Clause 6

Finance Bill – in a Public Bill Committee at 10:00 am on 10th May 2007.

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Rates of tobacco products duty

Question proposed, That the clause stand part of the Bill.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

You took me by surprise, Mr. Illsley.

Photo of Eric Illsley Eric Illsley Labour, Barnsley Central

In that case, I shall call the Minister.

Photo of Brooks Newmark Brooks Newmark Conservative, Braintree

As always, I turn to the explanatory notes when considering clauses. Paragraphs 4 and 5, which are in the background note section, are important because they show the thrust of the Government’s objective, and I shall reflect on them later when questioning the Minister.

The background note begins by saying:

“Keeping tobacco prices high is one of a number of measures set out in the Government White Paper on tobacco, Smoking Kills, intended to help existing smokers quit the habit”.

The Government are seeking, in part at least, to change behaviour. I appreciate that there are other ways of trying to change behaviour, but clearly this is a linchpin in changing behaviour. The background note continues:

“Research has consistently shown that the price of cigarettes affects demand. Cigarette prices in the UK are now at historically high levels.”

That goes back to the Minister’s discussion with my hon. Friend the Member for Windsor about price elasticity, what that does and how it impacts on demand. In normal cases I would agree that a higher price has an impact on demand. Unfortunately, it does not take into account—I shall go into this later—the increase in the illicit trade of cigarettes, particularly hand-rolled cigarettes. I want to probe a little further the assumptions about changing behaviour, price elasticity and the impact on the increase in supply of illicit tobacco.

I begin by noting that despite consistent increases in tobacco duty, revenue has been broadly flat for the past few years, given that the out-turn in 2002-03 was the same as the projection for 2007-08. Table C8 onpage 281 of the Red Book shows that tobacco duties were £8 billion in 2005-06 and £8.1 billion in 2006-07, and are projected to be £8.1 billion in 2007-08, so the increase has been relatively flat.

If duty rates are indexed to maintain the real price of tobacco, does the Treasury attribute the real-terms decline in receipts to there being fewer smokers or more cunning smugglers? Is the purpose of tobacco duty to raise revenue or to change behaviour, or a bit of both?

There are mixed messages here, as elsewhere. The Government say that smoking kills half of all smokers. Organised criminal gangs who smuggle tobacco provide a cheap and unregulated supply, which undermines the Government’s policy of using tax to maintain the high price of tobacco and to help to reduce smoking, especially among the young. That implies that the illicit trade has a measurable impact on public health. Is the Government’s anti-smuggling strategy focused on improving public health or safeguarding revenue, and what is their priority? Increasing tax has the potential to stimulate illicit trade and to provide better access for youngsters to indulge in tobacco products; hence the two objectives seem to be slightly contradictory.

The growth area in the illicit tobacco trade is in counterfeiting, which has both revenue and public health consequences. Last year, HMRC and the Treasury published findings that between 85 per cent. and 100 per cent. of cheap cigarettes sold in London were counterfeit. What is the latest estimate of the impact of counterfeiting on both public health and revenue? I shall be interested to hear whether the Minister has done some homework on that.

Last year, HMRC and the Treasury published a document with the tongue-twisting title, “New responses to new challenges—Reinforcing the Tackling Tobacco Smuggling Strategy”. Given that the Government admit that smugglers constantly change their strategy to avoid anti-avoidance measures, can the Minister offer the Committee an update on HMRC’s evolving strategy one year on?

HMRC goes on to argue that illicit market share is falling, although it admits to a statistical uncertainty, and it has moved to a definition of the illicit market based on a range between upper and lower estimates. That range, I read, is between 10 per cent. and 19 per cent. for 2004-05. Is the Treasury satisfied that data from consumer surveys and estimates with a spread of 9 per cent. are adequate for revenue forecasting purposes?

The Comptroller and Auditor General has to audit the tobacco duty revenue forecast based on data on the illicit market share dating from 2003-04 because of a lack of more recent firm data. I believe that that was outlined in the Budget 2007. The revised National Audit Office audited assumption assumes that the underlying duty paid on cigarettes will be 3 per cent. lower than the estimated out-turn for the current year. Again, I want to ask the Minister whether the Treasury is confident that no further downward revision of revenue forecast will be necessary.

In March 2006, the HMRC-Treasury paper admitted:

“Tobacco smuggling costs £2.9bn per year in lost revenue—the equivalent to 1p off the basic rate of income tax”.

That is equivalent to 35 per cent. of tobacco tax receipts; I get that number mathematically by 2.9 billion divided over 8.1 billion. How does that compare with HMRC’s estimate of the illicit market share as being between 10 per cent. and 19 per cent.? Would the cost of lost revenue as a percentage of total receipts not be a more useful way of judging the scale of the problem?

Is HMRC on track to meet the target for reducing the illicit market share to 13 per cent. by 2007-08, as outlined by the Government? This year’s Finance Bill contains plenty of anti-avoidance measures to protect receipts in other areas. Did Treasury officials consider the case for further legislation to tackle tobacco smuggling? Would tighter border controls help to tackle tobacco tax evasion? Would the reclaimed tobacco revenue not go some way towards paying for the new border police force suggested by the Leader of the Opposition, among others?

I read in HMRC’s report of 2005-06 that one in four cigarettes smoked in Britain is hand rolled, yet half of the hand-rolling tobacco used in the UK is thought to be illicit, costing £880 million in lost revenue in 2003-04. In fact, the major example of tax-motivated behaviour change has been the doubling of the number of those using hand-rolling tobacco since 1990. Given the continued growth in the market for hand-rolling tobacco and the level of tax evasion associated with it, is that the right kind of behaviour change for the Government to encourage?

Imperial Tobacco has said that its experience of a smoking ban in Scotland, introduced just a year ago, and the experience in other markets, such as Ireland, confirms its view that smokers will continue to smoke.  Any initial dip in consumption diminishes over time. Does the Treasury concur with that assessment and how did it reach its revised forecast that the ban would lead to a loss of revenue of just £100 million in 2007-08 and £500 million in 2008-09? Finally, is it anticipated that further revisions to the projection will be necessary?

Photo of Eric Illsley Eric Illsley Labour, Barnsley Central

For the avoidance of any further confusion, Members will notice that a number of clauses have no amendments so far. The question will be that the clause stand part of the Bill, which will enable debate. No one is required to move the question, as it is put by the Chairman, and any Member can speak to it.

Photo of Paul Goodman Paul Goodman Shadow Minister (Childcare), Treasury

Welcome to the Chair, Mr. Illsley. The Financial Secretary began by speculating about what your presence meant in terms of the goings on in the exalted world of the Speaker’s Panel. I would not be so bold as to follow him in that, but I know that you will enjoy every minute of these proceedings and I can see that you already feel thoroughly at home.

Photo of Eric Illsley Eric Illsley Labour, Barnsley Central 10:15 am, 10th May 2007

Order. For the benefit of the Committee, it is a little disconcerting to look around the room and see that the hon. Member for Coventry, South and I are the longest-serving Members here. As a former Opposition Whip, I know a lot about Finance Bills. The disappointment is that they have changed very little since 1988.

Photo of Paul Goodman Paul Goodman Shadow Minister (Childcare), Treasury

My experience could not possibly compare to yours, Mr. Illsley. Although you may not know the background to this—I shall be very happy to tell you all about it afterwards—you will at least be pleased to see that I have been restored to my correct gender and political party in the Committee’s proceedings.

Photo of Paul Goodman Paul Goodman Shadow Minister (Childcare), Treasury

For such an observant person as the Economic Secretary, I can scarcely believe that to be true.

Without any further ado, let me move on to what is left in the clause that my hon. Friend the Member for Braintree has not already covered in his masterly exposition. Just as with the corresponding clause in last year’s Bill, he has given the Committee a chance to explore the relationship between the rate of duty, the amount of revenue for the Treasury, and the effects as regards smuggling, counterfeit and lost revenue. There is obviously a relationship between those factors. The case for large increases in duties, which I think my hon. Friend the Member for Ludlow hinted at last year, is that they will help to reduce smoking and, on paper at least, bring in more revenue for public services. The case for lower rates, freezes or even cuts, which was hinted at last year by my hon. Friend the Member for Braintree—we were therefore able to have an interesting discussion—is that the law of unintended consequences applies. In other words, large increases  will stimulate the smuggling of tobacco and counterfeit products, and thereby reduce revenue and fail to reduce smoking, as people switch from legal to illegal tobacco.

In what was his key quotation from last year—which will probably explain his thinking this year, too—the Financial Secretary acknowledged those competing pressures and trade-offs, when, with reference to a Treasury study, he said:

“The model’s main findings show that, with tobacco, we are close to the revenue maximisation point with cigarette duty. That means that any large real increase in duty rates would increase smuggling and start to reduce, not increase, revenues.”

I assume that that is the position this year, too. That analysis helps to explain why the Government abandoned the tobacco duty escalator in 2001. It also helps to make the case for this year’s inflationary rise, which we do not intend to oppose.

It is perhaps significant that the Tobacco Manufacturers Association’s response to this year’s rise has been muted. It said that the

“announcement of an inflation-only increase in tobacco duty is an indication that the Government acknowledges that tobacco duty is the cause of the UK’s high levels of smuggling and crossborder shopping”.

While calling for a “fundamental review” of policy, the association also said:

“We welcome this continued restraint but it is still an increase. It will serve only to widen the price differentials between the UK and the rest of the EU. It will further encourage smuggling and counterfeit activity and enhance the economic incentive for smokers to shop abroad or purchase tobacco products on the black market.”

None the less, the tobacco manufacturers seem on the whole to be reasonably satisfied.

The same cannot, apparently, be said for Action on Smoking and Health. As the Financial Secretary knows, sadly, we cannot please all the people all the time. ASH said that it was

“disappointed that the Chancellor missed a golden opportunity to raise the tax on tobacco above the rate of inflation”.

ASH had called for a 19p increase on a packet of 20 cigarettes, which is equivalent to a 3 per cent. increase above the inflation rate.

As I have said, we do not intend to oppose the rises. We suspect that the balance is about right. However, I should like to ask some broader questions about the Government’s anti-smuggling strategy, in which the rise proposed in the clause presumably plays a part, following the same line of inquiry as my hon. Friend the Member for Braintree.

Last year, against a background of increased freight movement and visits and a rise in the consumption of hand-rolled products, the Committee had an opportunity to hear estimates from HMRC of revenue loss from smuggling and cross-border activity. My hon. Friend mentioned the counterfeiting figures, and the estimates last year showed that after progress between 2001 and 2003, there had been a rise in the non-cross-border element in 2003-04, from £2.6 billion to £2.9 billion, and an overall rise in revenue loss from £4 billion to £4.2 billion. What are the figures for 2004-05? Has the trend corrected itself or has there been a similar decline? Has consumption fallen as it has each year since 1999?

The Financial Secretary reminded the Committee last year that the Government’s anti-smuggling strategies are underpinned by memoranda of understanding—memoranda, not memorandums, as the hon. Member for Wolverhampton, South-West said last year; so, that is satisfactory—signed with the majority of the tobacco industry. The manufacturers clearly favour that approach, and they unsurprisingly lobby energetically for freezes or reductions in duties. It is worth noting that the Financial Secretary said last year:

“Duty cuts would not produce proportionate reductions in tobacco smuggling. Only a large cut in duty would be likely to have any significant impact on the behaviour of consumers and suppliers.”—[Official Report, Standing Committee A, 9 May 2006; c. 17.]

I assume that we can rule out such a large cut, because of the effect that it would have on revenue.

Although the approach to countering smuggling via memoranda of understanding satisfies the tobacco industry broadly, it does not meet with the approval of ASH. It says that the Government should consult formally with what it describes as “independent stakeholders”—I presume that it considers itself to be one of those independent stakeholders—and the tobacco industry on smuggling and, in particular, the development of a system of covert markings. I should like to know the Financial Secretary’s response to that idea in due course.

The Financial Secretary will be well aware that ASH also says that the Government should sign up to the agreement between the European Commission and Philip Morris International on tobacco smuggling. Under the agreement, which was signed in 2004, the company announced that it will pay the European Commission $1 billion in a landmark deal on tobacco smuggling. Under the agreement, the company is heavily penalised if its products are smuggled into EU countries. Originally, 10 member states signed up to the agreement with the Commission, and the deal meant that court action against PMI in the US was dropped.

The key elements of the agreement are seizure payments, which penalise PMI if any of its products are smuggled into the EU, and compliance protocols. The agreement is reviewed annually. The Select Committee on the Treasury said:

“We are concerned to note...that Customs have not sought a similar agreement with Philip Morris... Whether it would be better for the UK to sign the EU agreement or to seek a separate memorandum of understanding with Philip Morris depends upon the arrangements that can be negotiated with the company. But doing nothing is unacceptable.”

Again, I should like to know the Financial Secretary’s response to that point.

HMRC has traditionally argued that there would be limited financial benefit to signing such an agreement. ASH’s counter-argument is that there may not have been a clear financial benefit to date, in 2004-05, but it goes on to ask about the subsequent years looking to the future.

I have two final questions. First, do the Government fully support the development of a legally enforceable and comprehensive illicit trade protocol under the framework convention on tobacco control, the international health treaty signed by 142 parties? Secondly, what progress has been made on the development of track-and-trace technology, which allows authorities to trace supply lines and product distribution? In particular, what discussions have the Government held with other Governments—

It being twenty-five minutes past Ten o’clock,The Chairman adjourned the Committee without Question put, pursuant to the Standing Order.

Adjourned till this day at One o’clock.

Correction

Col. 33, line 53, Delete Mr. Timms and insert John Healey.