Sars loses R119 billion in tax revenue due to illicit cigarette sales since 2002

Sars has lost R119 billion of tax revenue due to illicit cigarette sales between 2002 and 2022. The illicit cigarette market comprised 5% of the market in 2009 and peaked at 60% in 2021, before decreasing to 58% in 2022.

According to a study conducted by Prof. Corné van Walbeek and Dr. Nicole Vellios from the research unit on the economics of excisable products at UCT’s School of Economics, if some people reduced their consumption if cigarette prices had been higher (if the illicit market did not exist), government lost R15 billion in excise revenue and R3 billion in VAT revenue in 2022.

Therefore, they found, government lost R119 billion at 2022 prices in excise and VAT revenue. The majority of the lost revenue occurred between 2010 to 2022, when R110 billion in excise and VAT revenue was lost.

They concluded that the South African government lost a significant amount of revenue by not receiving excise and VAT from all cigarettes consumed in South Africa and warned this trend is likely to continue if government does not secure the supply chain from the point of production to the point of sale.

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Using taxes to reduce smoking

Van Walbeek and Vellios say increasing excise taxes is the most effective tobacco control policy for reducing smoking prevalence. Reducing smoking decreases the substantial burden of disease caused by smoking, which was estimated to be around 25 700 premature deaths in 2016 among South Africans between the ages of 35 and 74.

British American Tobacco (BAT) and its predecessors (Rembrandt Tobacco Company) have dominated the South African tobacco landscape for many decades. According to their research paper, BAT still had a 91% market share in 2005 but after that other multinationals, mainly Philip Morris International and Japan Tobacco International, entered the market.

From 2010, small manufacturers, based in South Africa and neighbouring countries, entered the market and according to Van Walbeek and Vellios, they were presumably attracted by the very high profits the multinationals made.

“Using the large excise tax increases as a pretext, the multinationals increased the retail price of cigarettes since the early 1990s, thereby increasing their profit per cigarette. A large proportion of the new entrants’ cigarettes were sold at prices which did not even cover the excise tax, a practice that continues today.”

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Instability at Sars and taxes on cigarettes

They also point out that instability at Sars, that started around 2014, resulted in a reduced capacity to collect excise taxes from cigarettes. “The illicit trade problem was further exacerbated by the five month ban on cigarette sales related to the Covid-19 pandemic in 2020. After the sales ban ended, a substantial proportion of smokers, who had previously smoked multinational brands, stayed with the non-multinational brands.”

Finance Minister Enoch Godongwana highlighted his concern about the illicit market in his budget speech last year. He mentioned several strategies that Sars has implemented to fight it.

“On illicit trade, over the past three years, Sars took several steps to enhance its effectiveness in combating illicit trade, particularly in tobacco. To this end, Sars completed 2 316 seizures of cigarettes and tobacco products to the value of R598.8 million.” However, Van Walbeek and Vellios say, this number is only a small proportion of the illegal cigarettes in the market.

They warn that the illicit market threatens the Control of Tobacco Products and Electronic Delivery Systems Bill. Although this bill is more than five years old, it has not yet been signed into law. It proposes to implement plain packaging, ban point-of-sale advertising and make all indoor public places 100% smoke-free.

If the bill is implemented and the illicit cigarette market remains unchanged, the legislation may be undermined by the illicit market.

“Reducing the availability of illicit cigarettes is likely to decrease smoking prevalence. A lower smoking prevalence, eventually, reduces the substantial public health costs caused by smoking.”

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Cheap, tax-evaded cigarettes greatly reduce effectiveness of tobacco taxes

Van Walbeek and Vellios argue that cheap, tax-evaded cigarettes greatly reduce the effectiveness of tobacco taxes and also reduce revenue. “Tax-unpaid cigarettes represent a substantial loss to government.”

They say Sars should secure the cigarette supply chain to monitor cigarettes from the point of production to the point of sale. The Protocol to Eliminate Illicit Trade in Tobacco Products provides guidelines for reducing illicit trade, but South Africa has not yet ratified the protocol that commits governments to take effective steps to reduce the illicit trade in tobacco products, such as allowing only licensed manufacturers to produce cigarettes and implementing a track-and-trace system.

“If Sars does not secure the supply chain, South Africa will continue to lose valuable revenue,” they warn.

A group of cigarette manufacturers recently failed in their urgent bid to interdict Sars from installing closed circuit television (CCTV) cameras at their warehouses that would allow the revenue service to monitor the warehouses and the volumes produced to clamp down on illicit cigarettes entering the market.

British American Tobacco and Gold Leaf Tobacco had these cameras installed for years, but other manufacturers resisted this measure until now. The High Court ruling means that Sars can now install and monitor CCTV cameras in these manufacturers’ warehouses as well.