International Union Against Cancer * Union Internationale Contre le Cancer
At least, the minimum excise rate of 57 % should be maintained.
Comments on the Commission report COM (95) 285 final on the approximation of taxes on cigarettes
Luk Joossens
Consultant to the UICC
EU Liaison Office
1, Place du Luxembourg
1040 Brussels - Belgium
Tel : 32-2-502.68.38.
Fax : 32-2-512.66.73.
February 1996
Introduction
The taxation of cigarettes in the European Union is unusual in that it is composed of three elements. Like most goods, cigarettes are liable to Value Added Tax or VAT. Unlike other excise taxable items, however, they are subject to a mix of two types of excise duty - specific and ad valorem. Fixed or specific excise duties are imposed as a fixed amount per 1,000 pieces or per 1,000 grammes. Ad valorem excise duties are proportional to the final retail price.
The conflict between proponents of a predominantly ad valorem taxation structure and those who defend a high proportion of specific taxes is based on the differing effects of each of these taxation types on the cigarette market (1).
- Ad valorem taxation has a "multiplier effect".
This means that price differences at production level are multiplied with the addition of tax which leads to greater price differences between cheaper brands, who pay proportionately less tax, and more expensive brands.
The higher the level of ad valorem excise duties, the greater the multiplier effect.
This system allows large price differentials to continue to exist between the cheaper brands and more expensive cigarettes.
This may have the effect of allowing considerably cheaper, therefore more affordable, cigarettes to exist on the market which may encourage consumption among young people.
- Specific duties do not have a multiplier effect as the same tax is applied whatever the production cost.
This means that price differences between cheaper and more expensive brands are reduced.
It also means that manufacturers can increase prices without this having too high an incidence on the final retail selling price.
A price increase of 0.1 ECU combined with a purely specific excise tax would imply an increase in the final retail price of only 0.1 ECU.
With an ad valorem taxation, such a price increase would be multiplied leading to a possible final price increase of 0.4 or 0.5 ECUs.
The higher the proportion of specific taxes in the overall tax burden, the lower the price differential will be between cheap and expensive brands (1).
From a health point of view, ad valorem taxation has the advantage that it automatically takes account of inflation, as taxes increase automatically in proportion to the price. Ad valorem taxation has the disadvantage that cheap cigarettes are possible due to the combined effects of very low production costs and proportional taxation.
Again from a health point of view, specific taxation has the advantage of removing the very cheap cigarette brands, but has the disadvantage that it has to be increased regularly in order to take account of inflation.
The 1992 Directives
On 19 October 1992, the European Council of Finance Ministers adopted three directives on the approximation of taxes on cigarettes and other tobacco products. These directives were a compromise between those in favour of ad valorem taxation and those in favour of specific taxation. However, there was no obligation for Member States to have the same balance between the two types of duty. Council Directive 92/79/EEC stipulated that each Member State should apply an overall excise duty (specific and ad valorem combined) of not less than 57 % of the final retail selling price of cigarettes of the most popular price category, all taxes included.
Although all Member States are obliged to have both a specific and an ad valorem element in the taxation of cigarettes, the balance between the two types of duty still varies widely from one Member State to another.
From a health point of view, these directives were positive in that they lead to price increases in a number of countries.No Member State was obliged to reduce its price for tobacco products. However, the negative aspects of these Directives were that they did not prevent the existence on the market of excessively cheap brands and that there was no net minimum level of taxation.
The Commission report COM (95) 285 final
The 1992 Directives should have been reviewed by the Council on the basis of a report from the Commission not later than 31 December 1994. This report was only published in September 1995 and contained the following observations :
"3.3 The relationship between the specific and ad valorem elements of the excise duty has been the subject of protracted debate over many years. Some Member States apply the minimum specific element, whereas others choose the maximum, with corresponding effects on the ad valorem elements of the duty. This contributes to the differences in retail prices (...) there is no evidence to suggest that any proposed change in the ratio of specific to ad valorem excise would be agreed at the current time. Nor does such a change appear to be essential at present in order to improve the functioning of the Internal Market.
3.9 Given the position outlined above regarding the duty structure, the Commission does not consider it appropriate, at this stage, to bring forward measures aimed specifically at further rate approximation. At the same time, however, it has been noted that the existing rules, far from producing further rate approximation, could actually lead to increased rate divergence. The Commission considers that this could be contrary to development of the Internal Market and an issue which warrants examination.
3.11 This is a real issue in Member States where tax levels are at or just above the 57 % minimum rate. An increase in the ex-factory cost, for instance, can lead to an increase in retail price which would result in the overall excise falling below the 57 % minimum. This then requires the Member State concerned to increase its excise duty in order to once again respect the 57 % minimum.
3.12 (...) Such an outcome would, over time, stimulate growing divergence of tax burdens in the Community (measured in cash terms), which in turn would lead to greater tax- driven differences in retail prices. The Commission does not consider that such effects are in the interest of the Internal Market.
3.18 The Commission concludes that the duty structure for cigarettes should be examined further in the course of the consultation process referred to earlier. It also intends to pay close attention to the operation of the 57 % rule in high-taxing Member States, and will bring forward an appropriate proposal if this is found to be interfering with the process of rate approximation.
Fair consultation ?
In an article of the tobacco trade journal "Tobacco International" of December 1995, the history of the Commission proposals and of the industry lobbying is described in detail (2). The Commission had already drafted proposals in 1994, intended for the Member States and the Council. However, the draft was clearly seen by the tobacco industry, giving them an early opportunity to react and to influence events. After intensive lobbying, the Commission withdrew its proposals in July 1995, offering instead an Excise Conference for interested parties to be held in Lisbon. At this conference 42 representatives of the tobacco industry and only one of the health organisations were present. Despite several requests, health organisations were never informed by the Commission services of their initial proposals .
The Tobacco International describes these events as a clear victory for the industry.
"Lobbying by national tobacco industries, muddled thinking by the bureaucrats in Brussels, and a weak college of Commissioners have all combined to consign to the dustbin the latest draft proposals by the EU Commission to raise minimum excise levels on cigarettes and roll-your-own (RYO) smoking tobacco (2)" and "while the Commission was in the process of formulating its proposals, the tobacco industry could, and did, intervene-this time successfully" (2).
Critiques of the Commission' s proposals.
The main conclusion in the Commission report is that the existing rules are far from producing further rate approximation, i.e. that they are failing to bring tax rates in different Member States closer together.
According to a report on the Lisbon Conference prepared for the European Parliament 's Committee on Economic and Monetary Affairs (3), the increased rate divergence was even considered as the major problem with excise duties on cigarettes.
"It was observed that existing overall minimum rate of 57 % for cigarettes, far from producing convergence of rates, had perversely widened the differences between Member States" (3).
This observation is not based on facts as the gap between the cheapest and the most expensive country has been reduced from 6.20 % in 1992 to 4.80 % in 1995.
Retail selling price (for 1,000 cigarettes) in Ecus of the most popular category in Spain and Denmark in 1992 and 1995
1992 1995
Spain 27.06 39.30
Denmark 170.14 192.49
Source : Commission of the European Communities.
One could argue that a price differential of 480 % is still too important and is increasing problems for the functioning of the Internal Market after the removal of the border control. This seems not to be true.
It is important to reiterate that, in general, preferences for cigarette brands are nationally determined (4).
Although the most popular brand in Spain (Ducados) is a fifth of the price of the most popular Danish brand (Prince), the Danish market is not flooded with cheap Spanish cigarettes. The price difference between national brands is less important than the price differences between well known international brands.
The largest difference -between 20 Marlboro in Denmark and Portugal- is 240 %, but the differences between neighbouring countries are much smaller.
A British study by the Centre for Health Economics at York found that there is little incentive for cross border shopping : the savings on 800 cigarettes bought in France and taken back to Britain would be outweighed by the costs of the trip (800 cigarettes bought in France would save about £30, much less than the cheapest fares, and this is without costing the time taken). Cigarettes bought during a trip for other reasons would obviously not incur extra costs.
There is thus no evidence yet that cross border shopping is an important problem in Europe. It could become a problem if there were large price differences for the same brand of cigarettes in neighbouring countries.(5).
The Commission proposals are in contradiction with EU health policy
According to the Commission report, the main issue for the wider treaty objectives is "health protection, particularly in the context of Article 3(0) of the Treaty ("the Community shall contribute to the attainment of a high-level of health protection") and Article 129 ("health protection requirements shall form a constituent part of the Community's other policies"). Over half a million people in the European Union died in 1994 from tobacco-related diseases. Moreover, tobacco-related morbidity greatly adds to health-care costs. Taxation of tobacco products is an obvious means not only of discouraging tobacco consumption, but also of providing a contribution to the funding of consequent health-care costs".
Conclusions and policy recommendations from a health perspective
From a health point of view, the Commission is actually proposing the reverse of what is needed. In particular, the proposal that high tax countries should be allowed the option to refrain from making upward adjustments to their duty levels is in clear contradiction with EU health policy.
The proposals do not contain any incentive to raise taxes in Member States, suggest the possibility for some Member States to lower their taxation rate and do not set a minimum level of taxation in real terms in order to avoid the existence on the market of excessively cheap brands.
Ad valorem taxation has the advantage that it automatically takes account of inflation.
For this reason, we should maintain at least the 57 % rule or even increase it.
Specific taxation has the advantage of removing the very cheap cigarette brands and narrows the price gap between cheap and expensive cigarettes within countries, but also between countries (6).
For this reason, the EU should set the minimum tobacco tax level in ECU (at least 45-50 ECUs for 1,000 cigarettes) as well as in percentage terms.
The sum fixed in Ecus should be indexed every year in order to take account of inflation.
References
(1) BASP, Taxes on tobacco products : a health issue, Brussels, December 1992.
(2) Garran, R., Setback for RYO : EU's tobacco tax harmonisation, Tobacco International, December 1995, pp. 43-45.
(3) Patterson, B. Report on excise duty conference Lisbon, 13-15 November 1995, Brussels, 20 November 1995, 6 p.
(4) Joossens, L., Raw, M. , Smuggling and cross border shopping of tobacco in Europe , British Medical Journal, 310 : 27 May 1995, pp. 1393-1397.
(5) Buck, D., Godfrey, C., Richardson, G., Should cross border shopping affect tax policy ?, York : Centre for Health Economics, 1994.
(6) Health Education Authority and UICC, Tobacco taxes in the European Union : How to make them work for health ?, London, December 1994.