EU Policy and Illicit Tobacco Trade: Assessing the Impacts

Abstract

This report analyses the relationship between EU policy and the illicit trade in tobacco products. We consider three EU policies: (1) the EC Strategy and the Action Plan to tackle the illicit trade in tobacco products, (2) the revised Tobacco Products Directive, and (3) the Agreements between the European Community, individual Member States and the four major tobacco companies.

Full text

DIRECTORATE GENERAL FOR INTERNAL POLICIES
POLICY DEPARTMENT D: BUDGETARY AFFAIRS
EU Policy and Illicit Tobacco Trade:
Assessing the Impacts
BRIEFING NOTE
Abstract
This report analyses the relationship between EU policy and the illicit trade in tobacco
products. We consider three EU policies: (1) the EC Strategy and the Action Plan to tackle
the illicit trade in tobacco products, (2) the revised Tobacco Products Directive, and (3)
the Agreements between the European Community, individual Member States and the
four major tobacco companies.
IP/D/CONT/IC/2013_175-176-177 11/01/2014
PE 490.681 EN
7

This document was requested by the European Parliament's Committee on Budgetary Control.
AUTHOR(S)
Mr. Luk Joossens
Dr. Hana Ross
Mr. Michał Stokłosa
RESPONSIBLE ADMINISTRATOR
Mr Niels Fischer/Mrs Barbara Hermanowicz
Policy Department on Budgetary Affairs
European Parliament
B-1047 Brussels
E-mail: poldep-budg@europarl.europa.eu
LINGUISTIC VERSIONS
Original: EN
ABOUT THE EDITOR
To contact the Policy Department or to subscribe to its newsletter please write to:
poldep-budg@europarl.europa.eu
Manuscript completed in January 2014.
Brussels, © European Union, 2014.
This document is available on the Internet at:
http://www.europarl.europa.eu/studies
DISCLAIMER
The opinions expressed in this document are the sole responsibility of the author and do not
necessarily represent the official position of the European Parliament.
Reproduction and translation for non-commercial purposes are authorized, provided the source is
acknowledged and the publisher is given prior notice and sent a copy.
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EU Policy and Illicit Tobacco Trade: Assessing the Impacts
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CONTENTS
CONTENTS 9
LIST OF TABLES 11
LIST OF FIGURE 11
EXECUTIVE SUMMARY 13
1. Analysis of the European Commission Strategy to Tackle the Illicit Trade in Tobacco
Products 16
1.1. Introductory comments 17
1.2. The lack of reliable data 18
1.2.1. Cigarette seizure data 18
1.2.2. Empty pack surveys financed by PMI 19
1.3. No specific measures against illicit EU production 20
1.4. The signature, ratification and implementation of the FCTC protocol 21
1.5. The failing EU policy towards EU liaison officers 22
2. Impact Assessment of the revised Tobacco Products Directive on Cigarette Smuggling in the
EU 24
2.1. Background 25
2.2. The Tobacco Industry tends to exaggerate the illicit cigarette trade problem 25
2.3. The influence of the Tobacco Directive from 2001 on illicit cigarette trade in the EU 26
2.4. The Current Industry-commissioned impact assessments of the revised tobacco
product directive are Dubious 27
2.5. The possible Impact of the provisions of tobacco products directive on illicit cigarette
trade 27
2.5.1. Graphic Health Warnings 28
2.5.2. Restrictions on Packaging 28
2.5.3. Ingredients Regulation 29
2.6. Economic and Social impact 32
2.7. The magnitude of the impact 34
2.7.1. Strategy of the cigarette manufacturers 34
2.7.2. The effectiveness of Tobacco Products Directive’s mechanisms prevent illicit
cigarette trade
36
2.7.3. Comprehensiveness of the ban 36
3.
 Analysis of the Agreements between the EU and Major Tobacco Companies and assessment
of how the Member States make use of the money paid by the tobacco industry to fight the
illicit trade 37
3.1. Background 38
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Policy Department D: Budgetary Affairs
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3.1.1. Investigation and lawsuits regarding tobacco companies’ involvement in illicit
cigarette trade
38
3.1.2. Agreements with the four major tobacco companies 39
3.2. Effects of the agreements 39
3.2.1. The use of payments from tobacco industry 41
3.2.2. Ineffectiveness of the seizure-based payments 42
3.3. Presenting the agreements as corporate social responsibility 44
References 46
Annex 53
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LIST OF TABLES
Table 1. Cigarette seizure data in the EU-15 (1996-2003), EU-25 (2004-2006) and EU-27 (2007-
2012). 18
Table 2. Socio-economic characteristics of smokers of menthol and those of cigarettes not
intended for the Polish market 31
Table 3. Scenario analysis for non-domestic menthol cigarettes market share in the EU after
implementation of the revised Tobacco Products Directive 33
Table 4. Prevalence of counterfeits among seized cigarettes vs. consumed cigarettes in the EU 40
Table 5 Tax revenue lost on smuggled cigarettes vs. the revenue recovered from the
supplemental payments in the UK 42
Table 6.Tax revenue lost on smuggled cigarettes vs. the revenue recovered from the
supplemental payments in Poland 43
LIST OF FIGURE
FIGURE 1
Cigarette seizures and legitimate sales in Italy 1986–2002. 38
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EU Policy and Illicit Tobacco Trade: Assessing the Impacts
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EXECUTIVE SUMMARY
This report analyses the relationship between EU policy and the illicit trade in tobacco products.
We consider three EU policies: [1] the EC Strategy and the Action Plan to tackle the illicit trade in
tobacco products, [2] the revised Tobacco Products Directive, and [3] the Agreements between
the European Community, individual Member States, and the four major tobacco companies.
Analysis of the European Commission Strategy to Tackle the Illicit Trade in Tobacco
Products
In June 2013, the European Commission published its two-year strategy to tackle illicit tobacco
trade in the EU. Both the publication of the action plan and its general approach are positive
developments.
The Commission refers to two sets of data to measure the financial losses and the level of illicit
cigarette trade in Europe: the KPMG Project Star empty pack surveys financed by the tobacco
industry and the seizure data. Data from seizures and empty pack surveys provide useful
information on the origin of illicit products, but are unreliable for measuring the level of illicit
cigarette trade in the EU. KPMG Project Star data cannot be used to estimate the illicit cigarette
market in the EU because the report was commissioned to meet specific terms of reference
which are only known to Philip Morris International and KPMG.
We comment on several points regarding the EU strategy. First, the Commission pledges to
support signing, ratifying and implementing the WHO Framework Convention on Tobacco
Control (FCTC) Protocol on eliminating illicit trade in tobacco products and acknowledges the
protocol’s provisions on tracking and tracing measures as one of the most important elements of
the Protocol. However, many countries lack technical expertise in the technical matters of the
tracking and tracing provisions. There is a risk that the global tracking and tracing system will not
or hardly function, without the EU technical and financial support to the FCTC Protocol
implementation. Second, while the Commission acknowledges that illegal tobacco
manufacturing in the EU is a growing problem, the Strategy and the Action plan do not propose
any measures to control and prevent the illegal diversion of raw tobacco, acetate tow or
cigarette papers.
Finally, we recommend that posting additional EU liaison officers to important illicit cigarette
source and transit countries would be beneficial. While OLAF has only one EU liaison officer in
Kiev, the UK has 28 overseas intelligence officers who helped the country to prevent a revenue
loss of 815 million euros between 2011 and 2012. At a minimum, the EU should have liaison
officers in China, UAE, Ukraine and Russia, which could prevent substantial financial losses in the
entire EU.
Impact Assessment of the Revised Tobacco Products Directive on Cigarette
Smuggling in the European Union
Most of the reports concerning the impact of the revised Tobacco Products Directive on illicit
trade levels are commissioned by cigarette manufacturers. Growing evidence suggests that the
industry tends to overstate the illicit cigarette trade problem.
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Among provisions of the revised Directive, three are claimed by the tobacco industry to be
drivers of illicit cigarette trade:
 graphic health warnings
 restrictions on packaging
 and regulation of ingredients
Pictorial health warnings and the minimum pack size restriction are commonly adopted tobacco
control laws globally, and no convincing evidence of the impact of this law on illicit trade has
been presented so far. Many countries that adopted these measures have seen declines in their
illicit cigarette markets. The impact of the ban of non-menthol flavors on illicit cigarette trade
will be marginal, as these other cigarette flavors constitute only a fringe of the EU cigarette
market. The ban on menthol flavor will have only a minimal impact in countries where menthol
cigarettes are not popular, which is the majority of the EU.
In countries with high prevalence of menthol cigarettes, the impact of flavor bans on illicit
cigarette trade is also likely to be insignificant, because those who currently smoke flavored
cigarettes are much less likely than other smokers to use illicit cigarettes. Based on data from
Poland, a country that consumes over a third of EU menthol cigarettes, we found that a typical
smoker of flavored cigarettes is a young, well-educated female who lives in a city, while a typical
smoker of illicit cigarettes is an older, less-educated male living in a rural area.
We estimate that illicit and non-domestic legal menthol cigarettes accounted for only 0.2% of
total EU cigarette consumption in 2010. This is a combined effect of menthol cigarettes not
being popular in the EU and of a small illicit menthol cigarettes market share. The associated
revenue loss was at a mere 0.19% of total EU cigarette excise tax revenue.
The impact of the revised Tobacco Products Directive on cigarette smuggling in the EU is highly
dependent on how the companies decide to respond to the new regulations. However, even in
the worst-case scenario of large-scale tobacco industry involvement in supplying illicit cigarettes
to the EU, both the share of illicit menthol cigarettes in the total EU cigarette market and the
associated excise tax revenue loss would remain at minimum levels. The benefits of the ban on
menthol cigarettes far outweigh any risks associated with the possible increase in illicit cigarette
trade.
Analysis of the Agreements between the EU and Major Tobacco Companies and
Assessment of How the Member States Make Use of the Money Paid by the
Tobacco Industry to Fight Illicit Trade
During the period 1996-2012, cigarette seizures in EU were highest in 1999-2000 (around 6
billion a year), when the international tobacco companies were accused of being involved in the
smuggling operations, and among the lowest in 2003, when the lawsuit against these
companies had already been filed, but the EU had not yet signed any agreement with the
tobacco companies.
Investigations and lawsuits by the authorities have resulted in a review of the export practices of
the international tobacco companies in Europe, but it remains unclear whether the agreements
with the tobacco industry in 2004-2010 have contributed to the reduction of the smuggling
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activities. The high share of PMI contraband products in the EU, the large prevalence of an
Imperial Tobacco cigarette brand from Ukraine on the contraband market and recent
investigations over Japan Tobacco’s involvement in large-scale cigarette smuggling call into
question the effectiveness of the agreements.
The cigarette seizure payments might be an incentive for the tobacco companies not to be
involved in the smuggling operations, but their possible effect should not be overestimated as
very few seizures qualify for seizure payments. No seizure payments are made when the
cigarettes are counterfeit, and customs officials often rely on the industry to determine whether
cigarettes are counterfeit (not eligible for seizure-based payments) or genuine (eligible for the
payments). The industry has an incentive to classify seized cigarettes as counterfeit.
The amounts and the use of payments from the agreements with the tobacco industry are not
transparent. Only a few EU Member States shared information about the payments from the
cigarette manufacturers with us. Some of the EU Member States earmark the payments to fight
cigarette smuggling, while others direct the money to the general budget. The recovered value
of taxes and duties of seizure-based payments is minimal compared to what has been lost on the
smuggled cigarettes from the large seizures (as low as 0.4% in the UK).
Finally, the way the agreements are being presented to the general public may lead to
confusion. The agreements with Philip Morris International and Japan Tobacco International
were part of a settlement of legal claims concerning the involvement of these companies in
cigarette smuggling. The payments from these agreements are, however, being presented to the
public as the industry’s philanthropy and corporate social responsibility rather than as
settlement money.
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1. ANALYSIS OF THE EUROPEAN COMMISSION STRATEGY TO TACKLE
THE ILLICIT TRADE IN TOBACCO PRODUCTS
KEY FINDINGS
 In June 2013, the European Commission published its two-year strategy to tackle illicit
tobacco trade in the EU. Both the publication of the action plan and its general approach
are positive developments.
 The Commission refers to two sets of data to measure the financial losses and the level of
illicit cigarette trade in Europe: the KPMG Project Star empty pack surveys financed by
the tobacco industry and the seizure data. Data from seizures and empty pack surveys
provide useful information on the origin of illicit products, but are unreliable for
measuring the level of illicit cigarette trade in the EU. KPMG Project Star data cannot be
used to estimate the illicit cigarette market in the EU because the report was
commissioned to meet specific terms of reference which are only known to Philip Morris
International and KPMG.
 There is a risk that the global tracking and tracing system will not or hardly function,
without the EU technical and financial support to the FCTC Protocol implementation.
 While the Commission acknowledges that illegal tobacco manufacturing in the EU is a
growing problem, the Strategy and the Action plan do not propose any measures to
control and prevent the illegal diversion of raw tobacco, acetate tow or cigarette papers.
 We recommend that posting additional EU liaison officers to important illicit cigarette
source and transit countries would be beneficial. While OLAF has only one EU liaison
officer in Kiev, the UK has 28 overseas intelligence officers who helped the country to
prevent a revenue loss of 815 million euros between 2011 and 2012. At a minimum, the
EU should have liaison officers in China, UAE, Ukraine and Russia, which could prevent
substantial financial losses in the entire EU.
On 6
th
June 2013, the Commission published its communication to step up the fight against illicit
trade in tobacco products. The communication sets out the Commission’s proposals for a
comprehensive EU strategy to tackle this illicit trade. The communication is accompanied by an
action plan, which contains 50 measures, time lines and outcome measures to be developed and
implemented over the next two years.(1)
The objective is to protect the financial interests of the EU and its Member States. The annual
losses from illicit trade in tobacco products are estimated at 10 billion euros.
The communication notes that the seizure of other brands is steadily increasing. Other brands
are defined as brands not produced by the four manufacturers with which the EU has
cooperation agreements. The communication refers to the KPMG Project Star report to highlight
the importance of the EU illicit cigarette trade, estimated at 11.1% of total cigarette market in
2012. This corresponds to an increase of 30% over the last 6 years.
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1.1. INTRODUCTORY COMMENTS
The communication lists a whole range of approaches to be implemented by the EU institutions
(Commission, Council, Parliament and the Member States). No new budgets are allocated to
implement this policy. The action plan provides timelines (between 2013 and 2015) and
outcome indicators, without the description of specific objectives to achieve.
The strategy proposes specific actions in 4 key areas:
 Measures to decrease incentives for smuggling activities
 Measures to improve the security of the supply chain
 Stronger enforcement of tax, customs, police and border authorities
 Heavier sanctions for smuggling activities
The description of the planned measures is kept rather general without going in too many
details. Both the publication of the action plan and its general approach are positive
developments. The measures are:
 More investment in equipment and IT tools to protect borders
 Improved intelligence gathering, risk management and Joint Customs Operations
 Enhanced cooperation among EU agencies and with major source and transit countries
 Strengthened sanctions
 Sharing of expertise and best practises
 Endorsement of the WHO Framework Convention on Tobacco Control (FCTC) protocol
on combating the illicit trade in tobacco products
Investments in protection along the EU Eastern Border, for instance, should be encouraged.
Already in 2011, the Commission published an action plan to fight smuggling of cigarettes and
alcohol along the EU Eastern border. This action plan reports that Eastern Partnership countries,
in particular Moldova, Ukraine and increasingly Belarus and Russia are major sources of illicit
cigarettes and alcohol in the European Union.(2) Lithuanian customs officials believe that the
funding of border control services for automated licence plate and container code recognition
have resulted in more seizures.(3) Cigarette detectors, X-ray scanners, mobile customs teams and
reinforced controls at the border also resulted in less cigarette smuggling from Ukraine into
Poland and Hungary.(4,5)
Despite the positive approach, the absence of reliable data makes it difficult to evaluate the
action plan. The lack of new resources will affect its effectiveness. The OLAF policy towards EU
liaison officers and the lack of proposals to tackle illegal cigarette manufacturing are rather
worrisome. Despite the close cooperation between the tobacco industry, OLAF and Member
States, the major tobacco companies still seem to fail to control their supply chain.
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1.2. THE LACK OF RELIABLE DATA
The communication refers to two sets of data to measure the financial losses and the level of
illicit cigarette trade. Based on the cigarettes seizure trends, the problem of illicit cigarettes is
decreasing and based on empty pack surveys financed by PMI, illicit cigarette trade is increasing
in the EU. In the press release of 6
th
June 2013, the Commission says that ”the overall illicit trade
is increasing”.(6) Data from seizures and empty pack surveys provide useful information on the
origin of illicit products, but are unreliable for measuring the level of illicit cigarette trade in the
EU.
1.2.1. Cigarette seizure data
OLAF estimates the annual financial losses due to illicit cigarette trade at more than 10 billion
euros in the budget of the EU and the Member States. The OLAF estimate is based on seizures
reported by member States, which amounted to 4.5 – 4.6 billion cigarettes per year between
2005-2011.(1)
Seizures are a function of law enforcement activity. While seizure data provide an indication of
the trends in the illicit market, they cannot be used to make estimates of the illicit market,
because they do not take into account the efficiency, number and intensity of law enforcement
activities to seize cigarettes, nor the illicit trade of smaller consignments (below 100.000
cigarettes). For example, seizures of 100.000 cigarettes will not reveal the practice of 'ant
smuggling', which refers to the organized and frequent crossing of borders by a large number of
individuals with relatively small amounts of low taxed or untaxed tobacco products. Ant
smuggling, for instance, was very common between the Ukraine and Poland six years ago.(7)
Table 1. Cigarette seizure data in the EU-15 (1996-2003), EU-25 (2004-2006) and EU-27
(2007-2012).
Year
EU-15
Billion
cigarettes
Year
EU-25
Billion
cigarettes
Year
EU-27
Billion
cigarettes
1996 3 .1 2004 4 .1 2007 4 .8
1997 2 .6 2005 4 .4 2008 4 .6
1998 4 .7 2006 4 .6 2009 4 .7
1999 5 .7 2010 4 .7
2000 6 .2 2011 4 .4
2001 4 .8 2012 3 .8
2002 3 .6
2003 3 .3
Source: OLAF (8,9,10)
Note: During the period 1996-2012, cigarette seizures in EU were highest in 1999-2000 (around 6
billion), when the international tobacco companies were accused of being involved in the
smuggling operations, and among the lowest in 2003, when the EU had not yet signed any
agreement with the tobacco companies. In the EU-27, cigarette seizures have decreased from 4.8
billion in 2007 to 3.8 billion cigarettes in 2012. Based on the cigarettes seizures trends alone, one
might conclude that the problem of illicit cigarettes is decreasing in the EU.
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1.2.2. Empty pack surveys financed by PMI
The communication refers to the KPMG Project Star data which estimated illicit consumption of
cigarettes in the EU at 8.4% in 2007, 8.6% in 2008, 8.9% in 2009, 9.9% in 2010, 10.4% in 2011 and
11.1% for 2012. This corresponds to an increase of 30%, over the last 6 years,(11) while the
cigarette seizure data showed a decrease of 21% over the same 6 years.
KPMG data cannot be used to estimate the illicit cigarette market in the EU because the report
was commissioned to meet specific terms of reference which are only known to Philip Morris
International and KPMG. Page 1 of the 2012 KPMG report says: "KPMG wishes all parties to
be aware that KPMG 's work for Philip Morris International was performed to meet specific terms
of reference agreed between PMI and KPMG and that there were particular features determined
for the purposes of the engagement. The Report should not therefore be regarded as suitable to
be used or relied on by any other person or for any other purpose."(11)
Project Star uses empty cigarette pack surveys to make estimates on the illicit cigarette market in
the EU. This method can be valid if it provides a well described and at random methodology on
how the empty packs were collected, for instance, by collecting empty packs from the ground in
a random sample of sub-areas, which cover a city completely.(12) Project Star says that it collects
empty packs in the major cities of the 27 Member States, but it does not explain in which
neighborhoods they collect the packs. In each city there are neighborhoods with a high level of
illicit trade and neighborhoods with a low level of illicit trade. For instance, in the socio-
economic deprived area of New York, the South Bronx, a survey of empty packs showed that
76% avoided or evaded taxes.(13) It makes a difference whether the empty packs are collected in
deprived areas, such the South Bronx, or the wealthier areas.(12) Similarly, a survey among 4812
smokers in 2001 showed a large variation between London boroughs on the ease of buying
smuggled cigarettes. Among smokers in Islington, 80% thought smuggled cigarettes would be
easy to find, against only 45% of the smokers in another London borough, Wandsworth.(14)
Surveys conducted around sports stadia are also likely to have higher levels of illicit tobacco,
certainly where visiting fans have travelled from abroad.(15) Not the number of packs, but the at
random collection of the packs is important. Project Star does not provide this information. In
addition, Project Star underestimates the legal tax avoidance by smokers living close to the
border of a country with lower cigarette prices. Legal cross-border cigarette purchasing is very
common in European regions bordering countries with lower cigarette prices. In French and
German provinces/states bordering countries with lower cigarette prices, 24% and 13% of
smokers, respectively, reported purchasing cigarettes frequently outside their country. In non-
border regions of France and Germany, and in Ireland, Scotland, the rest of the UK and the
Netherlands, frequent purchasing of cigarettes outside the country was reported by 2–7% of
smokers.(16) Project Star will tend to overestimate illicit cigarette levels, particularly where cross-
border shopping is frequent (Austria, Finland, France).(17)
A recent and detailed analysis of Project Star comes to the following conclusion: “Project Star
overestimates illicit cigarette levels in some European countries and suggests PMI's supply chain
control is inadequate. Its publication serves the interests of PMI over those of the EU and its
member states. Project Star requires greater transparency, external scrutiny and use of
independent data.”(17) Other articles concluded also that tobacco companies are exaggerating
the threat of illicit tobacco based on surveys whose methodology and validity remain
uncertain.(18,19)
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PMI claims that Project Star was commissioned by PMI, the Commission and 27 Member States.
This information is misleading, because Project Star is only financed and commissioned by
PMI.(20)
KPMG claims that OLAF endorsed the methodology of Project Star. This is astonishing as a
spokeswoman for OLAF recently made a statement that “OLAF had not endorsed an empty pack
survey undertaken by BAT or any other cigarette manufacturer.”(21)
In a mail of OLAF to the authors of this report on 8th January 2014, OLAF explained that: “The
Project Star Report was a tool under the Agreement between the Member States of the
European Union, the Commission and Philip Morris International. The main purpose of the report
was to determine if Member States who joined the EU on or after 1 May 2004 would be entitled
to seizure payments as foreseen in the Agreement. It was never intended that the Project Star
report would be made public or used as a reference by the EU or the Member States when
highlighting the volume of the illicit trade in the EU, or used for any other purposes. However,
the Project Star document did become a public document following a request for access to the
report by a non-governmental organisation. It should be noted that as of now, the Project Star
report is no longer required under the terms of the Agreement in question.”
1.3. NO SPECIFIC MEASURES AGAINST ILLICIT EU PRODUCTION
According to the Commission communication, significant amounts of cigarettes are probably
produced illegally inside the EU. The number of known illegal factories has increased rapidly
from only five in 2010 to nine illegal factories in 2011.(1)
Europol also expects that illicit manufacturing within the EU will increase, since it is more difficult
to detect imports of raw tobacco and materials than imports of manufactured cigarettes.(22)
Since the end of EU tobacco subsidies, there is no more control over the production of raw
tobacco and without duties on raw tobacco, raw tobacco is a product without registration,
monitoring or control. For this reason, Member States have reintroduced measures to monitor
the production of raw tobacco. One example is Poland, where customs agencies observed large
increases in the circulation of raw tobacco leaf throughout Poland – from only 38 tons of illegal
raw tobacco discovered in 2009 to 170 tons disclosed in 2010. With easy access to shredders,
cigarette filter paper and roll-your-own cigarette machines, those smokers in Poland who sought
to circumvent the tobacco tax may have done so easily. Moreover, this growing trend in the
unregulated trade of raw tobacco leaf among ordinary consumers created additional concern
over the potential emergence of in-country factories specializing in the production of counterfeit
cigarettes.(23)
In order to prevent this, Poland introduced a tax on dried (cured) tobacco in January 2013.
Everybody who buys raw dried tobacco, which is still not a tobacco product, needs to pay this
tax, with the exception of registered agents or manufacturers. But the law contains a loophole.
Producers would sell moist tobacco leaves, straight from the fields and claim that this is a
product without taxes because it not dried tobacco.
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In order to fix this circumvention, Poland plans to change the law this year. All raw tobacco that
is separated from a living plant, but is not yet a tobacco product, will be subject to this tax. The
tax rate will be 229.32 PLN per kilogram, exactly the same rate as the minimum rate for the fine
cut smoking tobacco. The mechanism stays the same: a registered manufacturer or agent is
exempt from this tax, because the excise tax will be paid when it is turned into a tobacco
product. But, all other purchasers need to pay this tax on raw tobacco.(24)
The objective of the Polish legislation is to regain control over the production of raw tobacco,
which is the main component for manufacturing illicit tobacco products. Besides raw tobacco,
cigarette papers and acetate filter tow are other components for manufacturing illicit cigarettes.
Cigarette papers and acetate filter tow are listed in the harmonized tariff schedules of the
European Union, Canada, Brazil, China and the United States. Although cellulose acetate has
several industrial uses, acetate tow is used in very few products. More than 80% of world
production is used in the manufacture of cigarettes. There are also only a handful of companies
worldwide that manufacture acetate tow; seven are members of the Global Acetate
Manufacturers Association (GAMA).(25)
In a plenary address on combating counterfeiting and piracy last year, Secretary General Noble
from Interpol raised the issue of “acetate tow” and illicit manufacturing. Interpol aims to seek
collaboration with the acetate tow industry, in order to provide assistance in containing illegal
diversion.(26)
While the Commission acknowledges that illegal tobacco manufacturing is a growing problem,
no measures are proposed to control and prevent the illegal diversion of raw tobacco, acetate
tow or cigarette papers.
1.4. THE SIGNATURE, RATIFICATION AND IMPLEMENTATION OF THE FCTC
PROTOCOL
One of the first and foremost measures to control the supply chain is the signature, ratification
and implementation of the FCTC protocol on combating illicit trade of tobacco products. The
protocol was adopted on the 12
th
November 2012. After 14 months, 54 parties (15 EU Member
States and the EU) have signed and one party (Nicaragua) has ratified the protocol.(27) In
comparison, 168 parties had signed the FCTC and 23 parties had ratified the FCTC after one year.
The protocol will come into force 90 days after the ratification by 40 parties.
The most important article of the protocol is article 8, which contains specific provisions and
fixed deadlines:
 8.1 provides for a “global tracking and tracing regime, comprising national and/or
regional tracking and tracing systems and a global information sharing focal point
located at the Convention Secretariat” within five years of entry into force of the
Protocol;
 8.3 stipulates that “each Party shall require that unique, secure and non-removable
identification markings (hereafter called unique identification markings), such as codes
or stamps, are affixed to or form part of all unit packets and packages and any outside
packaging of cigarettes within a period of five years”;
 8.3 also stipulates a 10-year deadline for similar markings on other tobacco products.(28)
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The signature and ratification of the protocol is much slower than of the FCTC, and this for
several reasons:
 Many parties lack expertise in the technical matters of the tracking and tracing
provisions and would need technical assistance
 The secretariat of the FCTC has only a budget of $US 610.000 in 2014 and 2015 for the
protocol (or an annual budget of 222,000 euros in 2014 and 2015).(29)
 The FCTC protocol foresees a global information sharing focal point, but so far no
feasibility studies have been undertaken or no information is available on how this
global focal point would function.
The aim of the tracking and tracing system is to assist in the investigation of illicit trade of
tobacco products. Europe is the region where most of the cigarette seizures take place (30) and
would profit the most from such a system. Moreover, European agencies have the capacity to
undertake such investigations. There is a risk that the global tracking and tracing system will not
or will minimally function, without funding of the EU to support FCTC protocol implementation.
The Commission communication mentions financial support and technical assistance to the
WHO FCTC Secretariat and non-EU countries, but no information is yet available on how much
this support would be.
We do not expect the protocol to come into force in 2014. However, the 2014 adoption of the EU
Tobacco Products Directive and its article 14 on traceability will be an important incentive for EU
countries to ratify the protocol. In 2019 a traceability system for cigarettes and roll-your-own
tobacco will be obligatory by law under the Tobacco Products Directive in all EU countries.
1.5. THE FAILING EU POLICY TOWARDS EU LIAISON OFFICERS
According to available data, the main countries of provenance for smuggled tobacco products in
the EU are, in the order of importance: China, the United Arab Emirates (UAE), Vietnam, Malaysia,
the Russian Federation, Singapore, Belarus and Ukraine. China continues to be the source
country for the majority of seized cigarettes.(1)
OLAF had one liaison intelligence officer in Beijing from 2008 to 2012, but ended his contract for
budgetary reasons in 2012. Currently OLAF has only one liaison officer in Kiev.(31) The
Commission explained in its communication that it will examine “the usefulness of posting
additional EU liaison officers to important source and transit countries.”(1) While OLAF has only
one EU liaison officer, the UK has 28 overseas intelligence officers.(32) Not without success. The
seizure of cigarettes destined for the UK occurs twice as much abroad as in the UK. In 2012-3
1,928 million cigarettes were seized, of which 586 million were in the UK and 1,272 million
overseas.(32)
The UK has a successful policy to combat cigarette smuggling: the illicit UK cigarette market was
reduced from 21% in 2000 to 7% in 2011.(33) The National Audit Office reviewed in 2013 the UK
policy in tackling tobacco smuggling and focused in its key findings on the efficiency of overseas
officers. According to the audit, “HM Revenue & Custom’s focus on building overseas intelligence
is yielding success. As part of the 2010 spending review, HMRC funded 11 overseas intelligence
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EU Policy and Illicit Tobacco Trade: Assessing the Impacts
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officers, bringing the total to 28. Overseas intelligence officers work with host countries to
gather and exchange information on criminal activity including customs fraud. HMRC estimates
that its intelligence officers worked with overseas authorities to seize goods equivalent to
preventing a revenue loss of 658 million British pounds (815 million euros) between 2011-12 and
2012-13. In total, the overseas intelligence officers facilitated the seizure of an estimated 1,270
million cigarettes and 56 tonnes of hand-rolling tobacco overseas in 2012-13.”(32)
The EU policy towards liaison officers is rather difficult to understand. The investment is small,
but the gains could be significant. At a minimum, the EU should have liaison officers in China,
UAE, Ukraine and Russia, which could prevent financial losses in the EU of hundreds of millions
of euros. The most important source country for illicit cigarettes is China, but the EU decided not
to continue the contract of its liaison officer there. China is willing to cooperate and was one of
the first countries to sign the FCTC illicit trade protocol in January 2013.(27) In its
communication, the Commission stresses the importance of “illicit whites” coming from UAE,
Ukraine, Russia and Belarus, but only one liaison officer is funded in these countries. In 2011, the
Commission staff working paper emphasized that “it is necessary to engage with the Russian
Ministry of Interior and other relevant Russian Services on the problem of cigarette smuggling
and seek their cooperation.“(2) Cooperation agreements or official visits will not replace the
utility of an officer who lives in the country, who is in permanent contact with the local
enforcement officials, who is able to build personal relationships and to obtain intelligence. As
an enforcement official said, intelligence sharing between agencies rarely happens
automatically, but is often the result of interpersonal relationships.(34)
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2. IMPACT ASSESSMENT OF THE REVISED TOBACCO PRODUCTS
DIRECTIVE ON CIGARETTE SMUGGLING IN THE EU
KEY FINDINGS
 Most of the reports concerning the impact of the revised Tobacco Products Directive on
illicit trade levels are commissioned by cigarette manufacturers. Growing evidence
suggests that the industry tends to overstate the illicit cigarette trade problem.
 Among provisions of the revised Directive, three are claimed by the tobacco industry to
be drivers of illicit cigarette trade: graphic health warnings, restrictions on packaging,
and regulation of ingredients.
 Pictorial health warnings and the minimum pack size restriction are commonly adopted
tobacco control laws globally, and no convincing evidence of the impact of this law on
illicit trade has been presented so far. Many countries that adopted these measures have
seen declines in their illicit cigarette markets.
 The impact of the ban of non-menthol flavors on illicit cigarette trade will be marginal, as
these other cigarette flavors constitute only a fringe of the EU cigarette market. The ban
on menthol flavor will have only a minimal impact in countries where menthol cigarettes
are not popular, which is the majority of the EU.
 Those who currently consume flavored cigarettes are less likely than other smokers to
use illicit cigarettes. Based on data from Poland, a country that consumes over a third of
EU menthol cigarettes, we found that a typical smoker of flavored cigarettes is a young,
well-educated female who lives in a city, while a typical smoker of illicit cigarettes is an
older, less-educated male living in a rural area.
 We estimate that illicit and non-domestic legal menthol cigarettes accounted for only
0.2% of total EU cigarette consumption in 2010. This is a combined effect of menthol
cigarettes not being popular in the EU and of a small illicit menthol cigarettes market
share. The associated revenue loss was at a mere 0.19% of total EU cigarette excise tax
revenue.
 The impact of the revised Tobacco Products Directive on cigarette smuggling in the EU is
highly dependent on how the companies decide to respond to the new regulations. It
will also depend on the effectiveness of the Tobacco Products Directive’s mechanisms to
prevent illicit cigarette trade and on the comprehensiveness of the ban. However, even
in the worst-case scenario of large-scale tobacco industry involvement in supplying illicit
cigarettes to the EU, both the share of illicit menthol cigarettes in the total EU cigarette
market and the associated excise tax revenue loss would remain at minimum levels.
 The benefits of the ban on menthol cigarettes far outweigh any risks associated with the
possible increase in illicit cigarette trade.
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EU Policy and Illicit Tobacco Trade: Assessing the Impacts
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2.1. BACKGROUND
A possible change in illicit cigarette trade levels is only a small portion of the full and complex
impact of the revised Tobacco Products Directive (TPD) on the economy of the European Union
and welfare of its citizens. The socio-economic benefits of the revised TPD resulting from
reduction in health care costs, productivity losses, and premature mortality alone are estimated
at over 9.4 billion euros annually.(35) However, a comprehensive assessment of the effects of the
Directive on cigarette smuggling is arguably the most important element of the regulatory
impact analysis, because the illicit cigarette trade plays a key role in the debate over the new law.
There is much fear around the impact of the revised Directive on illicit trade in tobacco products.
Numerous reports presented to policy makers and the public demonstrate harmful effects of the
revised Tobacco Products Directive on the scope of illicit trade in Europe.(36–41) There is no
doubt that illicit trade in tobacco products has serious economic, as well as health and social
implications. It decreases governments’ tax revenue and can lead to higher levels of corruption,
both among citizens and public officials.(42) It also undermines the use of effective tobacco
control measures such as tobacco taxation,(43) youth access laws,(44) and health warnings,(45)
thus reducing their potential to prevent many tobacco-related premature deaths.(46) However,
most of the reports concerning the impact of the revised Directive on illicit trade levels are
commissioned by cigarette manufacturers. It is estimated that approximately 30% of Philip
Morris's profit, 18% of British American Tobacco’s profit, 20% of Japan Tobacco’s profit, and as
much as 60% of Imperial Tobacco’s profit is coming from the EU market,(47) and these
companies are obligated to maximize profits for their shareholders—although they must do so
lawfully.
2.2. THE TOBACCO INDUSTRY TENDS TO EXAGGERATE THE ILLICIT CIGARETTE
TRADE PROBLEM

It is no surprise that the proposed regulations of the new Tobacco Products Directive have been
strongly opposed by the tobacco lobby. In the past, tobacco companies countered policy
proposals supporting the control of tobacco use by arguing that cigarettes were not harming the
health of smokers. Few people would believe those arguments today. That is why tobacco
lobbyists reoriented the debate using economic arguments, particularly the argument regarding
the increases in illicit cigarette trade, when trying to persuade policy makers and the public
around the harmful impact of the tobacco control.
Because of the competing interests between profit-maximizing tobacco companies and the
public health and economic concerns of the EU, arguments regarding illicit tobacco trade that
are being presented by tobacco companies in public discussions around new tobacco control
regulations need to be treated with a special caution. Studies paid for and presented by cigarette
manufacturers are generally not independently verified or peer reviewed. Unlike academic
research studies, these studies provide only limited information about their methodology and
data collection, thus are not replicable.(18)
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The revision of the Tobacco Products Directive is certainly not the first time that tobacco
companies have raised concerns about illicit cigarette trade. The illicit trade argument has been
used lately by these companies to lobby against virtually any new tobacco control measure
around the world,(44) particularly tobacco tax increases, standardized packaging, and product
display bans.(48) These messages have been very effectively disseminated not only to policy
makers,(48,49) but also to the public. In Poland, for example, there have been at least four
tobacco industry corporate social responsibility (CSR) campaigns focusing on illicit cigarette
trade since 2010.(50) These campaigns involved presentations on TV, in the press and on
billboards, as well as the distribution of over a million leaflets to the public. The information was
disseminated directly at schools and Catholic parishes, and the industry even organized
workshops for customs officers.(50)
Growing evidence suggests that the industry tends to overstate the illicit cigarette trade
problem. For example, researchers from Germany found that the sampling method used in an
industry-funded study was not nationally representative, with systematic overrepresentation of
geographic regions along the country’s eastern border and around U.S. military bases, where
more illicit cigarettes can be expected.(51) Illicit trade estimates from industry-commissioned
studies were found to be significantly higher than those from academic studies in the UK,(52)
France,(53) Poland,(18) Australia,(54) and South Africa.(49) Also Project Star, a pan-European
study conducted by KPMG LLP and paid for by the tobacco industry, tends to exaggerate the size
of illicit cigarette trade.(17) Globally, contrary to tobacco industry predictions, increasingly strict
tobacco control regulations (55) did not affect the scope of illicit cigarette trade. The share of
illicit cigarette trade in the global cigarette market has remained relatively stable since
2000.(46,56)
2.3. THE INFLUENCE OF THE TOBACCO DIRECTIVE FROM 2001 ON ILLICIT CIGARETTE
TRADE IN THE EU
The 2001 Tobacco Products Directive regulates tar, nicotine, and carbon monoxide levels in
cigarettes, the size of text health warnings on all tobacco products’ packages, and bans the use
of misleading product descriptors, such as “light” and “mild” in the European Union.(57) The
directive had been strongly opposed by the tobacco industry, which challenged it in the
European Court of Justice.(58)
There is no evidence that the provisions of the 2001 Tobacco Products Directive increased illicit
cigarette trade levels in Europe. In fact, the number of smuggled cigarettes seized declined by
nearly half between 2000 and 2003,(see Table 1 in Chapter 1), which most likely indicates a
decrease in the levels of illicit cigarette trade in the EU in the years following the approval of the
Directive. In the UK, in spite of the 2001 Directive, the estimated illicit cigarette market share
declined from 21% in the fiscal year 2000/2001 to 13% in 2005/2006. This might be attributed to
the country’s 2000 anti-smuggling action plan and to the UK Parliamentary Public Accounts
Committee’s investigation on Imperial Tobacco’s suspected involvement in large scale smuggling
of its Regal and Superkings brands to the UK.(59)

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2.4. THE CURRENT INDUSTRY-COMMISSIONED IMPACT ASSESSMENTS OF THE
REVISED TOBACCO PRODUCT DIRECTIVE ARE DUBIOUS
Most of the claims regarding the impact of the revised Tobacco Products Directive on illicit
cigarette trade in Europe made by the cigarette manufacturers are entirely unsubstantiated. For
example, in 2013 Philip Morris International commissioned studies aiming to measure the
impact of a ban on menthol cigarettes on illicit trade in Finland and Poland – the two markets
with the highest share of menthol cigarettes in the EU. To measure consumers’ preferences, a
choice of cigarette brands and sales channels was presented on computer screens to smokers
who took part in this study. The studies concluded that removing menthol cigarettes from
regular stores increases preference for brands sold through street vendors (the study’s assumed
source of the illicit cigarettes) by 233% and 250% in Finland and Poland, respectively.(37,38)
There are serious methodological flaws in this approach. First, although the aim of the revised
Tobacco Products Directive is to protect the health of EU citizens by decreasing smoking
prevalence, the respondents to this study had no option to indicate that they would like to quit
smoking if the menthol cigarettes were no longer available in regular stores. The smokers were
only allowed to either indicate that they would continue smoking menthol cigarettes sold by
street vendors (black market) or to choose some other, non-menthol brand of cigarettes. There
was no “none of the above” option in this study forcing the respondents to indicate that they will
continue to smoke cigarettes, even if their preferred response to the menthol ban is to quit or
switch to menthol e-cigarettes. Second, it is not clear whether the respondents were even fully
aware that the “street vendor” was the study’s alias for the illicit channel. The methods section of
the study indicate that: “Subjects were not directly informed that this [street vendor] is an illicit
channel, but sufficient information was provided for them to reach this conclusion.” Third, the
costs of obtaining illegal cigarettes are higher. These include, for example, costs of obtaining
information on where the illicit cigarettes are being sold, costs of the trips to the place where
they are sold (since the illicit cigarettes are not as readily available as legal cigarettes), and the
moral costs of breaking rule (most people have reservations against breaking rules). However,
these two studies treated the decisions to buy cigarettes in regular stores and from street
vendors as equivalent and interchangeable. In the study setting, the brand choices available by
street vendors were presented to the smokers in the same way as the choices available in regular
stores, which is not the case. Finally, these studies do not address the issue of a menthol ban’s
effect on youth smoking initiation nor the long term effects of the ban.
2.5. THE POSSIBLE IMPACT OF THE PROVISIONS OF TOBACCO PRODUCTS DIRECTIVE
ON ILLICIT CIGARETTE TRADE
Among the provisions of the revised Tobacco Products Directive, three are claimed by the
tobacco industry to be potential drivers of illicit cigarette trade:
1) graphic health warnings
2) restrictions on packaging
3) regulation of ingredients
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The following reasoning for these assertions is provided. First, pictorial health warnings will make
cigarette packaging less pleasant looking, which will cause smokers to switch to more attractive,
illicit packs. Second, the minimum pack size restrictions will increase the unit price of the packs,
shifting smokers to the black market. Third, removing cigarettes with certain flavors from the
legitimate market will once again drive consumers to the illicit trade.(36)
2.5.1. Graphic Health Warnings
There is no indication that implementation of pictorial health warnings increases illicit cigarette
trade. More than 60 countries now require pictorial health warnings on cigarette packs, and
there is no research evidence of increased levels of illicit cigarette trade due to these new
regulations. In the UK, after implementation of pictorial health warnings in 2008, the illicit
cigarette share of the cigarette market dropped from 12% in 2008/2009 to 9% in 2012/2013,
according to estimates by HM Revenue & Customs.(60) This drop in illicit cigarette trade levels
occurred with the UK having one of the highest tobacco taxes in Europe. Similarly, a recent
survey of 1,024 smokers in Belgium revealed no significant purchases of cheap cigarettes from
friends and street vendors (illicit cigarettes) after the country’s implementation of graphic health
warnings in 2007.(61)
2.5.2. Restrictions on Packaging
The minimum pack size restriction is also a commonly adopted tobacco control law, and no
convincing evidence of the impact of this law on illicit trade has been presented so far. Laws
requiring cigarette packs to contain at least 19 or 20 cigarettes are present in 18 Member States,
and some Member States have requirements for the sizes of packs of Roll-Your-Own (RYO)
tobacco. Similarly to countries that adopted graphic health warnings, those which implemented
pack size restrictions have not experienced increases in illicit cigarette trade levels. For example,
in the mid-2000s more than 15% of all cigarettes smoked in Finland were sold in packs of less
than 20 sticks. These packs were banned and phased out of the Finnish market by 2009. Despite
the minimum pack size law, according to Euromonitor, a market intelligence company, the illicit
cigarette trade in Finland stayed at constant 5% to 6% levels so far.(56) Belgium banned
cigarette packs of 19 cigarettes in October 2003, but since then the purchases of illicit cigarettes
have remained marginal.(61) A similar law requiring a minimum pack size of 20 cigarettes was
implemented in Malaysia in July 2010. This law prohibited sales so called “kiddie packs”, packs of
14 cigarette sticks, which accounted for over a third of the Malaysian market in 2009. With illicit
cigarettes being very prevalent in Malaysia (38% of the total cigarette market in 2009 according
to Euromonitor), smokers in this country would have no problem with buying their small packs
on the black market after they were banned from the legitimate sales. However, this did not
happen. Illicit cigarette trade remained at stable levels of 37% and 36% of the total cigarette
market in 2010 and 2011, respectively.(56)
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EU Policy and Illicit Tobacco Trade: Assessing the Impacts
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2.5.3. Ingredients Regulation
The impact of ingredients regulations on illicit cigarette trade is unknown. Only a few countries
(e.g. Canada, USA, and France) have implemented regulations of tobacco products flavoring so
far, but these regulations affected only a small share of the tobacco market. Until now no country
has ever implemented ban on menthol cigarettes. Due to a lack of empirical data, the impacts of
the flavoring bans remain conjecture.
Among different cigarette flavors available in the EU market, the menthol flavor is
unquestionably most prevalent. According to Euromonitor, menthol cigarettes accounted for
roughly 5% of all cigarettes sold among the EU Member States in 2012, an increase from 4.5% of
sales in 2009. In 10 EU countries (Austria, Bulgaria, Croatia, Germany, Greece, Ireland, Italy, Latvia,
Slovenia, and Spain) the share of the menthol cigarettes in total cigarette market is less than 3%.
It is very unlikely that this share will increases after the implementation of the new Tobacco
Product Directive. As noted in a recent report submitted to the U.S. Food and Drug
Administration, “it would be very difficult to build a significant market for menthol cigarettes
without advertising, marketing, and packaging them as such”.(62) Only Finland, Poland and
Slovakia have a retail volume share of menthol cigarettes exceeding 10%. Menthol-flavored
cigarettes accounted for 24%, 20% and 11% of total cigarette sales in Finland, Poland and
Slovakia, respectively, in 2012.(56)
Other cigarette flavors available in the European market include vanilla, chocolate, caramel,
cherry, mango, strawberry, and passion fruit. The leading brand among these other flavors is
Black Devil, a product of Dutch manufacturer Heupink & Bloemen Tabak.(56) France already
adopted regulations that restrict use of flavouring ingredients in cigarettes in 2009. This law
prohibits sales and distribution of cigarettes with an excess of sweet and acidulous flavour.(63) It,
however, does not restrict menthol cigarettes sales. The law was implemented in order to
prevent younger people from starting smoking, and impacted sales of vanilla, orange, and
chocolate cigarettes in the country.(56) In the US, where the Food and Drug Administration
implemented a ban on several cigarette flavors in 2009 (menthols were not a part of this ban),
there have been no reports of black market in flavored cigarettes so far.(64) Banning non-
menthol flavors cannot significantly affect illicit cigarette trade in Europe since these cigarettes
constitute only a small portion of the EU cigarette market.
Smokers of flavored cigarettes are less likely to avoid and evade tobacco taxes than other
smokers
Although the impact of a menthol ban on illicit cigarette trade is unknown, particularly in
countries with substantial menthol cigarettes market share, it seems that smokers of menthol
cigarettes are less inclined to participate in the black market than other smokers. This is evident
from the abovementioned Project Star, an EU-wide study commissioned by the tobacco industry
and relying on discarded pack surveys and industry data. Although Project Star tends to
exaggerate the scope of illicit cigarette trade and its findings should be treated with special
caution,(17,18) the stunning difference between the Project Star estimated shares of non-
domestic (counterfeit, contraband, and legal non-domestic) cigarettes among all cigarettes and
among menthol cigarettes is indicative of how different smokers of menthol cigarettes and
smokers of illicit cigarettes are. For example, according to Project Star, in Estonia the non-
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domestic market share was 2% in menthol cigarettes and 25% in all cigarettes in 2012. The share
of non-domestic cigarettes among menthols was also much smaller than among all cigarettes in
Finland (12% vs. 23%), Hungary (2% vs. 5%), Latvia (9% vs. 34%), Lithuania (4% vs. 32%), Poland
(5% vs. 14%), Romania (1% vs. 10%), and Slovakia (0% vs. 2%).(11)
To find the reasons for the discrepancy in tax evasion among menthol and non-menthol
cigarette smokers, we used data on individual smoking behavior and smokers’ demographic
characteristics from the Global Adult Tobacco Survey (GATS) Poland.(65) Poland is the single
biggest market for menthol cigarettes among all Member States, as this country consumes one
in every three menthol cigarettes smoked in the European Union.(56)
GATS is a nationally representative household survey of non-institutionalized men and women
aged 15 and older. The study interviewed 7 840 individuals in Poland in 2009-2010. Among other
survey questions, current smokers were asked about their last cigarette purchase, including
whether the last purchased cigarettes were flavored. Additionally, they were asked to show a
pack of currently smoked cigarettes, and detailed information on the packs was collected,
including information on the tax stamp, and the health warning. These two questions permitted
the identification of smokers of flavored cigarettes, as well as those who possessed cigarettes not
intended for the Polish market. Socio-economic characteristics of each smoker were also
collected.
We used two pack features to determine whether the pack was intended for the Polish market:
excise tax stamps and health warnings. A damaged tax stamp is not always an indicator of tax
avoidance/evasion, as the stamps may be removed by a consumer. Therefore, only packs with a
tax stamp issued by another country, no stamp, or packs without the Polish health warning were
classified as packs non-taxed in Poland. We counted packs with damaged stamps, but with a
Polish health warning as cigarettes intended for the Polish market. The total of 2 270
respondents answered the question about cigarette flavor, and out of those 1 915 respondents
showed a cigarette pack. We used a mean comparison test to compare the characteristics of
respondents and packs presented by these 1 915 respondents.
We found that the share of packs not intended for the Polish market was more than twice lower
among the smokers of flavored cigarettes than among the smokers of non-flavored cigarettes
(3.3%; 95% CI: 1.4% to 5.2% vs. 6.8%; 95% CI: 5.5% to 8.0%). This difference is statistically
significant (t=2.4418; p=0.0147). When comparing the socio-economic characteristics of smokers
of flavored cigarettes with those of cigarettes not intended for the Polish market, we found that
these two groups are very different. Smokers of flavored cigarettes are predominantly women,
whereas less than one third of smokers of non-Polish packs are female (63.2% female among
smokers of flavored cigarettes vs. 31.9% female among non-Polish packs smokers). Smokers of
flavored packs are younger (mean age 40.3 vs. 45.3 ) and less likely to live in rural areas (35.2% vs.
63.0% ) than smokers of non-Polish cigarettes. Only 2.5% of smokers of non-Polish packs had
some college education, whereas this share among flavored cigarette smokers was 24.7%. All
these differences are statistically significant (see Table 2).
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EU Policy and Illicit Tobacco Trade: Assessing the Impacts
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Table 2. Socio-economic characteristics of smokers of menthol and those of cigarettes not
intended for the Polish market
Source: GATS Poland (65)
Note: The numbers in brackets represent the 95% confidence intervals.
1
Includes smokers who possessed cigarettes not intended for the Polish market
2
Includes smokers of flavored cigarettes
3
For the education variable, the sample of smokers of flavored cigarettes was 384, because of
two smokers who did not report their education levels.
People who smoke flavored cigarettes and those who smoke illicit cigarettes belong to very
different, almost disjoint groups. A smoker of flavored cigarettes is likely to be a young, well-
educated female who lives in a city. On the other hand, a typical smoker of illicit cigarettes is an
older, less-educated male living in a rural area. The share of all smokers who belong to this first
group and buy illicit cigarettes is very small. Only 0.6% of smokers surveyed in Poland were
smokers of flavored cigarettes who presented packs not taxed in Poland. Our findings are
consistent with findings from Belgium, where young women, a group not particularly prone to
illicit cigarette smoking, were found to be much more likely to smoke menthol cigarettes than
other age and gender groups.(61) This difference between the characteristics of illicit cigarettes
and menthol cigarettes smokers indicates that the impact of banning flavored cigarettes on illicit
cigarette trade is likely to be insignificant.
The availability of close substitutes for menthol cigarettes will make it even more unlikely for
smokers of menthol cigarettes to switch to the black market. Smokers of menthol cigarettes who
choose not to or are not able to quit will still be able to legally buy unflavored cigarettes and
other products containing nicotine. There are many smokers who switch from menthol to non-
menthol cigarettes each year. For example, the 1991 “Philip Morris Switching Book”, a study on
cigarette brand loyalty in the US, found that over 2% of menthol smokers switched to non-
menthol cigarettes from June 1990 to June 1991.(66) Another product that the smokers of
menthol cigarettes can choose instead of switching to black market is the menthol-flavored e-
cigarette, a product that will still be readily available in the European market even after the
implementation of the revised Tobacco Products Directive.
Gender (female) Age Education (college)
3
Residence (rural)
Smokers of flavored
cigarettes
1
N=386
63.21%
[58.38% to 68.04%]
40.33
[39.11 to 41.55]
24.74%
[20.40% to 29.07%]
35.23%
[30.45% to 40.02%]
Smokers of cigarettes
not intended for the
Polish market
2
N=119
31.93%
[23.43% to 40.43%]
45.34
[42.93 to 47.76]
2.52%
[-0.34% to 5.38%]
63.03%
[54.22% to 71.83%]
Mean comparison
t=6.22 t=-3.84 t=5.49 t=-5.52
p<0.001 p<0.001 p<0.001 p<0.001
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2.6. ECONOMIC AND SOCIAL IMPACT


To estimate the impact of the revised Tobacco Products Directive’s menthol cigarettes ban on
illicit cigarette trade in the EU, we used data from the European Commission’s Taxation and
Customs Union Directorate-General (data on excise tax revenues),(67) Euromonitor (data on
menthol cigarettes market share),(56) and from the Pricing Policies and Control of Tobacco in
Europe (PPACTE) project (data on illicit and non-domestic legal cigarette market share).(53) The
last source is an academic study that collected data from packs presented by smokers
interviewed in 16 EU countries in 2010. We decided to use PPACTE over the Project Star
estimates, because some evidence suggests that the tobacco industry-commissioned Project
Star might exaggerate the illicit cigarette trade problem,(18) and in some EU countries a
comparison of official government estimates with the PPACTE and Project Star estimates
suggested that the PPACTE estimates tend to be more accurate than the Project Star
estimates.(17) Table 3 presents the baseline state of non-domestic menthol cigarettes
consumption in the EU in 2010, as well as summarizes the result of three simulations of the
effects of the revised Tobacco Products Directive’s menthol cigarette ban on illicit menthol
cigarettes consumption and the resulting excise tax revenue loss in the EU.
The PPACTE estimates that out of all cigarettes consumed in the 16 EU countries in 2010, 6.5%
were illicit (mostly packs from outside the EU and counterfeited) and 2.5% were non-domestic
legal (mostly packs from other EU countries). Based on these estimates and the findings from
Poland suggesting that the share of non-domestic packs (illicit packs and non-domestic legal
packs) is roughly twice as low among smokers of flavored cigarettes than among all cigarette
smokers, we estimate that illicit cigarettes accounted for 3.25%, and non-domestic legal
cigarettes accounted for 1.25% of all menthol cigarettes consumed in the EU in 2010. Given that,
according to Euromonitor, there were over 28 billion legal menthol cigarettes sold in the EU in
2010, we estimate the consumption of illicit menthol cigarettes was at 945 million and non-
domestic legal menthol cigarettes was at 363 million in the EU that year. The total 1.3 billion non-
domestic menthol cigarettes consumed in the EU in 2010 accounted for only 0.20% of all
cigarettes consumed in the EU in 2010.
Using the European Commission data on EU Members’ excise tax yields, we estimated that on
average EU Members lost 0.12 euro on each illicit menthol cigarette and 0.07 euro on each non-
domestic legal menthol cigarette in 2010.(67) The difference results from the fact that generally
all EU tax revenue is lost on illicit cigarettes (packs mostly from outside the EU and counterfeited)
and only a portion of EU tax revenue is lost on the non-domestic packs. This is because, in
general, the non-domestic legal packs were taxed in an EU country with lower tobacco taxes and
consumed in an EU country with higher taxes. The loss on non-domestic legal packs results from
the difference between the excise tax yield in the destination and the source EU country. The
share of total cigarette excise tax revenue lost due to non-domestic menthol cigarettes
consumption in the EU was a mere 0.19% in 2010.
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EU Policy and Illicit Tobacco Trade: Assessing the Impacts
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Table 3. Scenario analysis for non-domestic menthol cigarettes market share in the EU
after implementation of the revised Tobacco Products Directive
Baseline
2010
Scenario 1 Scenario 2 Scenario 3
A. Legal sales of menthol cigarettes
(in millions)
28,139 0 0 0
B. Illicit menthol cigarettes
consumption
(in millions)
945 945 1,308 1,956
C. Non-domestic legal menthol
cigarettes consumption (in millions)
363 0 0 0
D. Total menthol consumption (A+B)
(in millions)
29,084 945 1,308 1,956
E. Non-domestic menthols share in
total cigarette consumption
0.20% 0.15% 0.20% 0.30%
F. Share of total cigarette excise tax
revenue lost due to non-domestic
menthol cigarettes
0.19% 0.16% 0.21% 0.32%
Source: PPACTE (53), European Commission (67), Euromonitor (56)
Note: Non-domestic legal menthol cigarette consumption (C) is assumed to be a subgroup of
legal sales of menthol cigarettes (A). These are the cigarettes taxed in one EU Member State and
consumed in another EU Member State. Revenue lost on these cigarettes is just 0.07 euro per
stick, a difference between the average excise tax yield in the source and destination countries.
After the EU-wide ban on menthol cigarettes sales, non-domestic legal menthol cigarette
consumption will discontinue. In each scenario we make a conservative assumption that there
will be no smoking cessation due to the law and all former menthol cigarettes smokers would
switch to non-menthol cigarettes.
In Scenario 1, we assume that illicit trade in menthol cigarettes stays at the 2010 levels, while
non-domestic legal menthol cigarette consumption discontinues with the ban on menthol sales
in the EU. This scenario is plausible, because both manufacturers and smokers will have time to
prepare for the ban up until 2020. Besides, the smokers of menthol cigarettes are in general less
likely to smoke illicit cigarettes. Under this scenario the non-domestic menthol cigarette share in
total cigarette consumption would fall to 0.15% and the share of total cigarette excise tax
revenue lost due to non-domestic menthol consumption would fall to 0.16%.
Under Scenario 2, we assume that all smokers of illicit menthol cigarettes will continue to smoke
cigarettes from the black market and former smokers of non-domestic legal menthol cigarettes
will switch to illicit menthol cigarettes. That is, under this assumption the number of non-
domestic cigarettes smoked in the EU remains at the baseline level. In this scenario the non-
domestic menthol share stays at 0.20% of the total cigarette market and the tax loss increases to
0.21% of total cigarette excise tax revenue in the EU, because the EU loses more tax revenue on
illicit cigarettes than on the non-domestic legal cigarettes.
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As noted above, smokers of menthol cigarettes are less inclined to smoke illicit cigarettes than
other smokers. In Scenario 3, we assume that the illicit menthol cigarette share is scaled up to the
levels of illicit cigarette trade observed for all cigarettes. That is, we assume that the share of illicit
menthol cigarettes increases from 3.25% to 6.5% of the menthol market. We believe that the
levels of tax evasion observed among all cigarette smokers represent each nation’s general
tendency to circumvent tobacco taxation, and therefore this simulation represents the upper
level for tax evasion among menthol cigarette smokers. This scenario would be only possible
with the tobacco industry facilitating a large-scale illicit cigarette trade from outside the EU.
Under this scenario the non-domestic menthol share increases to 0.30% of the total cigarette
market and the tax loss increases to 0.32% of total cigarette excise tax revenue in the EU.
The current usage of menthol cigarettes in the EU has multiple adverse social impacts. Like all
cigarettes, menthol cigarettes are very dangerous, killing roughly half of lifelong users. Besides, it
is well established that menthol flavoring in cigarettes is associated with smoking initiation,
especially among youth. It increases nicotine dependence in young smokers and decreases
smoking cessation in adult smokers. Prohibiting menthol as a cigarette flavoring would result in
reduced smoking initiation increased smoking cessation, and a significant reduction in the
number of premature deaths.(64,68) The benefits of the ban on menthol cigarettes far outweigh
any risks associated with the possible increase in illicit cigarette trade.
2.7. THE MAGNITUDE OF THE IMPACT
The probability of each of the above scenarios depends on different, exogenous factors.
Evidence shows that the levels of illicit cigarette trade are generally lower in countries with
stricter tobacco control laws, and that factors other than tobacco control measures are more
important determinants of illicit cigarette trade. These factors include the presence of informal
distribution channels (e.g. street vendors), weak tax administration, poor law enforcement, and
corruption.(46)
We identified three main factors that will influence the magnitude of the impact of the revised
Tobacco Products Directive on illicit cigarette trade in Europe:
1) the strategy of the cigarette manufacturers
2) the effectiveness of Tobacco Products Directive’s mechanisms to prevent illicit cigarette
trade
3) comprehensiveness of the ban
2.7.1. Strategy of the cigarette manufacturers
The single most important factor that will influence the size of the illicit cigarette market in
Europe is the business strategy of the cigarette manufacturers.
Tobacco companies are among the main stakeholders benefiting from cigarette smuggling.
Smuggling helps these companies to generate higher profits by enabling them to circumvent
some taxes. Through smuggling, cigarettes taxed in countries with lower tobacco taxes, such as
Belarus, Russia, Ukraine, and Serbia are being sold in countries with higher tobacco taxes, such as
the EU Member States. In addition, because the black market is not subject to any regulations,
through smuggling it is easier for those companies to reach children and youth, who are
potential new clients.
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Case Study 1. Cigarette smuggling from Ukraine
In 2008, Ukraine’s cigarette consumption and legal exports amounted to 100 billion cigarette
sticks. However, tobacco companies in Ukraine manufactured and imported nearly 130 billion
cigarette sticks that year. Most of these excess cigarettes (c.a. every fourth cigarette taxed in
Ukraine) have been illegally exported to the EU. As a result, Ukraine was identified by the World
Customs Organization as the most frequent source of contraband cigarettes in the world in
2008.
When asked whether the tobacco industry loses money to the illicit trade, Dmytro Redko, the
Director of Corporate Affairs at the Japan Tobacco International in Ukraine responded: “What do
you mean by loss? From the point of view of a company operating on the market, production of
extra goods means extra profits”.
Sources: The Center for Public Integrity (69), World Customs Organization (70)
It has been well documented that the business strategies of the tobacco industry have a vast
impact on the illicit cigarette market. For example, trading cigarettes illegally enabled the
industry to access closed Asian markets and created pressure for market openings.(71)
Worldwide, transnational tobacco companies have been found guilty of organising illicit tobacco
trade, and have paid billions of dollars in fines and penalties in compensation.(72) Also in
Europe, a civil action filed by the European Community against Phillip Morris and RJ Reynolds in
New York in 2000 accused the companies of smuggling cigarettes into the European Union.(73)
The parties settled in 2004, when the European Commission and Member States agreed to drop
their case in return for legal binding agreements (see Chapter 3).(74)
The same transnational companies that operate in the EU market also dominate the markets
outside the EU. Over 90% of all cigarettes sold in the EU are products of just four tobacco
companies: Philip Morris International, British American Tobacco, Imperial Tobacco Group, and
Japan Tobacco. The very same four companies control the markets of the biggest suppliers of
illicit cigarettes to the EU. In 2012, they owned 97.3% of Ukraine’s, 89.8% of Russia’s, and 81.2%
of Serbia’s manufacturers. In Belarus, British American Tobacco and Japan Tobacco International
have a long-term relationship with Neman Tobacco Factory Grodno, a company that dominates
the Belarusian cigarette market.(56) Because each of these four companies operates at
multinational levels, their strategies and goals are also global. Altering their product portfolio in
one market in order to satisfy consumer needs in other markets is definitely within the scope of
operation of these companies, regardless if those needs are being satisfied in legal or illegal
ways.
There is little doubt that the tobacco companies will try to circumvent the provisions of the
revised Tobacco Products Directive. For example, in 2013 Philip Morris International
commissioned a series of market research studies on a sample of 1 270 adult smokers of menthol
cigarettes in Finland and Poland, testing the possibility of introducing self-flavoring devices to
these markets. Such devices would allow adding flavor to either non-flavored cigarettes or to
loose tobacco prior to rolling it into a cigarette. The company made it clear that these tests were
conducted in response to a possible Tobacco Product Directive’s ban on the menthol cigarettes,
although the sales of such devices would be a clear circumvention of the Article 6 of the
Directive.(37,38) The self-flavoring devices are certainly not the only option considered by the
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tobacco companies to circumvent the provisions of the revised Tobacco Products Directive. If
facilitating illicit cigarette trade would turn out to be more profitable for these companies than
the introduction of self-flavoring devices, we can expect a rise in cigarette smuggling in Europe.
2.7.2. The effectiveness of Tobacco Products Directive’s mechanisms
prevent illicit cigarette trade
The Directive has mechanisms embedded that are designed to prevent illicit cigarette trade.
These include an EU-wide tracking and tracing system and security features designed to make
cigarette counterfeiting harder. The effectiveness of such system will highly influence illicit
cigarette trade in the EU. Codentify, a tracking and tracing system currently used by Philip Morris
International to control their supply chain, has many limitations.(75)
2.7.3. Comprehensiveness of the ban
According to Project Star, France has the largest inflows of non-domestic menthol cigarettes
among all European countries.(11) However, evidence from the International Tobacco Control
Policy Evaluation Project (ITC) shows that these cigarettes come to France predominantly from
other EU countries. In 2008, out of 1 540 respondents who reported having last purchased
cigarettes from a low or untaxed source, 81% reported that this pack was from another EU
country.(76)
With the provisions of the revised Tobacco Products Directive, menthol and other flavored
cigarettes will not only be banned in countries that are destinations for illegal menthol
cigarettes, such as France, but also in the source countries for these cigarettes, such as Poland
and the Czech Republic. This will further deter illicit cigarette trade in flavored cigarettes.
Therefore, it is extremely important that the ban on menthol cigarettes take effect in all EU
Member States and that no Member State be granted a transition period before this ban. Having
the ban in effect in all but one EU Member State would allow menthol cigarettes to flow almost
freely within the Schengen Area. This would highly increase non-domestic cigarette market
share levels in the EU, increase the resulting tax revenue losses and hinder the beneficial impact
of the directive on health.
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3. ANALYSIS OF THE AGREEMENTS BETWEEN THE EU AND MAJOR
TOBACCO COMPANIES AND ASSESSMENT OF HOW THE MEMBER
STATES MAKE USE OF THE MONEY PAID BY THE TOBACCO
INDUSTRY TO FIGHT THE ILLICIT TRADE
KEY FINDINGS
 During the period 1996-2012, cigarette seizures in EU were highest in 1999-2000 (around
6 billion a year), when the international tobacco companies were accused of being
involved in the smuggling operations, and among the lowest in 2003, when the lawsuit
against these companies had already been filed, but the EU had not yet signed any
agreement with the tobacco companies.
 Investigations and lawsuits by the authorities have resulted in a review of the export
practices of the international tobacco companies in Europe, but it remains unclear
whether the agreements with the tobacco industry in 2004-2010 have contributed to the
reduction of the smuggling activities.
 The high share of PMI contraband products on the EU market, the large prevalence of an
Imperial Tobacco cigarette brand from Ukraine on the contraband market and recent
investigations over Japan Tobacco’s involvement in large-scale cigarette smuggling call
into question the effectiveness of the agreements.
 The cigarette seizure payments might be an incentive for the tobacco companies not to
be involved in the smuggling operations, but their possible effect should not be
overestimated as very few seizures qualify for seizure payments.
 No seizure payments are made when the cigarettes are counterfeit, and customs officials
often rely on the industry to determine whether cigarettes are counterfeit (not eligible
for seizure-based payments) or genuine (eligible for the payments). The industry has an
incentive to classify seized cigarettes as counterfeit.
 The amounts and the use of payments from the agreements with the tobacco industry
are not transparent. Only a few EU Member States shared information about the
payments from the cigarette manufacturers with us.
 Some of the EU Member States earmark the payments to fight cigarette smuggling,
while others direct the money to the general budget.
 The recovered value of taxes and duties from seizure-based payments is minimal
compared to what has been lost on the smuggled cigarettes from the large seizures (as
low as 0.4% in the UK).
 The agreements with Philip Morris International and Japan Tobacco International were
part of a settlement of legal claims concerning the involvement of these companies in
cigarette smuggling. The payments from these agreements are, however, being
presented to the public as the industry’s philanthropy and corporate social responsibility
rather than as settlement money.
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3.1. BACKGROUND
One of the key elements of the Commission policy to combat illicit cigarette trade is the
collaboration and agreements with the four major international tobacco companies: Philip
Morris International (PMI), Japan Tobacco International (JTI), British American Tobacco (BAT), and
Imperial Tobacco Limited (ITL).
3.1.1. Investigation and lawsuits regarding tobacco companies’
involvement in illicit cigarette trade
Cigarette seizures in the EU peaked in 1999-2000 and reached 6 billion cigarettes a year. By 1998,
European governments and OLAF officials believed that the major cigarette manufacturers were
selling American cigarettes to traders who resold them into markets within the EU set up to
evade taxes. This believe led to investigations. In November 2000 in New York, the EC filed a civil
action against PMI, RJ Reynolds, and JTI accusing the companies of “an ongoing global scheme
to smuggle cigarettes, launder the proceeds of narcotics trafficking, obstruct government
oversight of the tobacco industry, fix prices, bribe foreign public officials, and conduct illegal
trade with terrorist groups and state sponsors of terrorism”.(78) In 2001, 10 EU countries joined
the lawsuit.
Figure 1.Cigarette seizures and legitimate sales in Italy 1986–2002.
Source: figure is based on data from Guardia di Finanza annual reports, 1986 to 2003 and Italian Institute
for Statistics
The investigations, which started in 1998 and the lawsuits, filed in 2000 against the tobacco
companies, were effective. Cigarette smuggling in Spain and Italy decreased from around 15% of
consumption in the 1990s to 1–2% of consumption in 2006. In both countries, cutting off supply
from the major tobacco companies to the illicit market was a key factor in reducing smuggling.
In this instance, investigating the role of the industry seems to have been an effective strategy to
combat smuggling. The OLAF investigation of the tobacco companies in 1998 and the Spanish
and Italian customs activities and ensuing lawsuit against the tobacco companies appear to have
had a significant impact. Over the period covered by these actions, there was a dramatic fall in
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the dubious US exports to Europe. A plausible interpretation of the data is that the industry
changed its export practices promptly in response to the investigations. What the investigations
and threat of legal action did was change the risk-benefit equation for the industry. The prospect
of a lawsuit and possible financial penalties increased the risks of supplying cigarettes that were
reaching the illicit market and reduced the benefits.(59)
3.1.2. Agreements with the four major tobacco companies
In 2004, the EU and Member States dropped the case against Phillip Morris in return for an
enforceable and legally binding agreement. Under the agreement, PMI agreed to pay the EC $1
billion over 12 years. The key feature of this agreement is that PMI will be heavily penalized if it
does not control smuggling of its cigarettes. PMI agreed to make payments in the event of any
seizures of its genuine products above 50,000 cigarettes in the 10 EU countries that were party
to the lawsuit. If more than 90 million genuine cigarettes are seized in those 10 EU countries
during one year, PMI agreed to pay 5 times the amount of taxes due (recently increased to 450
million genuine cigarettes for the 27 EU countries). The agreement also required PMI to control
future smuggling through a range of measures, which included controlling the distribution
system and contractors supplied, and implementing tracking and tracing measures.
Similar agreements were concluded with JTI (which had by then acquired the international
division of RJ Reynolds) in December 2007 (agreed payments: $400 million over 15 years), with
British American Tobacco (BAT) in July 2010 (agreed payments: $200 million over 20 years) and
with Imperial Tobacco Limited (ITL) in September 2010 (agreed payments: $300 million over 20
years). The three agreements also include seizure payments, similar to those included in the PMI
agreement (see above). While the first two agreements (PMI and JTI) were part of a settlement of
all legal disputes between the companies and the EC in relation to smuggling, the two latter
agreements (BAT and ITL) were not part of such settlement.
Neither the BAT Agreement nor the ITL Agreement signed in 2010 settled any existing legal
claim; both established extensive systems of cooperation between the manufacturers and the
relevant authorities of the EU and various Member States.
3.2. EFFECTS OF THE AGREEMENTS
The Commission states that the measures implemented by the four big manufacturers under the
cooperation agreements, such as tracking and tracing, due diligence and prevention of money
laundering, are effective and have led to a significant reduction of these companies’ products on
the illicit market. According to the Commission, the share of the other brands seized compared
to the main brands produced by the four big manufacturers is steadily increasing and reached
58% in 2011.(1)
We believe that the increase of seizures of other brands does not prove that the agreements are
effective. In Canada during the period 1992-2008 (79) or Brazil during the period 1990-2008,(80),
the share of the international seized cigarette has also diminished without tobacco industry
agreements. Tax regulations, investigations and lawsuits by the authorities have resulted in a
review of the export practices of the international tobacco companies in Europe and the USA,
but it remains unclear whether the agreements with the industry have contributed to the
reduction of smuggling activities.
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The cigarette seizure payments might be an incentive for the tobacco companies not to be
involved in the smuggling operations, but their possible effect should not be overestimated as
very few seizures qualify for seizure payments. No seizure payments are made when the
cigarettes are counterfeit, and customs officials often rely on the industry to determine whether
cigarettes are counterfeit (not eligible for seizure-based payments) or genuine (eligible for the
payments). The industry has an incentive to classify seized cigarettes as counterfeit. For example,
one industry-commissioned study states that on the one hand 16% of illicit Philip Morris
cigarettes consumed in the EU were counterfeit (page 53), but, on the other hand, 92% of illicit
Philip Morris cigarettes seized in the EU were counterfeit in 2011 (page 56).(81) In both cases, it is
mainly PMI who classifies the products as counterfeit or not. The reason why the industry-
estimated prevalence of counterfeits among seized cigarettes is almost six times higher than
among consumed cigarettes is unknown. Independent research should provide explanations for
the high percentage of genuine PMI products among the cigarette packs collected in the EU.
Table 4. Prevalence of counterfeits among seized cigarettes vs. consumed cigarettes in the
EU
Counterfeit share of PMI
seizures in the EU
Counterfeit share of PMI
contraband packs in the EU
(Project Star empty pack surveys)
Year % Year %
2006 81% 2006 15%
2007 83% 2007 20%
2008 83% 2008 18%
2009 79% 2009 17%
2010 88% 2010 16%
2011 92% 2011 16%
Source: KPMG Project Star 2011 (81)
The high prevalence of illicit whites produced by the companies that are a party to the
agreements is an indication that the seizure-based payments are not effective. Illicit whites are
defined by the EU (1) and Europol (22) as cigarettes produced entirely independently of the
traditional tobacco manufacturers. In Project Star, illicit whites are defined differently, without
making reference to the independent production of the traditional tobacco manufacturers.
Project Star classifies Classic, a cigarette brand produced by Imperial Tobacco
(https://www.tmdn.org/tmview/welcome), as an illicit white. Classic was the third most seized
cigarette brand in the EU (219.120.000 seized cigarettes) in 2008 (10) and was each year the most
prominent “illicit white” in the Project Star empty pack surveys in the period 2007-2012. (11)
During this period, the total consumption of contraband Classic was estimated at 17 billion
cigarettes in the EU. (11) Imperial Tobacco’ production facility in Ukraine is one of the largest
Imperial Tobacco manufacturing facilities in the world and produces both for the domestic and
export market.(82) In 2012, Imperial Tobacco sold 2,311 million cigarettes of its brand Classic in
Ukraine.(83) The company exports its cigarettes to rather dubious markets, such as Armenia,
Azerbaijan, Georgia, Moldova, Lebanon, the UAE, the US and Uzbekistan.(82) Imperial Tobacco
has signed a co-operation agreement with the EU to combat cigarette contraband in 2010,
which includes seizure payments for its cigarette brands. Due to the secrecy around the
agreements, we do not know whether Imperial Tobacco has paid seizure payments for the
seized Classic cigarettes, but we do note that the Imperial Tobacco cooperation agreement has
failed to address the problem of one of most prominent illicit cigarettes brands in the EU.
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Finally, investigative journalists made detailed accusations in 2011 that Japan Tobacco
International was involved in large-scale cigarette smuggling activities in the Middle East.(84) On
the 5th December 2011, OLAF started an official investigation on this case, but two years later no
further information is available.(85) It becomes more and more doubtful whether the
agreements with the major tobacco companies are successful in the fight against cigarette
smuggling.
3.2.1. The use of payments from tobacco industry
In October and November 2013 we contacted the governments of 27 EU Member States to
collect information about the execution of agreements with the four major tobacco companies.
We requested information on:
 How much money in general did each Member State receive each year from 2004 to
2012 under the terms of the aforementioned agreements?
 Was the money from these agreements used to combat illicit cigarette trade? If yes, how
much money from the aforementioned agreements was used to combat illicit cigarette
trade each year?
 What portion of the funds from Point 1 came from the recovered value of taxes and
duties in the event of seizures of over 50 000 smuggled cigarettes?
In most cases, we made this request under each country’s Freedom of Information Act.
Publically available information on the agreements is scarce. We received some information
from eight EU Member States: Belgium, Estonia, Finland, Germany, Poland, Slovakia, Slovenia,
and the UK. The failure for countries’ response might be associated with different laws regarding
access to public information or the fact that some countries might not want to share this
information. For example, when asked how much money did Spain receive from the
agreements, the Spanish Ministry of Finance and Public Administration, a body responsible for
the country’s budget, responded that they are not the best agency to answer our question.(86)
Detailed payment data provided by the Member States and by the European Commission is
presented in the Annex.
Out of the countries that provided us with data on the use of payments from the tobacco
industry, Estonia, Poland, and Slovakia earmark the payments to fight cigarette smuggling and
counterfeiting, while Belgium, Finland, Germany, Slovenia and the UK direct the money to the
general budget. The Czech Republic has a mixed system, where the base payments are used to
fight illicit cigarette trade, while the supplemental, seizure-based payments are directed to the
general budget.
Poland and the Czech Republic reported using these funds to purchase technical equipment for
authorities involved in combating illicit cigarette trade, such as customs, police, and border
guards.(87,88) Examples of such equipment are cars and communication equipment purchased
in Poland in 2013.(89) In addition, Poland uses the money for investment purposes, such as
building construction for the aforementioned involved in combating illicit cigarette trade,(88)
and for modernizing border checkpoints.(90)
We cannot determine whether earmarking of the tobacco industry payments or directing them
to the general budget is the best use of the money from the agreements. However, countries
need to make sure that the payments from the tobacco industry are not crowding out
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government investment in combating illicit cigarette trade. The UK, perhaps the most successful
Member State in terms of curbing cigarette smuggling, directs far more money to tackling illicit
trade in tobacco than it receives from the agreements with the tobacco industry. At the latest
Spending Round, the UK government decided strengthen the HMRC and UK Border Agency
(now Border Force) strategy called “Tackling Tobacco Smuggling: Building on our Success” with
a 25 million British pounds,(91) a sum over 12 times higher than the country’s 2012/13 receipts
from the agreements with the tobacco industry. Such large commitments allowed the country to
decrease the illicit cigarette share in its cigarette market, which dropped from 21% in 2000/2001
to 9% in 2012/2013, according to the estimates by HM Revenue & Customs.(60)
3.2.2. Ineffectiveness of the seizure-based payments
The seizure-based payments are the main mechanism of the agreements to deter the tobacco
industry from further involvement in illicit cigarette trade. Their intention is to punish the
tobacco manufacturers each time there is a large seizure of cigarettes produced by these
companies. Specifically, the agreements with each of the four tobacco companies allow EU
Member States to recover taxes and duties lost in the event that a Member State seizes more
than 50,000 smuggled genuine cigarettes produced by any of the four companies. These
payments are supplemental to the fixed baseline payments that the companies are committed
to pay. We analyzed how successful the EU countries were in recovering the lost tax revenue.
This was only possible for countries that provided the data on both the seizures and the
supplemental payments.
Table 5 Tax revenue lost on smuggled cigarettes vs. the revenue recovered from the
supplemental payments in the UK
Year 2010/11 2011/12 2012/13 Total 2010-2013
Large cigarette seizures that qualified for the supplemental payments
A. Number of seizures 7 5 5 17
B. Quantity of cigarettes seized 4,262,440 782,842 1,070,480 6,115,762
C. Seizure payments (£)
931,631 255,034 291,548 1,478,213
Total cigarette seizures of over 100,000
D. Number of seizures 257 231 265 753
E. Quantity of cigarettes seized 579,387,990 473,522,534 460,635,259 1,513,545,783
F. Revenue lost (£)
142,049,944 123,084,157 122,952,763 388,086,864
Sources: HM Revenue & Customs (91)
Note: The data on seizures of over 50,000 but less than 100,000 cigarettes, which could also
potentially qualify for the seizure-based payments, was not provided. We estimate total tax
revenue lost on smuggled cigarettes seized in all seizures of over 100,000 cigarettes based on
the average tax recovered per smuggled cigarette in the qualifying seizures (F=(C/B)∙E).
The UK reported 753 cigarette seizures of over 100,000 cigarettes in the financial years 2010-
2013. There were over 1.5 billion cigarettes seized during this time and we estimate the amount
of taxes lost on these cigarettes at 388 million British pounds (459 million euros). However, the
UK reported that there were only 17 cigarette seizures that qualified for the seizure-based
payments in that period and less than 1.5 million pounds have been paid (see Table 5).(91) This
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means that based on the agreements with tobacco companies the UK managed to recover less
than 0.4% of what have been lost on the smuggled cigarettes from the large seizures.
In Poland, in addition to the information from the Ministry of Finance, we received detailed
information on seizures of over 50 000 smuggled cigarettes from individual customs chambers.
There are four customs chambers in Poland that mount guard over the eastern EU border, out of
which three agreed to share their seizure data with us. There were 3,000 large cigarette seizures
in these three chambers alone from 2008 to 2012 and a total of nearly 912 million cigarettes
were seized in these seizures.(92-95) We estimate that the lost tax revenue on these smuggled
cigarettes amounted to over 303 million Polish zloty (75 million euros) from 2008 to 2012. Our
data does not include information on large seizures by other customs chambers and by other
law enforcement authorities, such as the police and fiscal authorities. However, in 2008-2012
Poland managed to recover only 4.4 million Polish zloty based on the agreements with tobacco
companies,(88) which represents a mere 1.5% of the 303 million lost on the smuggled cigarettes
seized just in the 3 customs chambers (see Table 6).
Table 6.Tax revenue lost on smuggled cigarettes vs. the revenue recovered from the
supplemental payments in Poland
Year 2008 2009 2010 2011 2012
Total
2008-2012
Supplemental payments received by Poland in 2008-2012 in PLN
4,400,000
Cigarette seizures of over 50,000 in three customs chambers: Biała Podlaska, Białystok, and Przemyśl
Number of seizures 931 887 723 590 537 3,668
Number of cigarettes seized 209,468,571 203,079,140 157,864,724 157,730,770 183,809,609 911,952,814
Tax revenue lost in PLN 53,341,957 56,992,130 54,203,484 61,086,371 77,511,664 303,135,606
Sources: Customs Chambers in Poland,(90-93) Ministry of Finance in Poland,(86) European
Commission (67)
Note: We estimate tax revenue lost based the European Commission data on cigarette taxes on
the most popular price category (MPPC) cigarettes for 2008-2010 and on the weighted average
price (WAP) of cigarettes for 2011-2012. In 2008 and 2009 the agreements with British American
Tobacco and Imperial Tobacco were not in effect, so seized cigarettes manufactured by these
two companies were not subject to supplemental payments for those years.
In the Czech Republic, there were 48 cases of cigarette seizures of over 50,000 cigarettes from
2008 to 2012. In these seizures a total of 30.5 million cigarettes were seized. We estimate that the
lost tax revenue on these smuggled cigarettes amounted to at least 71.6 million Czech crowns
(2.6 million euros). However, the country managed to recover the lost taxes and duties from only
8 out of these 48 cigarette seizures. A total of 11 million Czech crowns were paid in these
supplemental payments – at most 15% of what has been lost on the seized smuggled
cigarettes.(87)
In Estonia in 2009, the only year for which both the seizure data and the supplemental payments
data were available, there were 27 cigarette seizures of over 100,000 cigarettes, in which almost
11 million cigarettes were seized.(96) Based on the European Commission data on cigarette
taxes in Estonia,(67) we estimate that the tax revenue lost on these cigarettes amounted to 885
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thousand euros. That year Estonia received 107 thousand euros in the seizure-based
payments,(97) which was over 12% of what have been lost on the smuggled cigarettes from the
large seizures, a ratio 30 times higher than in the UK in 2010-2013.
Even with the most liberal estimates of the levels of illicit whites and counterfeit cigarettes in the
EU, the ratio of the seizure-based payments to the revenue lost on seized smuggled cigarettes
should be much higher than the levels currently reported by the Member States (e.g. less than
1% in the UK). This low ratio proves that the way the agreements with tobacco industries were
set up and/or executed allows the industry to keep costs low and prevents the States from
getting the intended benefits, as envisioned by the agreements. Moreover, with low probability
of contraband cigarettes being seized and a low prospect for seizure-based payments, it is
unlikely that the supplemental payments will deter the tobacco industry from facilitating illicit
cigarette trade.
3.3. PRESENTING THE AGREEMENTS AS CORPORATE SOCIAL RESPONSIBILITY
The way the agreements are being presented to the general public may lead to confusion.
Although the agreements with Philip Morris International and Japan Tobacco International were
part of a settlement of legal claims concerning the involvement of these companies in cigarette
smuggling,(73) this fact is often omitted from industry announcements, and the agreements are
being misrepresented as the corporate social responsibility.
By signing the cooperation agreements with the EC and the participating Member States, these
two tobacco companies sought for and obtained a dismissal of all pending legal claims. The
preamble to the agreement with Philip Morris states that: “the Parties agree that it is in the
public interest (…) to swiftly resolve (…)without any admission of liability, all matters between
the Parties that relate to the alleged conduct, acts or omissions that were asserted or could have
been asserted in the Litigation”.(98) The agreement with Japan Tobacco states that: “the EC and
the Participating Member States hereby absolutely and unconditionally fully release and
discharge JT Group Companies (…) from any and all EC Claims and all such claims are hereby
waived.”(99)
The language of the JT press release concerning the agreements is, however, very different: “The
JT Group cooperates with government authorities around the globe in its efforts to combat the
illegal trade of cigarette products. (…) JT believes that today’s forward-looking agreement
represents a significant milestone in the JT Group’s endeavours to tackle this societal issue while
protecting the brand equity of the company’s products.”(100)
Following the tobacco industry statements, a distorted impression of the agreements is given in
the press. For example in Poland, when reporting about the payments that Polish law
enforcement authorities received from the tobacco companies based the agreements, one of
the country’s most influential news magazines called these payments “sponsoring” and stated
that the payments were made because the industry was “vividly interested in combating
cigarette smuggling”.(90) In other case, when the agreed payments allowed the law
enforcement authorities in Poland to purchase cars and other equipment to combat illicit
cigarette trade, media called this purchase “assistance” from the tobacco industry to the Polish
authorities.(89)
44

EU Policy and Illicit Tobacco Trade: Assessing the Impacts
________________________________________________________________________________________
Even the Ministry of Finance in Poland in its official statement about the payments from the
tobacco industry, explains that these payments were possible thanks to the agreements with the
companies and states that “the aim of the agreements with tobacco companies is cooperation in
combating illicit cigarette production and cigarette smuggling, including cigarette
counterfeiting.” Moreover, even though the title of the agreement with Philip Morris is “Anti-
Contraband and Anti-Counterfeit Agreement and General Release”, the Polish Ministry refers to
this document as an “Agreement between the European Community, Member States, and Philip
Morris International Inc. on combating cigarette contraband and counterfeiting”, which ignores
the “general release” aspect of that document.(101)
The fact that the payments from Philip Morris International and Japan Tobacco International are
being presented to the public as philanthropy rather than as settlement money paid by the
industry charged with organizing cigarette smuggling is to the advantage of the industry. First, it
helps the industry to unwind some of the effects of the industry’s poor reputation.(102) Second,
it helps to build industry rhetoric around cigarette smuggling. Tobacco lobbyists use arguments
about increasing illicit cigarette trade to oppose many pro-health regulations, such as cigarette
tax increases. However, some evidence suggests that the industry claims about the scale of the
illicit cigarette problem are exaggerated.(17,18) By presenting the agreed settlement payments
as their commitment to combat illicit cigarette trade, tobacco companies shift perceptions of
their credibility as a partner in the discussions around the public policy.
The industry’s transformation from the accused into the benefactor demonstrates the industry’s
capability to control the narrative in public discussions around tobacco business and tobacco
control.
45

Policy Department D: Budgetary Affairs
________________________________________________________________________________________
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EU Policy and Illicit Tobacco Trade: Assessing the Impacts
________________________________________________________________________________________
ANNEX
Payment dada provided by the Member States and the European Commission.
EU
The plan for the distribution of the payments was agreed between the EU and the participating
Member States. The payments are based on a formula which involves a number of factors,
including the amount of taxes and duties on cigarettes in each of the Member States. The
amount allocated to the EU (9.7%) corresponds to the EU's share of custom duties and VAT
accruing to the EU budget as revenue.
The remaining 90.3% of the payments received from the tobacco manufacturers related to the
annual installments consist of 3 shares: 10% equal sharing between the MS, 40% based on tax
receipts on sales and 50% based on seizures.
The Commission has distributed the following amounts received under the cooperation
agreements to the MS until 2014:
 840,531,763.21 U.S. dollars from PMI (619 million euros in 2014 exchange rates)
 195,669,829.27 U.S. dollars from JTI (144 million euros in 2014 exchange rates)
 27,929,724.84 British pounds from ITL (34 million euros in 2014 exchange rates)
 6,473,833.77 euros from BAT
Source: European Commission (103)
Czech Republic
73 million Czech crowns received from the agreements from 2008 to 2012. Supplemental
payments amounted to 11 million crowns that time.
Estonia
Payments from the agreements with tobacco companies in EUR
Year Base payments Seizure-based payments Grand Total
2008
293 280,23 293 280,23
2009
137 810,51 106 857,83 244 668,34
2010
157 782,52 157 782,52
2011
101 120,41 465 547,69 566 668,1
2012
212 144,25 218 273,55 430 417,8
2013
106 084,63 134 243,71 240 328,34
Grand
Total
1 008 222,55 924 922,78 1 933 145,33
Finland
Payments from the agreements with tobacco companies in EUR
2004/2005 2006 2007 2008 2009 2010 2011 2012
0 11 795 209 2 814 908 1 942 686 2 278 347 1 163 738 1 326 360 1 146 653
53

Policy Department D: Budgetary Affairs
________________________________________________________________________________________
Germany
Payments from the agreements with tobacco companies in EUR
Year
Total payments Base payments Seizure-based payments
2004
- (first payment in 2006) - -
2005
- (first payment in 2006) - -
2006
80.311.881,96 € 80.311.881,96 € -
2007
26.385.879,55 € 12.220.652,82 € 14.165.226,73 €
2008
10.827.818,91 € 9.991.119,56 € 836.699,35 €
2009
15.756.875,45 € 14.606.102,61 € 1.150.772,84 €
2010
12.407.551,22 € 11.352.416,57 € 1.055.134,65 €
2011
9.610.657,36 € 8.795.245,45 € 815.411,91 €
2012
14.288.208,03 € 13.145.880,34 € 1.142.327,69 €
Poland
46,646,244.96 Polish zloty received from the agreements from 2008 to 2012, out of which 9.48%
were the supplemental, seizure-based payments.
Slovenia
Payments from the agreements amounted to around 2 million euros in the period from 2007 to
2013.
The UK
Payments from the agreements with tobacco companies in GBP
2010/11 2011/12 2012/13 Total
%of all
Payments
Base payments
1,983,321 1,720,033 1,703,365 5,406,721 79%
Seizure
payments
931,631 255,034 291,548 1,478,215 21%
Total payments
2,914,953 1,975,069 1,994,915 6,884,937 100%
54

EU Agreements with four cigarette manufacturers - main facts
__________________________________________________________________________________________

 EUAgreementswithfourcigarettemanufacturers‐mainfacts

Company PhilipMoris
International
(PMI)
JapanTobacco
International
(JTI)
BritishAmerican
Tobacco(BAT)
Imperial
TobaccoLimited
(ITL)
Signed 2004 2007 2010 2010
Duration 12years
(2016)
15years
(2022)
20years
(2030)
20years
(2030)
Paymentstobemade USD1billion
over12years
USD400million
over15years
USD200million
over20years
USD300million
over20years
Paymentssofar Almost100% USD280million USD27million USD50million
Supplemental/additional
payments
1.Incaseofseizureof50,000ormoregenuinecigarettes,paymentof
100%ofthedutiesandtaxesdue
2.Ifthenumberofseizedcigarettesexceedsthebaselineamount,
supplementalpaymentrisesto500%oftheevadeddutiesandtaxes
Baselineamount 90million(now
450million)
90million 150million 90million
Mainelements (a) conduct rigorous checks on its customers and contractors
(“EC Compliance Protocols”);
(b) accept only limited forms of payment for cigarettes in order
to combat money laundering;
(c) implement far-reaching product-tracking and product-
tracing procedures so that information can be obtained about
the chain of supply if cigarettes are subsequently found in illicit
channels;
(d) cooperate fully with law enforcement authorities; and
(e) make substantial payments to the EU and the participating
Member States.
Provisionforthe
negotiationofapossible
newAgreement
Yes
No
Yes
Yes
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