

Source: Illicit Trade Survey, BAT

Why to buy? Price level differences

Consumer demand is unchanged due to price level gaps.

84% of respondents claim lower price as single decisive factor for buying. Price competition on black market as well: avg 237 HUF price drops to 223

HUF (2004 vs 2005).

Priluki Oszoblivi - 64 - - Next - 64 108 236 L&M 428 100 170 230 Ronson 378 39 154 176 Prima Optima - 60 - Marlboro 592 153 273 258 Raquel Slims - 138 - Memphis 485 - 186 212 LD 383 58 - 174 Pall Mall 447 100 170 230 Vision - - 108 - Vogue Superslims 632 253 - - Davidoff 612 249 342 - Saint George 46 - 154 Slim Agenda 495 - Fort - 72 Vikend - 86

SerbiaWeighted average price 2005 (RA) (in

HUF)Hungary Ukraine* Romania

*Wholesale price might be even low er Source: BAT Hungary

Tobacco market development

0

5000

10000

15000

20000

25000

2001 2002 2003 2004

Total DP cigarette DNP DP OTP Total DP Tobacco Total tobacco consumption

v

Jun 2001 +HUF10

Jan 2002 +HUF20 Sep 2002 +

HUF30

Jan 2003 +HUF15

May 2003 +HUF35

Jun 2003 –HUF25

Sep 2003 +HUF25

Price increase:

Jun 20012,4%

MPPC tax increase %: Jan 2002 Apr 20025,0% 4,4%

Sep 200217,0%

Feb 2003 May 20032,8% 17,0%

Jan 200429,9%

Source: BAT Hungary

Estimated state revenue losses

State revenues

(Bn HUF) 2000 2001 2002 2003 2004

Excise duties, tobacco 99 110 127 151 166

VAT, tobacco 51 56 61 66 64

Total, tobacco 150 166 187 216 230

State revenues development 11% 13% 15% 6%

Excise duty development, MPPC 14% 16% 28% 37%

Estimated losses in revenues, if total volume legal n/a 9 14 28 74

Despite a 37% tax increase, in 2004 the state revenue development drops below the 2001 level. In 2004, estimated state losses amount to

74 Bn HUF. In 2005, the legal market keeps shrinking.

Source: BAT Hungary

Other aspects, assumptions & conclusions

“… It is estimated that some 25% of cigarettes produced globally or more than 210 billion cigarettes (the difference between reported exports and imports) go to the black market. Of these about one third are believed to be smuggled into and within Council of Europe member States.” (Council of Europe, Organised Crime Situation Report 2004, Strasbourg, 23 December 2004)

It is the excise duty policy, that may be accounted as one decisive factor in creating or maintaining the price differences.

It is the price difference from country to country, that fuels tobacco smuggling.

It is tobacco smuggling that also fuels international crime organizations and international terrorist organizations, raising national security issues.

The shaping of national excise duty policies needs a very complex approach that takes into account all relevant aspects such as purchasing power, state revenues, national security, and health impact as well.

Industry efforts & results Constructive dialogue with policy-makers

Coordinated industry input for better regulation and effective enforcement

Continuous flow of information to support efficiency of state investigations and checks

Contribution to state enforcement especially customs (e.g. destruction of seized goods)

Promoting a complex approach relating to all main aspects (state revenues, crime issues, health issues, consumption patterns, etc)

First results Better regulations (new competences for customs in IPR cases) Closer state-industry collaboration (cooperation agreement between

tobacco association and customs) Significant drop in illicit trade consumer share

Volume: 11% (July 2006) vs 19% (Jan 2006) vs 20% (total 2005) Incidence: 11% (July 2006) vs 18% (Jan 2006) vs 22% (total 2005)