To optimise its revenues from excise products, a government must employ a comprehensive strategic approach. Such an approach includes balanced tax rates that do not tip the scales towards illicit trade, and effective methods to ensure the collection of taxes due. This is the view of the International Tax and Investment Center (ITIC), an American non-profit research and education foundation, which serves as a global clearinghouse for good practices in tax and investment issues.

In her presentation at September's Tax Stamp Forum - and in her publication 'The Illicit Trade in Tobacco Products and How to Tackle It' - Elizabeth Allen of ITIC describes the key elements of a comprehensive tax strategy. She has 35 years' experience with HM Revenue and Customs (HMRC) in the UK and has worked with other governments, including, in 2010, the Southern African Development Community, where she led a review on tobacco and alcohol illicit trade in the region.

Ms Allen's experience has led her to believe that paper tax stamps are a distraction to governments because they can be counterfeited and give a false sense of security. She much prefers resources to be invested in enforcement. 

This is a summary of her recommendations for building a comprehensive tax strategy:

Understand Size and Nature of Illicit Trade

As a first step, governments and their law enforcement agencies need to understand the size and implications of illicit trade and identify those involved. There are several indicators of the presence and growth of illicit trade that include an unexplained drop in legal market sales, disturbances in the flow of government revenues, an increase in seizures of illegal products, the emergence of brands without the correct markings, and changes in the results of anti-illicit trade surveys.

To measure the size of its tobacco illicit trade, the UK uses tax gap methodology that compares household surveys with declared revenues. This has allowed it to estimate a drop in illicit trade from 20% in 2001 to today's level of 11%. Mrs Allen advises that there are more sophisticated methodologies around, but this method serves as a baseline to judge future effectiveness in tackling illicit trade.

Balanced Tax Rates

In Ms Allen's experience, many people believe the key consideration of any balanced tax policy is the amount of revenue required. But, in fact, a longer-term approach is needed, to take account of ...

First, the purchasing power of the consumer - sudden hikes in taxes can cause major shockwaves in an economy, which make people switch behaviour. In times of economic downturn people have less money and the goods they are addicted to are less affordable. So they turn to illicit markets.

Second, tax rates in neighbouring countries - nowadays there are many customs unions in the world where customs controls are being removed to facilitate trade. That is all well and good, except in those cases where excise taxes are different between the countries within a union. And when, in addition, a union does not effectively control the movement of goods between those countries, the scene is set for illicit trade. This issue of price disparity is a political one, as governments want to reserve the right to tax what they like in the way they like. Ms Allen questions whether this is sensible, as one of the key ways of reducing illicit trade is to harmonise tax structures so that there is less profit available to the criminal.

Effective Tax Collection

Ms Allen has often heard people saying that excise taxes collect themselves. 'No, they don't', she is quick to stress.

Countries use different methods to collect and control tax revenues. Excise administrative systems are usually based on checking factory output, bonded warehouse inventories and import volumes. This can be complemented - and, in the case of 80 countries is complemented - by the use of fiscal markers, including tax stamps or digital coding. The markers are used either as an additional audit mechanism or as a means of tax payment itself.

However, in the view of the ITIC, even the most sophisticated paper tax stamp systems cannot fully protect a market from illicit products and have failed to protect excise revenue. Like cigarettes, paper tax stamps are subject to very high quality counterfeiting, often within weeks of appearing. Paper stamps are also vulnerable to theft and re-use by smugglers.

'I'm not a fan of paper tax stamps,' says Mss Allen, 'because I think they are distracting. Somehow governments get the idea that if you have the right technology there's no more problem. Well, you can have the best technology in the world, but if you don't have enough enforcement staff who understand the business process and the revenue weaknesses in the system, and they don't have the tools or the training, then it is not worth investing a lot of money in tax stamps, whether they are paper or digital.'

'And I fear', she continued, 'that because tax stamps can be easily counterfeited, they have somehow left a nasty taste in the mouths of governments that have invested a lot of money in them. So I think there's a lot of catching up to do by governments which have invested in the technology but not the enforcement. '

'My personal view is that the way forward is the electronic digital identifier, but the difficulty with that is that there is no visible authentication. If you can build in both then that would be really helpful.'

Supply Chain Control

According to Ms Allen, 'one thing that is key to tax administration is licensing and registration. There must be control of the taxpayer base and all those involved in handling and moving taxable goods. Do you know who they are? Are they fit and proper persons? Do you control them adequately? And what about the control across the supply chain between, say, wholesaler and retailer, or street seller? In many governments, it's a different enforcement authority. The revenue people may control the revenue at manufacture, and perhaps at wholesale, but they do not usually control what happens at the retail stage; that's usually down to whoever looks after labeling requirements and quality standards. I'd argue that there's a need for the control to be joined up at this point.'

Another aspect that is key to supply chain security - and an important element of the FCTC Protocol on illicit trade - is a tracking and tracing regime to help combat the diversion of genuine product into illegal channels. Tracking is the ability to monitor the forward movement of goods through the supply chain and tracing is the ability to re-create the movement. Governments need to have a system that does both.

Effective Legislation

Ms Allen advises that in order to be effective, legislation needs to be clear and simple to administer. It must be 'in line with the times', to facilitate a modern e-government system with electronic documentation. And it should provide user-friendly guidance to tax payers.

Legislation must provide law enforcement officers with sufficient authority to take action, and must leave no room for interpretation. A case in point where the law lacks clarity is in Egypt. Egyptian laws do not explicitly provide customs with the authority to seize goods in transit that violate intellectual property rights. This creates uncertainty within customs and among judicial personnel responsible for IPR cases. As a result, Egyptian Customs may have no choice but to let consignments pass through Egyptian Free Trade Zones.

Enforcement

Ms Allen emphasises that an effective targeted enforcement strategy is the cornerstone of any comprehensive anti-illicit trade strategy. Without it, all the other elements are of little use. However, to be effective it does require considerable investment in skilled resources and tools. Fully trained human resources are the key tool in the fight against illicit trade. They need to know the legal requirements for successful prosecutions and be able to use IT tools and analyse data sources. They should be kept up-to-date with intelligence and technical developments (eg, counterfeit techniques).

A cross-government enforcement strategy, including local police and local agencies, is also essential to effective enforcement. And enforcement authorities should be involved in discussions on tobacco and alcohol regulation.

Says Ms Allen: 'I've been quite horrified when hearing about the proportion of enforcement authorities that have been involved in the WHO discussions. Yes, I believe there have been a lot more recently, but to start with there were very few. The discussions were mainly conducted by health authorities'.

Educate the Public

Says Ms Allen: 'most revenue and enforcement authorities tackle supply, but how many tackle demand? Are there joint public awareness efforts with health, education and commerce ministries, or whoever it is who polices quality standards and labeling of products?'

'But there's a bit of a Robin Hood attitude to alcohol and tobacco crime. It's not quite like shooting people is it? So why do we bother? Is it really a crime? Well does the general public realise that a lot of the money from illicit tobacco and alcohol go to financing not just criminal gangs but terrorist and insurgent activities across the world, where they are indeed killing people? I don't think the public knows'.

Cooperation

There are many organisations involved in the regulation and trading of excise goods, all with their own targets and priorities. Says Ms Allen: 'I found that it's not the norm for health authorities to work closely with revenue and enforcement authorities. In fact, in some countries I've visited in the course of my work, I've found almost the opposite. That's because enforcement authorities, particularly the customs and revenue people, talk to the tobacco industry, and are therefore regarded as evil in the eyes of some health department officials. But if you can get people to work together you are going to be much more effective'.

As she states, if a country does not have a comprehensive taxation strategy based on solid enforcement, it is not going to achieve optimised revenues. She gives the UK as a best practice example, where tobacco illicit trade was massively reduced in the last decade due to a multi-faceted strategy that included heavy investment in enforcement personnel and equipment.

What this strategy also included, however, was the use of a fiscal marker and anti-counterfeiting feature on each pack. This shows that visible devices for authentication and proof of tax paid also play an important role, whether they are carried on a tax stamp or not. 

Contact www.iticnet.org.