Fact Sheet: Tobacco Smuggling
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Tobacco Smuggling Fact Sheet (71KB PDF)
Every year tens of billions of cigarettes disappear into the lucrative black market for tobacco products.1 This smuggling seriously harms public health by undermining tobacco tax policies, reducing average prices for cigarettes and making tax-free cigarettes available to young people and price-sensitive smokers who might otherwise quit. Cigarette smuggling also helps finance criminal and terrorist groups, as well as reduces government revenue that is an increasingly important funding source for tobacco control and other public health programs.
How Smuggling Works
Organized tobacco smuggling generally involves the diversion of large consignments of cigarettes onto the black market while the product is in transit. By diverting cigarettes while they are in the wholesale distribution chain (where they are carried untaxed), large-scale smugglers generally avoid all taxes. Smuggling is widely misunderstood to arise from exploitation of tax differentials between countries, but this is a relatively small part of the problem and much less profitable to the smugglers. In fact even if all countries had exactly the same price and tax structure, smuggling would continue on a similar scale.
Winners and Losers in Smuggling: The Problem of 'Perverse Incentives'
The root of the problem is that losses arising from smuggling fall on national finance ministries, not on tobacco manufacturers or wholesalers that control the distribution system. On the other hand, tobacco manufacturers and wholesalers gain from smuggling in several ways: they make their profit when the product is first sold; smuggling creates a supply of cheap cigarettes and lowers average prices, boosting demand; and smuggling enables tobacco company lobbyists to press for lower rates of tobacco tax in the legal market, again with the aim of boosting demand. The profits derived from cigarette smuggling are enormous. It is estimated that this trade is as lucrative as the trade in illicit drugs, but the criminal penalties for cigarette smuggling are much lighter.
These 'perverse incentives' mean that a freight container of cigarettes worth up to US$2 million at legal retail prices can somehow be 'lost' to the black market in transit. Most of that lost revenue is ultimately due to finance ministries in countries in which the product will eventually be sold, but tobacco companies and wholesalers still take their share even if the product enters the black market. Smuggling would be unlikely to occur if the tobacco companies and wholesalers had an incentive to protect the full US$2 million retail value of the consignment. Instead they have the opposite incentive—to facilitate smuggling.
Why Smuggling Occurs
The tobacco industry argues that high tobacco taxes are the primary cause of tobacco smuggling and that reducing taxes is the only cure. However, smuggling occurs in all parts of the world, even in regions where taxes are low.2 The reality is that price is only one of many factors that influence smuggling rates. Others include:
Tobacco Industry Complicity: As recent court cases and internal industry documents make clear, cigarette companies have been heavily involved in smuggling operations. Senior tobacco industry executives have been convicted of smuggling-related offences in Hong Kong and Canada, and a wholly-owned subsidiary of R.J. Reynolds Tobacco Company pled guilty to charges related to its involvement in smuggling cigarettes from the United States into Canada. In 2003, the Canadian federal government launched a $1.5 billion-dollar lawsuit against R.J. Reynolds and Japan Tobacco alleging a conspiracy to flood the Canadian market with smuggled cigarettes.3 Meanwhile, Colombia's provincial governments have filed suit against Philip Morris alleging that the tobacco company defrauded the governments of billions of dollars in revenues through a complex smuggling and money-laundering scheme.4 In January 2005, British American Tobacco faced new allegations that it had taken part in a multi-million dollar smuggling operation scheme in Canada.5
Weaknesses in the Transit System: The lack of more secure systems for transporting cigarettes in international trade fuels the black market by giving smugglers access to a large supply of cigarettes free of all taxes and duties.
Cross-Border Price Differentials: Price differentials are a significant factor in the case of informal bootlegging. It is much less a factor in large-scale organized smuggling of "in transit" cigarettes. Contrary to popular belief, for example, smuggling is not common in those Nordic countries with high cigarette taxes.6
Duty-Free Sales: The existence of a large volume of duty-free tobacco products in international commerce creates opportunities for smuggling.
Lack of Resources: Most countries do not devote the necessary resources to tobacco tax enforcement until after a smuggling problem has developed. It is much more difficult to eradicate smuggling networks once they are established than to take measures to prevent the networks from taking root in the first place.
Lax Enforcement and Insufficient Penalties: Smugglers tend to thrive in countries that tolerate smuggling, where enforcement is lax and corruption is widespread. In addition, many countries fail to treat tobacco smuggling as a serious crime, imposing penalties that are a fraction of those for smuggling other products such as pharmaceuticals or firearms. This makes tobacco more attractive to smugglers, who weigh the huge potential for profit against the small chance of getting caught, convicted, jailed and/or fined. In March 2000, the UK government announced a series of measures designed to curtail tobacco smuggling, such as the requirement of a duty paid mark and deployment of additional Customs officers. However, there are no sanctions for non-compliance. In contrast, a July 2004 agreement between Phillip Morris, the European Community and 10 EU Member States has specified severe ramifications in the event of non-compliance. The agreement, which will last for 12 years, was a result of a lawsuit filed against Phillip Morris for smuggling cigarettes into the EU. The key feature of this agreement is that Philip Morris International (PMI) will be heavily penalized if it does not control smuggling of its cigarettes. PMI agreed to make payments in the event of seizures of their genuine products above certain quantities (for any seizure of genuine PMI cigarettes in the 10 EU countries, the company agreed to pay back all taxes due - if more than 90 million genuine cigarettes are seized in those 10 EU countries, PMI agrees to pay 5 times the amount of taxes due). Furthermore, the Agreement contains provisions on tracking and tracing, record-keeping, approval and termination of contractors, money laundering and compliance protocols to control future smuggling.7
Lack of Effective International Cooperation: While international treaties and other mechanisms have been developed to reduce trafficking in pharmaceutical drugs, illegal drugs, firearms and other products, no similar systems have been implemented to reduce tobacco smuggling. Although the World Health Organization Framework Convention on Tobacco Control (FCTC) contains some useful measures to combat smuggling, these still need to be elaborated in a protocol (see below).