LONDON ECONOMICS
This study is a continuation of previous studies by London Economics on the taxation of fine-cut tobacco (FCT) in Europe, building on the findings in markets such as Belgium, Germany, the Netherlands and the United Kingdom.
Whilst previous studies established economic principles, this study focuses on the scenario of an economic downturn, and examines how consumers are likely to react to a deterioration of economic conditions and a reduction in disposable income. This study is divided into three sections:
1. Understanding the impact of an economic downturn on FCT consumption;
2. Understanding the impact of an economic downturn on tax revenues; and
3. Understanding the relationship between an economic downturn and the trade in illegal cigarettes.
KEY FINDINGS
The study demonstrates that during economic downturns, smokers are more likely to switch to illicit consumption, unless fine-cut tobacco is relatively more affordable than domestic cigarettes. FCT can capture priced-out consumers and mitigate the negative financial impact of reduced duty-paid consumption on government revenues.
Based on independent datasets from several European markets, this analysis provides evidence that:
- FCT consumption is typically more price-sensitive compared to cigarette consumption, even though Member States’ markets are distinct in terms of the prevalence of FCT and consumer characteristics;
- During an economic downturn when consumers’ disposable incomes are under increased pressure, smokers are likely to seek cheaper alternatives; and
- The buffer function of FCT is crucial for to containing illicit trade and safeguarding government revenues.
The relative affordability of FCT compared to cigarettes should be maintained, as it mitigates the negative impact of a long-lasting economic downturn on the contribution of tobacco excise to public finances. In absence of a meaningful tax differential between FCT and cigarettes, cigarette consumers may not down-trade to FCT, but will seeking cheaper, mainly illegal alternatives. Similarly, and exacerbating the pressures on public finances, existing FCT smokers will also be driven to seek alternatives.