Greg Hands (Shadow Minister, Treasury; Hammersmith & Fulham, Conservative)

My hon. Friend is right. I will talk about counterfeit brands later, because the huge rise in counterfeit or fake brands, which are designed to look like real brands, is an important part of the whole equation.

A packet of Pall Mall cigarettes retailed at around £4.20 before the increases in the Budget, and a packet of Marlboro cigarettes retailed at around £5.80. That was after the increase in ad valorem, but before the increase  in specific duties. The sales figures show that there appears to have been a general shift in consumption towards cheaper brands, which may be expected because the tax regime changed, and people react against duty rises that disproportionately affect mid-priced and premium cigarettes.

Interestingly, the Government appear to recognise that ad valorem duty has ratcheted up the differential, which is where their problems begin. Members of the Committee may be aware—as a member of the European Scrutiny Committee, I am certainly aware—that the European Commission recently consulted on the structure and rates of excise duty that are applied to cigarettes and other manufactured tobacco. It subsequently published a draft directive, which I will address in due course. The Government submitted quite a lengthy document in response to the consultation, which can be downloaded from the European Union website. I think that it is also available on the European Scrutiny Committee website.

The document is called, “Response to the Commission’s Consultation Paper on the structure and rates of excise duty applied on cigarettes and other manufactured tobacco”, and it is a detailed and very well reasoned response. Referring to the problem that I have just outlined, the Government’s paper states:

“Under an ad valorem regime, this multiplier effect makes it more costly for producers to raise the pretax price, which has implications on the behaviour of producers in imperfectly competitive markets such as tobacco, which is characterised by small numbers of large firms. The multiplier effectively increases the marginal revenue a supplier in such a market perceives and this means it is then profitable for the supplier to lower prices and raise output.”

In other words, the Government’s position is that a large amount of ad valorem incentivises producers to raise profits by lowering prices and raising output. That raises an interesting question as to whether we want Government policy to make tobacco manufacturers lower prices and raise output. That is exactly what is happening, which is surely contrary to the health objectives of the tobacco duty policy.

Of course, the ad valorem element of duty is an EU requirement. This is not a speech against the ad valorem element, but raising it is not an EU requirement. Taxing the tax on cigarettes increases the price advantage of cheaper varieties without any convincing rationale from the Government in either revenue or health terms. Indeed, in revenue terms, the sale of cheaper brands is, on the face of it, negative for public finances, as less ad valorem will be brought in.

So did the Government think that the higher ad valorem duty that they introduced in November was a good idea? Reading their response to the EU consultation, one would think not, because they made it clear that they believed that

“there is a strong case for specific duties as the only option for taxing tobacco products.”

So suddenly the Government were saying that we should only have the specific duty and get rid of the ad valorem duty, just months before they bumped up the ad valorem duty in the PBR. That makes no sense. Specific duties are, of course, the other element of the tax on cigarettes and are based on the weight of tobacco involved, not the price of any particular brand.

To spell it out, by arguing for specific taxes as the only option in their response to the EU, the Government argued that the ad valorem tax should be scrapped  altogether when the EU approves a new directive on this subject. But in the PBR, the Government went in completely the opposite direction, raising the ad valorem part of the duty and leaving the specific part where it was. I accept that the PBR was neutral on revenue and prices. However, following the Budget, November’s change to the ad valorem rate has proved to be far from neutral. It altered the structure within which other changes are now occurring like the changes in clause 12.

The increases in specific duty will now widen the gap between cheap and expensive cigarettes by far more than would have been the case due to the November steep increases in ad valorem. This will hold true for any future increases in specific duty or in other matters such as production costs. When VAT returns to 17.5 per cent., the gap will widen again because the ad valorem duty taxes the tax on cigarettes. So the VAT increase will lead to an even larger rise in the price of a packet of cigarettes because of the increase in the ad valorem as it is assessed on the VAT.

It is not clear to me why the Government are set to take this course. There are no apparent health benefits associated with cheaper cigarettes. I have even seen arguments that cheaper cigarettes may be less healthy than premium brands. The justification for having the duty in the first place ultimately rests on health grounds. When the Exchequer Secretary to the Treasury justified maintaining prices in line with inflation last year, she said that it was because it would

“continue to encourage people to smoke less or to give up”.——[Official Report, Finance Public Bill Committee, 15 May 2008; c. 221.]

In my view, increases in ad valorem duty encourage people to trade down in terms of what they spend on a packet of cigarettes by changing brand, as much as they encourage people to smoke less or to give up. That is not just my argument. The Government even argue that the change will encourage trading down more than it will encourage smoking cessation. This is another line from their response to the EU consultation. They said:

“Specific duties are the most effective way of maintaining high prices for tobacco products and thus encouraging people to reducing smoking or quit”.

Therefore it is quite extraordinary that since the PBR the Government have done exactly the opposite of what they themselves told the EU that they regarded as being effective. This was not that long ago. It is just over a year or a year and a half ago that they made this submission to the EU. So the only charitable conclusion is that the PBR changes were as hurried and botched in relation to tobacco as they were in relation to alcohol. It may have seemed to make sense to offset the Chancellor’s cut in VAT by hiking ad valorem duty because as a one-off short-term measure the correlation was close, but in the medium term it simply is not and its main impact has been to widen the duty differential between cheaper brands and premium ones.

The Government stand condemned by their own words. As they said in their submission to the EU:

“Substantial evidence shows that younger smokers are more price sensitive, and the existence of cheaper cigarettes tends to make individuals more likely to smoke, and to make smokers less likely to give up. Specific duty, in increasing the price of all cigarettes, deters the taking up of smoking, and encourages smokers to reduce their consumption and quit.”

That is an absolutely clear-cut case for raising specific duty, rather than ad valorem, a regime that the Government  wanted to see abolished in their response. Specific duty is the one most likely to lead to smoking cessation, not ad valorem.

See this speech in context