Introduction

Tobacco tax increases that result in higher prices for tobacco products are considered the most effective tool at reducing tobacco use.1 In many countries, governments are also finding tobacco taxation to be an effective mechanism to increase revenues. At the same time, regional economic integration is increasing rapidly in many regions with the development of free trade areas (FTAs), customs unions, common markets, economic unions and monetary unions. Some economic blocs have chosen to include tax policy harmonisation (generally, but also tobacco excise taxes specifically) as part of this integration. The purpose of this paper is to consider how tobacco excise tax harmonisation can heighten the positive effects of taxation for public health. At the same time, the paper explores the risks and challenges of tobacco tax harmonisation—including political complexities—and considers how policy makers might mitigate them. Additionally, it is important to consider the motivations of the tobacco industry which may seek to use regional tax harmonisation to undermine tobacco control efforts by slowing policy developments.

This research comprises four major components. We begin with a general discussion of tax harmonisation specific to the context of tobacco. Second, we combine technical discussion with international relations theory to explore the opportunities and challenges of tax harmonisation, incorporating the complexities of navigating both domestic and international politics. We then present case studies from three diverse regions both from a technical perspective and through this theoretical lens. Finally, we use the experiences from these case studies to draw some important policy lessons.

Background

Harmonisation of tax policies is typically part of a broader programme of economic integration. The logic of economic integration derives from the concept of comparative advantage, which demonstrates that economic liberalisation—particularly the removal of barriers to trade (eg, tariffs)—typically increases social welfare.2 The broader logic underpinning tax harmonisation is the desire to ‘level the playing field’ by mitigating the possibility that states will engage in a race to the bottom in terms of low tax policies to attract investment.3 ,4 Furthermore, tax harmonisation is thought to reduce transaction costs for government5 and industry6 as there is less necessity to expend resources on maintaining differing policies.

There is important variation in the types of tobacco tax harmonisation. In its most typical form, participating countries coordinate the rate of tobacco excise taxation. In many cases, it also compels the type of excise tax: specific, ad valorem or combinations of the two. Harmonisation might also compel countries to agree to a minimum or maximum tax burden (the percentage of excise tax in the price) and/or the minimum or maximum value of tax (a minimum is referred to as a floor while a maximum as a ceiling, independent of whether this is a percentage or a value). Finally, harmonisation might require that countries coordinate regular tobacco tax increases to adjust for inflation and/or income growth.

Tax harmonisation can mitigate certain types of illicit trade in tobacco products by reducing the incentives and opportunities to avoid and evade excise taxes. A tangible example is that, with open borders, a smoker has the opportunity to purchase cigarettes in a lower tax jurisdiction and consume them in a higher tax jurisdiction (tax avoidance, which is legal). A bootlegger has an opportunity to purchase cigarettes in the lower-taxed jurisdiction and resell them in a higher-tax jurisdiction (tax evasion, which is generally illegal). Tax harmonisation thus reduces the incentives and opportunities for tax avoidance and evasion. However, evidence indicates that levels of illicit trade are not higher in jurisdictions with higher tax rates7 and that poor tax administration, lax enforcement and/or corruption are the most significant drivers of large-scale illicit trade. Furthermore, regions with highly-harmonised tax regimes do not have lower levels of illicit trade than regions without harmonisation. For example, illicit trade in the European Union (EU) averaged 15% in 2011,8 higher than the global average of 11.6%.7 While the tobacco industry employs a narrative of illicit trade to undermine tax increases, the need to integrate taxes regionally may also slow tax increases given the complexity of collective action.

In order to examine tax harmonisation, it is important to consider briefly the principal types of economic integration. An FTA is at the base of all regional economic blocs and allows for the free movement of goods within the borders of the member countries, which still have freedom to impose their own tariffs on third parties. As FTAs increase their level of institutionalisation, member countries sometimes form a customs union, which is an agreement to implement a common external tariff (CET) that member countries apply uniformly to all goods imported from outside the FTA. A CET implies that all member states will levy the same import tariff on the same product no matter the point of importation,9 including tobacco products.

Tobacco control proponents sometimes confuse import tariffs and/or CETs with excise taxes; distinguishing between them is critical for the effective development of tax as a tobacco control policy. Governments levy excise taxes on certain products (eg, alcohol and tobacco) purchased within a country, regardless of origin; in contrast, a tariff is only levied on imported products. Tariffs are rarely a viable tobacco control tool because they only apply to imported products and are most commonly levied as an ad valorem tax, which is less effective at reducing tobacco consumption and raising revenue than specific taxes or other mixed or hybrid systems.10 Whereas specific taxes are based on quantity, ad valorem taxes are based on the value of the product; since the value of the tax reflects the product price range, consumers can avoid the impact of ad valorem taxes by trading down to cheaper products. Countries that import all tobacco products could use import tariffs as a tobacco control tool, but such a strategy would be viable in a harmonised regime only if no production occurs in the entire bloc. Finally, the global trend is towards tariff reduction to promote free trade, and higher import tariffs are counter to this deeply entrenched international policy norm.

Theoretical discussion

While tobacco control experts have a strong grasp on the technical components of tobacco taxation (see WHO10), scholars have paid scant attention to the political complexities of harmonising regional tax regimes. Accordingly, we introduce several useful approaches from the international relations field that will help to highlight some of the more common challenges to economic cooperation among countries, including the challenges of complex bargaining, the role of power and the competing demands and pressures of domestic politics in international negotiation.

First, multiple countries bargaining in already complex economic arrangements is an enormous task. While bilateral negotiations are typically challenging, the obstacles to agreement—including the difficulties of conveying information and preferences—increase markedly in a regional context with many parties and potentially contentious issues.11 To maximise their negotiating position, parties will frequently overplay their sacrifices while underplaying others’.12 The probability of failure or dilution of objectives in the negotiation is high.

Even in successful negotiations, issues regarded as more important will receive greater attention.13 Thus, if the negotiation is principally about trade liberalisation—the foundation of most regional economic agreements—then other areas, including tax harmonisation, may receive less emphasis.14 It might be convenient for negotiators to ignore issues that are not central to the negotiations and/or to use them as a bargaining chip to help achieve agreement in other areas. Thus, in the case of tobacco tax harmonisation, parties might come to an agreement that falls short of ‘best practices’ sought by tobacco control proponents.

At the same time, complex negotiations can provide opportunities for tobacco tax harmonisation. With multiple issues on the agenda, shrewd negotiators can find cross-cutting positions that satisfy the parties and reach many goals.15 ,16 Negotiators can sometimes lock countries into agreement about issues regarded as less central precisely because parties do not want to expend political capital opposing them. If parties believe that the ‘stakes’ are low, coordination of tobacco tax policies may be more attainable. Unfortunately, we have little empirical evidence on how the negotiators of international economic agreements conceptualise the relative importance of tax policies.

Most international relations scholars conceptualise a significant role for power in the international system, including in negotiations. Neorealist scholars privilege the role of state power to an extent that negotiation is mostly inconsequential,17 arguing that international agreements largely reflect the preferences of stronger states. Liberal institutionalist scholars argue that cooperation is possible—even common—in the international system, though they do not dismiss the important conditioning role of state power.18 ,19 Similarly, in theories more specific to negotiation such as structural analysis,20 scholars recognise that power asymmetries among key actors deeply affect outcomes. More powerful actors are more likely to achieve their preferred outcome, or something approximating it.

Power asymmetry—particularly among states—can markedly shape outcomes, which can cut either way for tobacco control. On one hand, multilateral agreements with a dominant—or hegemonic—state power may be able to harmonise taxes more easily and effectively if the dominant power has strong preferences for these outcomes. On the other hand, countries may encounter difficulties harmonising tax policies if the most powerful country does not want harmonisation or would harmonise around a tax policy that is suboptimal for public health.

Many situations demonstrate more ambiguous power dynamics, however, in which multilateral entities without an obvious pivotal or hegemonic power encounter substantial challenges in reaching an agreement.21 As a result, bargaining is complex and often produces policies that are suboptimal for a certain outcome. For tax harmonisation, such negotiations could lead to a ‘mean’ of preferred tax levels, which for some countries will be lower than the tax level they would have set in the absence of regional harmonisation. For tobacco taxation to be effective as a tobacco control tool, the tax structure needs to be efficient, well designed and with sufficiently high rates that tax increases result in higher prices, and hence lower consumption. If the process of negotiation leads to the lowering of tax rates in some countries, tax harmonisation could actually be detrimental to tobacco control.

To add further complexity, international bargaining typically happens on both international and domestic levels.22 Negotiators from each country must contend with the preferences of the other countries and domestic constituents. Returning to the concept of power, but this time in a domestic setting, it is reasonable to assume that domestic actors wield different amounts of power and influence in the negotiation process and help to define each government's negotiating options or ‘space.’ Moreover, in the case of tobacco taxation across the globe, there is inevitably one set of major actors with a particularly strong interest in the outcome: tobacco firms. Thus, in the many countries with strong tobacco industries and/or weak public institutions, there is increased risk that the industry could influence international negotiations to its own benefit. The industry's preferences are case-specific (though it typically seeks lower tax rates) and it is possible that the industry will push for tobacco tax harmonisation at a regional level if this suits its overall business strategy.

Finally, once there is harmonised regional tobacco tax policy, its success depends in a large part on the quality of the institutions responsible for its implementation. In regions with strong institutions, harmonisation is more likely to occur in a predictable, efficient and effective way.23 In many regions, however, the capacity of tax authorities is limited and the hard-fought battle for regional harmonisation could produce little in return.24

We now turn to a discussion of tobacco tax harmonisation efforts in several regional economic arrangements to evaluate opportunities and risks through the lenses of economic and international relations theory. We present three cases: the EU and two regions in Africa. The EU represents a ‘most likely’ case for tobacco tax harmonisation because it has comparatively strong tobacco control policies and high capacity around taxation and tax administration. There is very little tobacco tax harmonisation elsewhere in the world except, somewhat surprisingly, in Africa. In many ways, West Africa represents a ‘least likely’ case because of low tax capacity and weak tobacco control, and it permits us to evaluate tobacco tax harmonisation efforts in a context that hugely contrasts the EU case. The dynamics in the third case, Southern Africa, lie mostly in between the broader dynamics in the other two regions.

European Union

The EU is currently the most successful model of regional tobacco tax harmonisation. Though it has some weaknesses, tobacco tax rates remain high enough to reduce affordability. While some aspects of the EU system will be difficult to replicate in many low- and middle-income countries (LMICs) because of a lack of capacity in monitoring and enforcement, there is much to emphasise positively.

The EU is an economic union of 28 member states. The EU, together with some neighbouring countries, is also a customs union and members thereby enjoy free movement of goods, services and labour within the union and implement a CET. The EU is also a single market, meaning members agree to binding commitments in many areas of economic—and non-economic—organisation, including taxation. Moreover, though individual countries are enormously important in the decision-making structure, there are also institutions designed to promote the broader goals of the union, including the European Commission and the European Parliament. This structure helps to mitigate at least some of the influence of the EU's more dominant states.

In terms of tobacco taxation, EU member states are required to meet both a minimum excise tax burden (excise tax as a percentage of retail price) and an excise tax floor. Since 1993, the minimum excise tax burden has been 57% of the retail price. Excise taxes must consist of both a specific and ad valorem component and the combined value of both must be at least €64 per 1000 cigarettes (excise tax floor). Additionally, all member states must levy value-added tax (VAT) at a minimum rate of 15% (13% on a tax-inclusive basis) which results in an effective minimum total tax burden of 70% of the retail price. Recently, the EU has increased the minimum excise tax burden to 60% and the excise tax floor to €90 per 1000 cigarettes, effective 2014. As a result, most EU member states have similar tax burdens, which are among the highest in the world. The minimum excise tax burden, however, does not guarantee identical prices across the EU.25

In recent years, the EU has expanded membership rapidly, mostly in Eastern Europe. New member states are required to meet the minimum tax requirements within a relatively short time period after accession, leading to significant excise tax increases.25 Additionally, the most recent adjustment to the EU tax policy will reduce between-country variation in cigarette prices because of the relatively large increase in the excise tax floor.26

The EU has overcome obstacles to achieve its high level of integration across a range of policy areas, and among a large and growing number of disparate members. In terms of tobacco products, EU members have among the highest cigarette taxes and prices in the world. But, it is critical to underscore the region's institutionalisation: the EU has well-developed institutions with high technical and enforcement capacity. For example, the EU employs a mixed excise tax structure with both specific and ad valorem taxes. While this is optimal for the EU, it is complicated and not easily replicable in many other contexts. Moreover, from a political perspective, the EU has developed institutions that are designed partly to overcome collective action problems that groups of countries typically face in making policy. While larger EU members wield disproportionate power, the power of any one member is attenuated by the institutional structure,27 a rare dynamic in other regional arrangements.

West Africa

Economic integration in West Africa is complicated with two important overlapping blocs, the Economic Community of West African States (ECOWAS) and the West African Economic and Monetary Union (WAEMU). ECOWAS is a group of 15 nations that has struggled to integrate economically for decades and is still not an FTA.28 In terms of harmonisation on tobacco taxes, the ECOWAS directive requires member states to implement an ad valorem excise tax with a minimum rate of 15% and a maximum rate of 100% on the cost, insurance and freight (CIF) price (imports) or ex-factory price (domestic production).29 However, Ghana levies an ad valorem tax of 150%, well above the maximum rate,30 demonstrating that ECOWAS's capacity (and perhaps will) to monitor and enforce the agreement is extremely weak, at least in the area of tax administration.

WAEMU is a group of eight mostly Francophone countries that are all members of ECOWAS, but are more deeply integrated economically, sharing a common currency, forming an FTA and maintaining a CET (since 2000). A tax directive requires all countries to levy ad valorem excise taxes on cigarettes at a minimum rate of 15% and a maximum rate of 45% on the CIF or ex-factory price.31 Benin, Senegal and Togo levy excise taxes at or above 40% and Togo's government has indicated interest in exploring rates higher than 45% (interview, legislative finance committee member, Togo, November 2010). Senegal temporarily implemented a specific tax due to tax administration difficulties related to tobacco industry price reductions but was required to revert back to an ad valorem system as a result of the WAEMU directive.

Currently, WAEMU offers potential for improved harmonisation because it is well integrated economically compared with many developing regions and has existing—though suboptimal—harmonised tobacco tax policy. Rather than requiring new policies, optimised harmonisation would involve changes to three key elements of existing tax policies: increasing the rate; removing or at least markedly increasing the ceiling; and changing from ad valorem to a specific excise tax. Adding a much higher floor and a minimum excise tax burden would further improve the current situation. Because WAEMU member governments continue to make many key collective economic decisions by consensus, tax harmonisation progress is likely to be slow. More encouragingly, despite the genuine challenges of coordinating economic policy among eight countries with comparable economic/political power, WAEMU has a history of overcoming collective decision-making challenges. This may partly reflect the legacy of France's continuing economic and political influence from the colonial era, which is thought to be important to the preservation of WAEMU.32 Without stronger pressure—for example, from a hegemon, a supra-institutional body (as with the EU) or an influential international organisation (such as the International Monetary Fund)—to speed the process, economic policy integration is likely to continue to be slow.33

ECOWAS, in contrast, demonstrates the challenges of a mostly uninterested hegemon, Nigeria, which comprises roughly half of the region's economic activity. As most international relations theory would predict, Nigeria typically seeks policies favourable to preserving and improving its regional position, and it has particularly emphasised security concerns in its interactions with other ECOWAS members.34 In terms of economic integration, Nigeria's long reluctance to implement a CET is a strong indication that its first priority is to protect Nigerian domestic industries.35 Nigeria has yet to embrace tax harmonisation. Further mitigating the prospects for tobacco tax harmonisation, Nigeria has recently become the West African hub of tobacco manufacturing for British American Tobacco, with strong associated pressures on Nigerian officials for policies favourable to the industry.36

Like most LMICs, ECOWAS faces additional challenges related to internal capacity for tax administration. Even if ECOWAS members were to harmonise tobacco taxes, there remains an overall lack of institutional capacity to implement tax policies effectively.24 While WAEMU also faces limited tax capacity, it benefits from greater experience and success, as well as the support of the French government in ensuring that its members meet some threshold of administrative competence. In contrast, ECOWAS faces slow progress in economic integration and has very limited capacity to implement region-wide policies.37 Until ECOWAS demonstrates genuine commitment to regional integration in the form of a viable FTA and perhaps a CET, the prospects for regional tax integration appear very dim.

Southern Africa

The Southern African Customs Union (SACU) has a mixed record on tobacco tax harmonisation. Established in 1910, SACU's five member countries comprise the world's oldest existing customs union. SACU's main purpose is the free movement of goods and services within the region and the application of a CET. Four of the countries also make up the Rand Common Monetary Area, effectively using a common currency, the South African Rand. Unusually, especially for a union involving only LMICs, there are also common excise taxes, with revenues paid into a pool which countries share according to a consensual formula.38

Tobacco excise taxes are adjusted annually by South Africa, which currently follows a rule whereby the total tax burden of the uniform specific excise tax and VAT (levied at 14% or 12.3% on a tax-inclusive basis) is set to 52% of the recommended retail price in a backward looking manner.39 While the tax structure is effectively a hybrid one, the tax is implemented as a uniform specific tax and is matched by the other four countries, effectively creating a specific tax floor in all SACU countries. VAT is, however, levied at differential rates by SACU members and results in a different value of total tax in each country. Additionally, there is no barrier to other SACU members raising additional levies although none currently do; however, Botswana does have an additional levy on alcohol products.40 Levies are extra-budgetary and thus are not included in the excise tax pool.

After 1991, higher tobacco excise taxes in South Africa contributed to a marked decrease in cigarette consumption. Excise taxes declined substantially between 1961 and 1990, mostly as a result of inflation eroding their real value; this contributed to a 37% decline in real prices in this period, which in turn contributed to a 269% increase in aggregate tobacco consumption. From 1991, however, excise taxes increased regularly and by significant amounts. Between 1990 and 2009, real excise taxes increased by 467% and real prices by 261%, while the real net-of-tax price increased by 190%, indicating an overshifting of excise tax increases.41 These changes contributed to a decline in aggregate tobacco consumption, which fell by 37% during this period, and in smoking prevalence, which fell from 33% in 1993 to 24% in 2009.39 Higher excise taxes have also resulted in large increases in real excise tax revenue, rising by 256%.

The increases in excise taxes in South Africa have resulted in commensurate increases in excise taxes across SACU countries, with presumably similar impacts on consumption, prevalence and revenue. These changes are positive from both a public health and fiscal perspective. The regional situation would likely be very bleak if South Africa had not pursued this aggressive tax policy: if South Africa had allowed the trend of declining real excise taxes in the 1990s to continue, we would instead be arguing about the negative impact of excise tax integration in the SACU and how integration had prevented individual member states from pursuing tax policies meeting their own public health and fiscal objectives. Essentially, the benefits of harmonisation are significant because the union's hegemonic state pursued an aggressive tobacco tax policy.

In large part, SACU's tobacco tax success has benefited from having a hegemon that is a dynamic democracy with a strong civil society and robust institutions that have resisted many of the pressures from politically and economically powerful actors pushing for weak tobacco control policies.42 ,43 Notably, however, recent increases in taxes have largely been the result of tobacco industry pricing, and not efforts by the government.41

Finally, SACU is a small group of LMICs with an unusually long history of deeply integrated economic policy, led by South Africa. The dynamics of SACU are likely to be difficult to replicate in other regions that are institutionally weaker and/or have little experience with economic integration.

Risks and rewards of economic integration and tax harmonisation

Economic integration brings about many benefits, mostly as a result of economic efficiencies and the gains from free trade. Possible costs include the loss of policymaking independence and economic sovereignty. The specific rewards of harmonised tobacco taxation that follow ‘best practices’ might reasonably include increased tax revenue, higher prices for tobacco products and related decreases in tobacco consumption and/or smoking prevalence.

Attaining tobacco tax harmonisation best practices is beneficial for both fiscal and public health outcomes. Beyond directly increasing rates, improved structural policies including high tax floors and the elimination of tax rate ceilings are likely to help in increasing rates and reducing the incentives for ‘weaker’ states to generate a race to the bottom. The establishment of minimum excise tax burdens should have similar positive effects. In most lower-capacity regions, the utilisation of specific excise taxes instead of ad valorem ones is likely to ease implementation and reduce price differentials between countries. Reduced regional variation in tobacco prices as a result of harmonisation might also help mitigate tax avoidance and/or evasion, although it is certainly not a fix-all. Finally, though still extremely rare, provisions for regular tax increases would help to address issues related to affordability.

Undoubtedly, tobacco tax harmonisation is politically and technically challenging, and setting appropriate and realistic goals and developing reasonable expectations are important for success. Each region has particular dynamics that shape these challenges. Governments will have to overcome different types of collective action problems to agree politically on harmonised policy. Technical, political and economic idiosyncrasies create multiple, and often conflicting, constraints on tax harmonisation and clearly show that there is no ‘one size fits all’ approach. Nevertheless, even in many challenging contexts, this research suggests that elements of tobacco tax harmonisation demonstrate potential for inclusion in the arsenal of tobacco control strategies, though this strategy should not be seen as a substitute for improving domestic tax policies, which may then positively affect the regional tax scenario.