I was honored to moderate the spirited and informative “80 minutes Around the World Panel” on the second day of the Tax Stamp Forum in Miami. The distinguished panel was comprised of revenue department officials from all four corners of the world who shared the illicit trade challenges they face and discussed their approaches to combat these issues, including tax stamp and marking programs.
The panel included Jerome Horton (Board of Equalization, California), Xavier Cardenas (Servicio Nacional de Aduana del Ecuador), Florian Hertel (Zollkriminalamt, Germany) Aftab Baloch (Federal Board of Revenue, Pakistan) and Jorge Gaona (formerly Subsecretaria de Estado de Tributacion, Paraguay).
In 2003, the State of California passed the comprehensive Cigarette and Tobacco Product Licensing Act, which implemented a comprehensive licensing and inspection scheme, increased penalties and authorized the State of California to implement a high-tech encrypted tax stamp for all cigarettes sold to protect the $114 billion in annual tobacco excise tax revenue.
California implemented the SICPATRACE stamping system in 2005 to follow cigarettes along the states three-tier system from manufacturer to retailer. The stamp makes it easier for investigators to identify illegal and counterfeit product and trace genuine product back to the stamping agent or wholesaler.
Chairman Horton reported that the Board of Equalization (BOE) has reduced tobacco tax evasion over $200 million over the last 10 years and has seized over 70 tons of illegal tobacco products, worth over $200 million over the last 5 years alone.
Besides these successes, the California BOE still wrestles with an underground economy, where illegal goods are trafficked, estimated at $9 – 12 billion annually.
Pakistan currently does not have any excise tax stamp system and its most recent attempt to implement a track and trace system for tobacco products in 2013-2014 was defeated due to industry concerns. Pakistan plans to launch a sophisticated track and trace system for its five key excisable goods, tobacco, cement, water, fertilizer and sugar in 2016.
Pakistan reports struggling with three different types of illicit trade in tobacco products. (1) The Underreporting by major manufacturers of cigarette volume shipped into Pakistan’s five provinces, which accounts for 80% of Pakistan’s cigarette volume, (2) illicit tobacco products trafficked into Afghanistan along its long porous border with Afghanistan, (3) and tobacco products illegally manufactured within the federally administered tribal area.
Mr. Baloch estimated the illicit trade in tobacco to have grown by 43% to $24 billion over six years on $100 billion annual tax revenue.
Ecuador: Ecuador currently has no tax stamps for its tobacco products, but is currently conducting a track-and- trace label pilot test for liquor products. Illicit liquor was and is Ecuador’s most significant issue. The majority of illicit tobacco and liquor products is trafficked by criminal organizations and enters Ecuador through its extensive and porous land borders with Colombia and Peru.
The illicit trade is driven by tax differences for liquor; for example 12 year-old whiskey costs around $90 in Ecuador, but only $30 in neighboring countries. Ecuador’s pilot track-and- trace system for liquor products leverages a two-pronged strategy with increased border enforcement, including electronic surveillance and point-of- sale inspections where alcoholic drinks are sold, which includes bars, restaurants and hotels. The track-and- trace label allows for easy authentication by revenue authorities and wholesalers.
Germany: Germany employs tax stamps banderols on all cigarette packs sold, representing €40 billion annual tobacco tax revenue to the German Government. Germany currently does not have a track-and- trace system in place, but is expected to adopt track-and- trace based on FCTC or TPD illicit trade regulations.
The illicit trade in tobacco products in Europe is complex. Germany borders many countries and tax rates across Europe vary greatly, resulting in cigarette prices ranging from €2 in the cheapest countries, to €6 in Germany and upwards to €10 - 12 in the UK and Norway, creating plenty of incentive for illicit trade.
As a result, Germany is facing a plethora of illicit trade issues including the importation of untaxed cigarettes, smuggled cigarettes from low tax-countries, illegal manufacturing, counterfeit cigarettes and the emergence of illicit whites, which are no-brand duty-free cigarettes imported in evasion of all taxes. Mr. Hertel noted however, that at this point Germany authorities have not observed any counterfeit or forged cigarette tax stamps.
Paraguay: Paraguay in comparison is experiencing the most significant illicit trade issues of the panel. Paraguay is a known source country of cheap low-tax cigarettes to neighboring countries, especially Brazil. According to Mr. Gaona, Paraguay is a country with a population of only 7 million, but is a host to 25 manufacturers, all within 40 kilometers of the border with Argentina and Brazil. These facilities produce around 60 to 70 billion cigarettes a year, or the equivalent of 400-500 packs of cigarettes for every man, woman and child living in Paraguay.
Clearly such quantities cannot be for local consumption. Mr. Gaona estimates that only 5% of Paraguay’s production is consumed locally and the other 95% is smuggled into neighboring higher tax countries, mainly Brazil. These cigarettes get trafficked over 4,000 miles into Brazil through networks established for over 20 years.
This significant illicit trade is driven by Paraguay’s low tax rate of 13% and allowed to fester due to ineffective regulations, insufficient enforcement resources and rampant corruption. Top government officials have entanglements with the tobacco industry in Paraguay. For example, Paraguay’s president is one of the owners and top shareholder of Paraguay’s largest cigarette manufacturer Tabacalera del Este. 1
Since 2004, Paraguay applies tax stamps to cigarettes, liquor and beer bottles, but currently has no track-and- trace system. The most recent attempt was defeated due to political influences and industry concerns.
The participants represented not only a broad range of illicit trade environments and challenges in combatting illicit trade, but also highlighted differing levels of progress against the implementation of a comprehensive strategy to successfully combat illicit trade.
Four key themes emerged from the discussion:
1.) Common yet different: While the incentive for illicit trade activity was always monetary gain through tax evasion, non-tax factors influenced how the illicit trade had manifested itself in each country.
2.) Comprehensive approach is key: While each country faced a unique illicit trade environment, the principles of comprehensive strategy to successfully combat illicit trade were consistent across environments and include a robust licensing scheme, enhanced coordination across agencies, increased enforcement, strengthened penalties, tax stamps, track-and- trace systems, as well as public education efforts.
3.) One size does not fit all: While the principles for a comprehensive approach are the same, implementation needs to be country specific to reflect the specific illicit trade environment.
4.) Enforcement is king: While a comprehensive approach is needed, all efforts will be futile, if there is no effective enforcement environment in place.
It was striking to hear from representatives from around the globe that the incentive for illicit trade across various product categories, including tobacco, liquor, cement, beer and sugar was tax avoidance of high taxes.
Below is a more in-depth exploration of the four key themes:
Common yet different: Tax differences drive illicit trade. From California to Ecuador and Pakistan, these differences in tax rates either between countries or within a country between states or provinces provide the economic incentive for criminal organizations.
While the incentive for illicit trade activity was always monetary gain through tax evasion, non-tax factors influenced how the illicit trade had manifested itself in each country. Government reports confirm this. In a recent study, the National Academy of Sciences (NAS) reports, “cigarettes in the United States and most other countries are subject to high taxes, which create incentives for tax evasion and tax avoidance. Although high tax margins may provide an initial incentive for smuggling and other evasion schemes, other factors—such as the ease and cost of operating in a country, corruption, and the strength of border controls—are also important contributors”.
This has resulted in differing illicit trade pictures across the globe. In Germany, driven by a strong legal framework, active trademark owners and dense geography, illicit trade is now dominated by illicit whites – cheap no-brand duty free cigarettes designed to evade all taxes in all countries. Similarly, for the United States the NAS reports, “there is no evidence that the tobacco industry is currently involved in the illicit trade in the United States.” Rather the illicit trade in the United States is driven by bootlegging operations.
In contrast, Paraguay, due to the high-levels of corruption and weak regulations has become one of the key illegal “exporter” of illicit cigarettes to South America.
Comprehensive approach is key: Throughout the panel discussion, common principles for a comprehensive anti-illicit trade strategy started to emerge. Most importantly, these principles work together like building blocks to reinforce each other and build a more robust system over time.
Chairman Horton noted, that California’s approach created a transparent group of participants authorized to sell tobacco products through its comprehensive licensing system. The state built upon this with increased enforcement by dedicating more resources to retail enforcement, increasing retail audits ten-fold and increasing corresponding penalties. The increased audit and enforcement functions, aided by the new tax stamp and increased penalties, such as threat of loss of license, created a strong legal incentive for wholesalers and retailers to comply with the system.
Two recent government research studies by Center for Disease Control and the NAS echo the need for a comprehensive framework to combat illicit trade through a robust licensing scheme, enhanced coordination across agencies, increased enforcement, strengthened penalties, tax stamps and track-and- trace systems, as well as public education efforts.
Ecuador started to implement such a system. Over the last 8 years has completely overhauled its tax administration and enforcement infrastructure. Ecuador has focused to establish the foundation for successful enforcement with a new fully automated electronic system, electronic signatures, profile risk systems, new regulations, and new personnel training.
One size does not fit all: While the themes across panelist were surprisingly similar, the need for customized solutions for each country became very obvious. Significant underreporting by major manufacturers, as well as revenue loss through illegal manufacturers plagues Pakistan. Manufacturing licensing, volume control and enforcement resources are most needed to address this.
Ecuador will be able to demonstrate how an appropriate track and trace system can assist in keeping untaxed illicit products form entering its country. Germany on the other hand faces the issue of illicit whites and requires increased border protections and increased cooperation with law enforcement across Europe, such as Europol. A track-and- trace system will have very limited, if any, impact on illicit whites.
Enforcement is king: All participants reiterated multiple times the need for adequate, dedicated and effective enforcement resources. Chairman Horton stated “placing the encryption or identifier on the product is good, but if you don't have the investigative arm, to conduct investigation and if you can’t track the product from seed to sale you will pretty much wasting your time, since criminals will find a way around it to evade the tax”. The CDC and NAS reports affirmed the same. The two reports stated, “Regulations and technologies to monitor and control the supply chain of tobacco products will have limited impact without enforcement efforts.” Ecuador reported that compliance was being slowly achieved through diligent enforcement. The liquor duty label alone does not enforce itself. Mr. Cardena reiterated the point that while controls and regulations are important, they cannot be implemented if there is a lack of human resources, enforcement resources or key personnel.
Final words During the panel discussion and after the panel, participants shared two more important insights:
Illicit trade never ends: The illegal profit incentive is so strong, that criminal organizations trafficking in contraband products will always try to find a new way to evade taxes and make illegal profits. As a result, enforcement agencies need to continuously adapt, improve and evolve.
California, for example, now is looking into new ways how to combat the remaining $9 – 12 billion underground economy trafficking in illegal goods, drugs, even humans, through new legislation aimed at tearing down the remaining silos hindering enforcement.
Gain public support: To truly make a difference against illicit trade, public stakeholders need to be convinced that the battle is worth the fight. Lawmakers need to be convinced that illicit trade threatens the economy, jobs and public security. Consumers need to understand the impact illicit trade has on taxes, schools and public safety, since illicit trade invites more crime, including human trafficking, prostitution and drug trafficking. And Public Health officials need to understand the impact illicit product has on public health and engage all stakeholders to combat it.