Tax Avoidance Evasion An Overview Frank J Chaloupka

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 1

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

Impact and Variability of Tobacco Taxes 3

Taxes, Prices and Tobacco Use n 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 4

Cigarette Taxes and Prices Globally 5

State Cigarette Excise Tax Rates – 2010 WA MT VT ND OR MN ID WY NV SD MI CO AZ KS KY MO WV NM OK TX AK VA NC TN AL NJ DE CT NYC $5. 85 MD D. C. ≥ $3. 00 per pack GA LA $2. 00 -$2. 99 per pack FL HI MA RI SC AR MS Anchorage $3. 45 OH IL IN NH NY PA IA NE UT CA Chicago $3. 66 WI ME $1. 50 -$1. 99 per pack $1. 00 -$1. 49 per pack 50 -99 cents per pack <50 cents per pack CDC, Office on Smoking and Health. State Tobacco Activities Tracking and Evaluation (STATE) System. 6

Definitions 7

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

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

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

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

Measurement 12

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

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

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

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

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

Measuring Avoidance & Evasion • Individual tax avoidance a bit easier to assess n Econometric analyses of tax paid sales that account for various factors, including: • tax/price differences • population density • travel patterns • Distance n US estimates suggest up to 12. 5% of total consumption in early 2000 s 18

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

Measuring Avoidance & Evasion • Individual tax avoidance – self-reported data n 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% 20

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

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

EU Tobacco/Economics Survey Pack Inspection B 10) 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 in [country specific] language 1 Health warnings in foreign language Lack of health warnings 2 3 23

EU Tobacco/Economics Survey 24

EU Tobacco/Economics Survey Pack Inspection B 10) 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] stamp Foreign stamp Stamp removed or destroyed Lack of stamp/Duty-free pack 1 2 3 4 25

EU Tobacco/Economics Survey 26

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

Determinants 28

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

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

The illicit cigarette market share (%) and the average cigarette pack price($) in high, middle and low income countries in 2007. 6 10% 12% 18. 00% 17% 16. 00% 5 14. 00% 4 12. 00% 10. 00% 3 8. 00% 2 6. 00% 4. 00% 1 5$ 2$ 2. 00% 1$ 0 0. 00% high income Source: WHO & IUATLD, 2009 middle income low income cigarette pack price

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

Smuggling and Corruption 33

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

Policy Options 35

Impact of Avoidance & Evasion n 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 36

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

Does NOT Eliminate Revenue Impact of Taxes 38

Impact of Avoidance & Evasion n World Bank Policy Report: • Rather than forego tax increases, appropriate response is to crack down on illicit trade n 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 39

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WHO FCTC n 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: n n “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 41

WHO FCTC n 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…… n Protocol negotiations ongoing 42

WHO’s Best Practices in Tobacco Taxation n 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 43

WHO’s Best Practices in Tobacco Taxation n 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 44

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

WHO’s Best Practices in Tobacco Taxation n 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 46

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

WHO’s Best Practices in Tobacco Taxation n 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 n License suspension, revocation 48

WHO’s Best Practices in Tobacco Taxation n 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 49

WHO’s Best Practices in Tobacco Taxation n 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 50

www. iarc. fr/en/publications/pdfs-online/prev/handbook 14 (coming in 2011) www. who. int/tobacco/publications/tax_administration/ fjc@uic. edu 51