Less means more: Looking at global tax

When it comes to taxes on the drinks industry – both import/export tarrifs and duty – a lower rate doesn’t just mean more jobs and growth, but also less criminality and ill-health.

(Photo: Flickr/Phillip Ingham)

The relationship between alcohol producers and governments the world over is complex and contradictory. And despite inter-government negotiations and international trade pacts, the subject becomes ever more intractable.

While producers want a stable framework against which to develop their businesses, politicians treat alcohol taxation as a policy tool with which to improve health, to achieve social engineering (e.g. curbing binge drinking), to protect local products and develop their domestic economy through differential tariffs against imports – and, above all, as an easy source of revenue.

Not infrequently, these objectives are in conflict.

In 2004 a World Health Organisation study of alcohol taxes said:”Taxation (and accordingly price level) is an effective measure [of reducing consumption] and should be high enough to keep levels of harm as low as possible while not encouraging an increase in illegal home production and smuggling.” If only that Panglossian aspiration was simple to achieve.

Reducing criminality

Take the example of East African Breweries (EAB), in which Diageo has a controlling stake. In 2004, EAB launched an “entry-level” beer, Senator Keg, which was targeted at low-income Kenyan consumers who traditionally drink illicit alcohol for both economic and cultural reasons.

Senator was designed to introduce drinkers to a hygienic, unadulterated and aspirational product which over time would generate a market for higher quality branded beers and, eventually, spirits as the economy improved. For the Kenyan government the benefit was the gradual weaning of the population to a wholesome beverage with the associated enhancement of national health.

Initially, the beer was sold at a quarter of the price of Tusker, EAB’s main brand, but at a marginal premium to local illicit beverages. By 2008, consumption in Nairobi alone had grown to 400,000 litres a day, according to local reports. Crucial to this growth was Senator not being subject to excise duty, just sales tax.

One estimate suggests that Senator’s sales rivalled Tusker’s in 2012, but in 2013, in a revenue raising exercise, the Nairobi government slapped excise duty on Senator, which effectively doubled its wholesale price. Consumption slumped (some reports say by 75%) as drinkers reverted to moonshine.

Diageo CEO Ivan Menezes

Diageo’s chief executive, Ivan Menezes, said recently: “There is no reliable data… but we have a sense that in many parts of Africa it [illicit alcohol] is more than half the alcohol consumption… which has enormous effects of lack of revenues and all the underground stuff which is not good for governments or anyone.”

And industry estimates suggest that a third of all alcohol consumed in Eastern Europe and Latin America is produced illicitly; in parts of Asia, India in particular, the proportion is two thirds. This is encouraged by high tax levels.

Examples of tariff barriers to protect local products and jobs are widespread. Brazil, for example, has a lower duty rate on its local spirit, cachaça, than on imported rival alcohol to protect jobs and a local industry.

Minding their own business

Some governments effectively ban imports. No beer can be imported to Nigeria while in Ethiopia domestic breweries are taxed at lower rates in a bid to stimulate local production of raw materials such as sorghum and barley. While this generates economic development this may generate, the question comes about when governments accept the need for lowering the barriers to wider trade and accepting the influx of premium global brands on an equal tax basis.

In India all imported spirits face a 150% by value import tax, which gives a virtually impenetrable level of protection to local production. And although not the main motive, Diageo’s purchase of a 55% stake in United Spirits, the country’s biggest producer, will give it a significant price advantage over rivals when it transfers production of some of its international brands such as Smirnoff vodka to USL for the Indian market. Meanwhile, producers are pressing for a single national tax rate to apply across India’s individual states to combat market distortion.

When neighbouring countries operate different tax levels, the challenges are myriad.

Even in a theoretically single market such as the EU, one set of consumers, the British, pay 25% of the excise receipts of all 28 countries. That is why there is a resurgence of day-trips across the Channel. And booze-cruises are just one manifestation of how high taxes in one country increase the temptation to avoid them, legally or otherwise.

Playing into the hands of fraudsters

Simple fraud to beat alcohol taxes is becoming ever more prevalent as the global value of spirits increases.

The latest involves six Vietnamese charged in February with running a smuggling scheme which has cost the Hanoi government least US$600,000 in lost revenues. It is alleged that more than half of the 100,000 barrels of vodka involved found their way onto the local market rather than the intended destination of Laos. Because the vodka was for export, it left the Hanoi distillery exempt from the 25% luxury tax imposed on spirits in Vietnam.

And if you seek an example of countries thwarting another’s rules, consider Delhi’s “wine wallahs”. India’s national import tariff and the provincial excise duty rate combined are so high that a thriving underground commerce exists in buying “surplus” bottles of duty-free alcohol from embassies and selling them on the black market.

The spirits’ industry’s drive for product premiumisation plays into the hands of fraudsters by increasing the returns for faking global brands. By its very nature, it is impossible to calculate the level of fraud taking place in the global market but Ian Fitzsimons, Pernod Ricard’s General Counsel, told shareholders in the latest annual report: “The counterfeiting business is booming.”

There are several factors behind this. By definition, faking luxury goods is increasingly attractive to organised crime gangs as demand for limited supplies of the genuine article expands. As emerging markets develop, so does the target consumer group and consequently the potential for large profits. And as the incidence of faking and counterfeiting increases, so does the determination of brand owners and trade bodies to protect their products and trademarks. The more crime is attempted, the more it is detected.

The Scotch Whisky Association says that at any time it is involved in between 60 and 70 court actions around the globe to protect product identity and integrity. And hundreds of other infringements are stopped before the cases get to court.

Miles Beale, Chief Executive, Wine and Spirit Trade Association (left) and David Frost, Chief Executive, Scotch Whisky Association (right) launching the ‘Drop the Duty!’ campaign calling for a 2% cut in alcohol duty

Barmy Britain

Finally, as an example of how confused national policies can be, look no further than Britain, where 80% of the retail price of a bottle a scotch is duty and tax. The duty is 44% higher than when the “escalator” was introduced in 2008.

Labour’s rationale (apart from raising revenue) was to increase the retail price of beer, wine and spirits to curb consumption as a health measure and to combat binge drinking. That argument was abandoned two Budgets ago when the Conservative chancellor, who had maintained the escalator for three years, dropped it and then cut the duty on beer.

Such is the price barrier to demand created by high alcohol taxes in the UK that the Scotch Whisky Association in its pre-Budget submission calculates that a 2% cut in wine and spirit duties (not the retail price) would actually yield £1.5bn a year extra for the Chancellor through enhanced sales volumes. This is an example of where duties rise too far a price barrier is erected, the customer trades down and the total tax take (including VAT) falls.

By implication, such a cut would also benefit British exports, notably Scotch, by giving an example to those countries who justify their own high imposts on alcohol by pointing at the high (and often higher) level of taxation in the home market.