Key Issues

estimony by David Sweanor, Senior Legal Counsel.

I am a lawyer, based in Canada, and have worked full time on public health issues involving tobacco for the last 15 years. During this time I have been very active in analyzing, and contributing to, the economic research on the role of tobacco prices in determining consumption patterns. I have also spent considerable time studying the potential for black markets and exploring ways to effectively prevent the development of such illegal behavior. I have also been very involved in analyzing the role of the tobacco industry in assisting the creation of a smuggling market, and seeking to benefit from the threat, or existence, of such a market.

I have also worked with groups such as the American Cancer Society, National Cancer Institute and American Medical Association in the United States in analyzing these issues in a U.S. context. My international activities in this area include work with the World Bank, Pan American Health Organization and World Health Organization. I have authored numerous reports and articles on the creation, and prevention, of smuggling.

It is important to state, from the beginning, that you will be hearing many things about taxes and smuggling. Much of it will be confusing or contradictory. I ask you to critically examine the evidence and arguments brought before you and to determine the credibility of the messengers and the ultimate sources of their evidence.

Health and medical organizations are interested in the role of tobacco product pricing for only one reason: the affordability of tobacco products has been shown to play a key role in determining tobacco consumption and is particularly important in influencing youth consumption patterns. The public health community has studied the numbers, evaluated the studies, considered all of the arguments, and received the guidance of leading economists. There is no hidden agenda for the health community. Health groups know the tobacco industry arguments, and have heard them for years. We have also studied their positions and determined that they are without merit. Yet their statements continue to be made – clearly more for reasons of public relations than accuracy.

Having testified before a Senate committee last week I was surprised to see that outlandish estimates of smuggling – almost certainly originating from the tobacco industry – could be repeated and not challenged. Also, that a tobacco industry ‘front group’ could present a well-scripted and misleading smuggling story without being questioned about the source and extent of their funding from the tobacco industry.

Health organizations want what is best for this country. They will, in my experience, go to great lengths to provide detailed, accurate, information. I urge you, in the weeks ahead, to think critically of the information presented to you. Remember the reputation for deceit within the tobacco industry, and carefully evaluate the information that comes directly or indirectly from its public relations machine. You will find some of the tobacco industry statements to be incredible. You will also find them to be non-credible.

THE SMUGGLING THREAT

Based on my experience with tobacco pricing and smuggling issues I conclude:

1. The Canadian tobacco smuggling problem of the early 1990’s was a result of a unique set of circumstances that do not apply to the United States.
2. Tobacco price increases can have dramatic benefits for public health.
3. There are effective strategies for combatting the criminal behavior involved in smuggling.

To begin with, I think it is important to understand the context in which smuggling threats arise. Warnings of potential black markets usually accompany any suggestion of higher taxes on tobacco products or government action to regulate the manufacturing of tobacco products. In the case of price increases, which is the current focus of this committee, it is important to reflect on the public health motivation for higher tobacco prices.

THE PUBLIC HEALTH IMPACT OF TOBACCO PRICING

There is a strong consensus among the public health community that pricing plays a critical role in the determination of overall tobacco consumption. As with other consumer products, there is a general rule that consumption goes down when prices go up.

The impact of tobacco prices on consumption is an area that has been extensively researched in the United States, and this research is widely used throughout the world. Based upon a thorough evaluations of all of the data in this country, Frank Chaloupka, a highly regarded economist from the University of Illinois at Chicago, recently prepared a paper for the Health Sciences Analysis Project. It concludes that a 10% price increase will reduce consumption by about 4% among adults, and by two to three times that among teenagers. Further, and not surprisingly, the larger the price increase the greater the decline in consumption. The current McCain bill proposals, according to Professor Chaloupka, would reduce overall cigarette demand by 20% and would lower prevalence of teen smoking by about one third.

It is the public health benefit from higher tobacco prices that has created the wide support for such measures among health and medical organizations. The tobacco industry directly and through intermediaries has sought to sow doubt about the role of pricing. But the health and scientific communities that have examined any tobacco industry argument have found no credible evidence to disprove existing economic research.

THE CANADIAN EXPERIENCE

The Canadian experience with tobacco pricing and smuggling is often mentioned in the current debates in the United States. In my view much of what is stated by those working for the tobacco industry is simply inaccurate. The facts are as follows. and I would be pleased to provide additional information to this committee:

1. From the early 1980’s to the early 1990’s Canada significantly increased tobacco taxes as part of a comprehensive plan to reduce tobacco use and thus tackle our largest cause of preventable death. In doing this we relied heavily upon the research on tobacco pricing that had been carried out in the United States.
2. During this time the real price of tobacco products increased by a total of about 150%. Average retail prices, translated at prevailing exchange rates, increased to between US$4.00 and US$5.00.
3. Government tobacco tax revenue more than tripled.
4. Total domestic consumption of cigarettes, even after accounting for the highest credible estimates of smuggling, fell by 40% per capita. This was half again as fast as what was achieved in the United States during this time.
5. The prevalence of daily smoking among 15 to 19 year olds fell from 40% at the beginning of the 1980’s to only 16% by 1991.
6. The tobacco industry made many threats about the potential for smuggling of U.S. cigarettes into Canada. But this problem never developed as a significant issue, in part because Canadian and U.S. cigarettes differ in tobacco blends and taste.
7. The Canadian operations of the multinational tobacco companies started shipping ever-larger quantities of Canadian cigarettes across the U.S. border. This avoided Canadian taxes, allowing the products to be shipped (illegally) back into Canada. By 1993, despite a legitimate annual market in the U.S. for well under a billion Canadian-style cigarettes, there were about 20 billion Canadian cigarettes shipped to this country, primarily into northern New York State.
8. Smuggling of tobacco products became a significant problem in parts of Canada, particularly in Quebec, by 1992 and 1993. It was estimated in a study published by a federal Health Department journal (Chronic Diseases in Canada) that smuggling had come to represent over a quarter of the Canadian market by 1993. The vast majority of all of the cigarettes smuggled into Canada, likely in excess of 95%, originated from Canada, were shipped by the tobacco companies across the border to take advantage of the low U.S. tax rates, and were then brought back into Canada illegally.
9. Faced with an embarrassing problem in Quebec at the time of a politically sensitive election period, the federal and Quebec government announced massive tobacco tax decreases in February of 1994. These decreased forced down taxes in provinces neighboring Quebec. Interestingly, the Western provinces refused to lower taxes and opted for a crime prevention strategy instead. Rather than losing revenue to increased smuggling these provinces saw tobacco tax revenue increase.
10. Since the tax reductions, the prevalence studies by the tobacco industry itself have shown a reversal of trends in smoking among young adults. Numerous provincial studies have shown the same thing. Not surprisingly, lowering tobacco prices stimulates demand just as increasing the taxes reduces demand.

WHAT CAN THE UNITED STATES LEARN FROM THE CANADIAN EXPERIENCE?

There are many things the United States can learn from Canada’s experience with tobacco pricing and smuggling. Foremost among these is the fact that tobacco price increases do reduce overall consumption. The American research was borne out by the Canadian experience. Most importantly, teens are particularly price sensitive. Significantly higher tobacco prices act almost like a vaccination against tobacco dependency among young people.

The role of the tobacco industry in facilitating smuggling is also of great importance. In my view Canada would never have had to lower tobacco taxes, and would still have the benefits of much reduced youth smoking, had the tobacco companies not fought anti-smuggling initiatives while supplying the smuggling ‘pipeline’. While fighting off initiatives such as better package markings and an export tax on suspicious shipments, the tobacco companies engaged in massive shipments across the border into New York state. This was despite the fact that the legitimate market for Canadian-style cigarettes there was virtually non-existent.

This experience from Canada is repeated around the world. We know, for instance, that roughly a third of all global cigarette exports are never legally imported. This amounts to over 300 billion ‘disappearing’ cigarettes annually – an amount equal to over 60% of the current U.S. market. We also know that some of the countries to which cigarettes are legally exported are really just being used as a convenient stopping off point in smuggling operations. It is extremely likely, in my opinion, that this smuggling trade is operating with the passive or active support of the tobacco companies. These same companies then seek to use the existence of a smuggling threat as a tool in avoiding tax increases.

As the source of much of this ultimately smuggled tobacco, the United States could help control it. As U.S. tobacco product prices rise toward world levels this country will also have a vested interest in assisting efforts to eliminate the black market trade.

There is, based upon experience elsewhere, a clear lesson for the United States. If the domestic companies can be prevented from benefiting from smuggling they will be powerful allies in combating smuggling. But if they benefit from smuggling they become highly motivated enemies of smuggling control measures.

At the same time as the U.S. can prepare to prevent black markets in tobacco products it is critical to recognize that this country is in a very different situation than that faced by Canada a few years ago. Any discussion of a repeat of the ‘Canadian smuggling experience’ should bear in mind the following points of differentiation:

1. The vast majority of Canadians live within a short distance of the U.S. border, there is enormous traffic across the border, and the border is relatively easy to cross both legally and illegally. The U.S. population has a very different distribution pattern in relation to international borders.
2. The low tobacco taxes in the United States made the ‘back and forth across the border’ ploy viable. By international standards it is not that Canada’s taxes were high, but that the tobacco taxes in the United States were so extraordinarily low. If tobacco taxes were increased in the U.S., it would allow Canadian taxes to be reapplied, removing the largest and most open U.S. border as a smuggling threat.
3. The Canadian government appeared unable or unwilling to tackle the sources of the criminal trade. Our government did not take on the tobacco industry over its ultimate supplying of product to the smugglers, and failed to implement effective anti-smuggling measures. Canada was also unable to influence tobacco pricing policies in our enormous southern neighbor. The United States is, and this may just be my opinion, a more powerful nation and better able to negotiate policy changes in neigboring countries.

OTHER RELEVANT U.S. FACTORS

In examining the risks of tobacco smuggling it is also important to look at other factors within the United States. These include the following:

1. U.S. federal tobacco tax, at 24 cents a pack, is very low by the historical standards of the United States. In inflation adjusted terms this tax is considerably lower than what it was 40 years ago – before all of the evidence on tobacco as the leading cause of death, and price as a major determinant of consumption. Clearly there is room to increase the tax without necessarily creating a smuggling problem.
2. In determining how large a tax increase is possible we can look at other nations. Many countries have tobacco products costing $4 or $5 a pack with minimal smuggling. By the standards of wealthy countries the U.S. has exceedingly low tobacco taxes.
3. Even with the price increases currently discussed in the United States the resulting prices will be lower than those Canada had five years ago, and lower than several Canadian provinces have today.

HOW TO CONTROL SMUGGLING

As with other areas of potential criminality there are many options other than simply giving up an action, which though valuable, could invite criminal behavior. There could, for instance, be higher penalties for smuggling, increased enforcement, and the implementation of effective tax markings on legitimate products. Reducing the country’s largest cause of preventable death and redressing the harm caused by an industry operating outside of normal moral behavior are valuable goals.

Implementing effective crime prevention and detection measures are of great importance. So, too, is cooperation at an international level. In addition, public education efforts on the role of tobacco taxes and the effect of smuggling is important. We need to remember that the large majority of Americans do not now use tobacco products. Of those who do, 70% wish to quit completely. And nobody wants their children to become dependent. This is an issue of great public interest and overwhelming support, and that public support can play a huge role in preventing crime.

The profit can be taken out of smuggling. To begin with we can reduce the supply of product to smugglers by stopping the local companies from shipping it to them. After all, the purchasers of smuggled products want the major domestic brands, not obscure foreign brands. They can only get these brands if there is a willing supplier.

We can also increase the costs of operating a smuggling business. This can be done through higher penalties and greater probability of apprehension. Such efforts are assisted by things like prominent package tax markings and consumer education.

Finally, we can reduce the demand for smuggled product. In doing so we should emphasize the role of helping people successfully break their dependency on tobacco products. As we assist the vast majority of smokers who wish to quit to successfully do so, we will reduce any potential for contraband. We will also greatly improve the lives of millions of people.