The costs of driving smoking underground
It is not surprising that the total ban on cigarette sales in South Africa, under COVID-19 lockdown regulations, has generated a thriving black market. This impact of banning sale of goods with an inelastic demand profile has been understood since at least the lifting of the Volstead Act (prohibition) in the United States (US) in 1933.
But 14 years of prohibition in the US (1919-33) allowed racketeers like Al Capone to entrench their activities and remained a problem long after alcohol sales became legal again. South Africa’s ban on tobacco products shows a similar pattern. Not only is the ban itself of dubious efficacy but is also undermining attempts to rebuild state capacity to deal with a long-standing illicit tobacco problem.
The ban was imposed when South Africa entered a strict lockdown (subsequently defined as Level 5), on 26 March 2020, to combat the spread of the coronavirus. All tobacco and tobacco products sales were declared illegal. Most of the other activities which were temporarily banned have been allowed again as the lockdown has been eased through Level 4 to its present Level 3. But tobacco remains outlawed.
This constitutes a considerable loss to the national fiscus. A group of companies centred on South Africa’s biggest cigarette manufacturer, British American Tobacco (BAT), estimated that when the ban reached the 100-day mark, on 5 July 2020, government had lost R3.5 billion. Most of this is in excise taxes which made up just under half the over-the-counter cost of each BAT packet of cigarettes before the lockdown. Former South African Revenue Services (SARS) official Bernard Sacks estimates that government loses R1.2 billion in excise duties per month in addition to R300 million in Value Added Tax (VAT).
Significantly, the ban appears to have had only a small impact on aggregate tobacco use. A study in late April/early May by the Research Unit for Excisable Products at the University of Cape Town (UCT) found that more than 90 per cent of smokers had bought cigarettes during the lockdown despite the ban. The online study of 12 200 smokers found that only 16 per cent of smokers in the sample had successfully quit in response to the ban.
According to government, there are an estimated 8 million smokers in South Africa, consuming an estimated 26 billion cigarettes per year.
What is probably most significant is that the 84 per cent of smokers who did not or could not quit consuming tobacco products have continued to source their fix from what would, prior to the lockdown, have been regarded as illegal and informal sources.
The source of illegal (untaxed) tobacco products in South Africa has been a matter of some controversy. What is clear is that this was a thriving market even before cigarette sales were declared illegal. The UCT Research Unit on the Economics of Excisable Products estimated that the illicit market constituted 30 per cent of the total market in 2017 (up from 5 per cent in 2009). A 2018 survey of 6 townships in 4 provinces, by the same unit, produced a figure of 35 per cent.
The country’s authorities lost control of the illicit cigarettes phenomenon more than a decade ago when specialised units at the South African Revenue Service (SARS) were deliberately white-anted by racketeers, allegedly with the collaboration of the formal tobacco industry. A narrative was formulated and placed in the media, initially in the Sunday Times, that those charged with reining-in the illegal industry were a ‘rogue unit’ with extensive involvement in criminal activity.
Recent books by officials in or close to the unit (Tobacco Wars by Johann van Loggerenberg and Dirty Tobacco by Telita Snyckers) show that the issue was that the unit was in fact successful and had been making inroads into the illicit market. In 2014, immediately before it was ended, SARS’ enforcement exercise, Operation Honey Badger, seized 270 million illicit cigarettes, up from 54 million 2 years before that.
Illicit tobacco products have mostly come from one of two sources:
Illegal smuggled imports from Zimbabwe, accounting for 57 per cent of the illicit market
‘Ghost exports’ – cigarettes produced in South Africa, ostensibly for export (and therefore excise exempt) but in fact sold locally.
What is not clear, however, is what the sources are of the cigarettes sold illegally in South Africa since the March lockdown. Products offered by big formal companies like BAT do not seem to be available. Anecdotally, it would appear that the most widely available products are those made by Gold Leaf, an intermediate sized firm with factories in both Zimbabwe and South Africa.
On the other hand, what is clear is that criminal distribution networks are thriving. Johann van Loggerenberg describes them as being ‘in overdrive‘. He argues that illicit dealers make up to R30 million per container. Snyckers argues that the margins on illegal tobacco products exceed those of heroin (2 400 per cent for tobacco compared to 1 800 per cent for heroin).
Immediately prior to the ban, there were signs that a revitalised SARS, under new commissioner Edward Kieswetter, was starting to regain lost ground in the struggle against illicit tobacco. The UCT Research Unit on the Economics of Excisable Products reported that tax revenue from cigarettes had risen nearly 20 per cent on the previous year for 2019/20. The Unit argues that this rise does not represent an increased numbers of intensity of tobacco use in South Africa but increased formalisation, through both increased efforts on the part of SARS and cooperation from big listed tobacco companies .
The ban on cigarettes puts these gains in peril. It does not seem to have succeeded in much reducing the size of the market but, by rendering distribution illegal, has handed that activity back to criminals and racketeers. It is an unfortunate unintended consequence but, as the US experience with the Volstead Act should tell us, it should not have been an unexpected one.
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