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

Tobacco taxes, tobacco use, and
government revenues

Types of tax avoidance & evasion

Measuring tax avoidance & evasion

Determinants of tax avoidance & evasion

Policy options for curbing tax avoidance &
evasion
2
Impact and Variability of
Tobacco Taxes
3
Taxes, Prices and Tobacco Use

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:

Illicit trade, contraband, smuggling,
bootlegging, counterfeit, etc.
• Tax Avoidance

Legal methods for avoiding tobacco taxes
• Tax Evasion

Illegal methods for avoiding tobacco taxes
8
Tax Avoidance & Evasion
• Individual tax avoidance

Reservation, Internet and other direct, dutyfree, and cross-border purchases
• Generally not illegal, but states require local taxes
to be paid

Brand/product switching, carton purchases,
use of cheaper outlets
• Bootlegging

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
Generally avoids all taxes
• Counterfeit


products bearing a trademark without the
approval of the trademark owner
Often involved in organized smuggling
10
Tax Avoidance & Evasion
• Illegal Manufacturing



Unreported or under-reported
manufacturing, distribution and sale of large
consignments of tobacco products
Generally avoids all taxes
Often involved in organized smuggling
• Brand Repositioning

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
None fully captures all tax avoidance and evasion
13
Measuring Avoidance & Evasion
• Comparing recorded exports of
tobacco products to recorded
imports
Difference reflects leakage into black
markets
 Recent estimates suggest 20-30
percent of exports do not appear as
imports
 4-10 percent of global consumption
 Will be largely organized smuggling

14
Extent of Illicit Trade
1400000
Import
1200000
Export
1000000
2000: 14%
trade gap
121 billion
pieces
Quantity of Export & Import
Gap Widening
800000
600000
400000
Highest gap in 1996
399.6 billion pieces
36% of global exports
200000
02
20
99
19
96
19
93
19
90
19
87
19
84
19
81
19
78
19
75
19
72
19
69
19
66
19
63
19
60
0
19
Import and Exports (Million pieces)
Increasing Gap in Quantity of Global Cigarette Trade
(Export minus Import) 1960-2003
15
Source: ECOSOC Trade Database: Ayda Yurekli
Measuring Avoidance & Evasion
• “Expert Opinions”

Customs officials, tobacco industry
representatives, tax authorities, and
others
• Potential bias in some sources



Widely varying estimates across
countries
Recent estimates 10-12%
Again, largely reflecting organized
smuggling
16
Tax Avoidance and Evasion
17
Source: Tobacco Atlas, 3rd edition
Measuring Avoidance & Evasion
• Individual tax avoidance a bit
easier to assess

Econometric analyses of tax paid sales
that account for various factors,
including:
• tax/price differences
• population density
• travel patterns
• Distance

US estimates suggest up to 12.5% of
total consumption in early 2000s
18
Measuring Avoidance & Evasion
• Individual tax avoidance – selfreported data
International Tobacco Control Policy
Evaluation Study
 Tobacco Use Supplement to the
Current Population Survey
 European Survey on Economic
Aspects of Tobacco Use
 Others

19
Measuring Avoidance & Evasion
• Individual tax avoidance – self-reported
data

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
% Tax Avoiders, 2006/07
20.00%
15.00%
10.00%
5.88%
5.00%
M
MI
N
O
H
NJ
KS
PA
SD
AZ
NY
IN
CT
M
T
NM
AK
ID
TN
NC
HI
CA
VA
G
A
W
Y
TX
IA
O
K
LA
UT
AL
DE
W
I
M
S
NV
CO
SC
O
R
NH
FL
M
O
KY
ND
VT
DC
M
D
RI
AR
W
V
IL
W
A
M
A
M
E
NE
0.00%
Source: Tax Burden on Tobacco, 2008 and TUS-CPS
21
Tax Avoidance – United States
% Other Tax Avoiders, 2006/07
2.50%
2.00%
1.50%
1.00%
0.86%
0.50%
RI
AK
O
R
W
Y
FL
O
K
IN
M
D
AL
AR
CO
DE
G
A
IA
ID
IL
KY
LA
M
N
M
O
M
S
M
T
NC
ND
NE
NH
NJ
SC
SD
VA
W
WI
V
M
MI
A
NY
NV
W
A
CT
M
E
KS
UT
DC
TX
NM
PA
O
H
TN
AZ
HI
VT
CA
0.00%
Source: Tax Burden on Tobacco, 2008 and TUS-CPS
22
EU Tobacco/Economics Survey
Pack Inspection
B10) Please, could you show me the latest pack of cigarettes
or hand rolling tobacco that you bought?
No
Yes
1
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
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
B10) Please, could you show me the latest pack of cigarettes
or hand rolling tobacco that you bought?
No
Yes
1
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

Expert Opinions
• Potentially most comprehensive

Econometric modeling
• Cross-border shopping, bootlegging

Self-report and pack inspection
• Mix of individual avoidance and
bootlegging/smuggling

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
Larger scale efforts avoid all taxes
29
Tax Avoidance – United States
Cross Border Tax Avoidance and State Cigarette Taxes, 2006/07
25.00%
% Tax Avoiders
k
20.00%
15.00%
10.00%
5.00%
0.00%
$0.00
$0.50
$1.00
$1.50
$2.00
$2.50
State Tax per Pack
Source: Tax Burden on Tobacco, 2008 and TUS-CPS
30
The illicit cigarette market share (%) and the average
cigarette pack price($) 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$
high income
middle income
2.00%
1$
0
0.00%
Source: WHO & IUATLD, 2009
low income
cigarette pack
price
Determinants of Avoidance &
Evasion
• Corruption
• Weak tax administration

Absence of tax stamps; weak or non-existent
physical controls; unlicensed manufacturers,
distributors, retailers; weak customs
authorities
• Poor enforcement

Limited resources for border patrols, customs
authorities, etc; low penalties
32
Smuggling and Corruption
33
Determinants of Avoidance &
Evasion
• Presence of informal distribution
channels

e.g. Street vendors, unlicensed distributors
• Presence of criminal networks

e.g. Organized crime, terrorist organizations
34
Policy Options
35
Impact of Avoidance & Evasion

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
Cigarette Prices and Adult Prevalence, New York,
1995-2007
25
$6.75
$6.25
23
$5.75
22
$5.25
$4.75
21
$4.25
20
$3.75
19
$3.25
18
$2.75
1995
1997
1999
Prevalence
2001
2003
2005
2007
Price (2008 dollars)
Source: Tax Burden on Tobacco, 2008 and TUS-CPS
37
Pric
Prevalence
24
Does NOT Eliminate Revenue Impact of Taxes
Cook County Cigarette Tax and Tax Revenues - FY01-FY06
$225,000,000
$1.75
$205,000,000
$1.55
Tax per Pack
$1.35
$165,000,000
$1.15
$145,000,000
$0.95
$125,000,000
Chicago tax up
to 68 cents, 1/1/06
Chicago smoking
ban, 1/16/06
$0.75
$0.55
Chicago tax rises
from 16 to 48 cents
$0.35
$105,000,000
$85,000,000
$65,000,000
$45,000,000
$0.15
$25,000,000
2001
2002
2003
2004
2005
2006
Fiscal Year
Tax
Revenues
38
Tax Revenues
$185,000,000
Impact of Avoidance & Evasion

World Bank Policy Report:
• Rather than forego tax increases,
appropriate response is to crack down on
illicit trade

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
40
WHO FCTC

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:


“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 dutyfree tobacco products.”
• Guideline development in early stages
41
WHO FCTC

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……

Protocol negotiations ongoing
42
WHO’s Best Practices in
Tobacco Taxation

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

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

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

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

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

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

License suspension, revocation
48
WHO’s Best Practices in
Tobacco Taxation

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

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/handbook14
(coming in 2011)
www.who.int/tobacco/publications/tax_administration/
fjc@uic.edu
51