Rates of tobacco products duty

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

May I begin by welcoming you back to the Chair, Mr. Atkinson?

Clause 12 relates to the levels of tobacco duty, which are superficially not particularly controversial. We do not oppose the increases in duty. However, a number of questions need to be asked about the Government’s approach to the structure of tobacco duty andI hope the Minister will provide some answers in her response. The effect of duty increases on illegal supplies is also a concern, particularly if sterling recovers ground against the euro.

For those less familiar with the structure of tobacco duty, I will briefly run through it—partly because it is more complicated than one might initially expect. I was a smoker for some years and used to await the announcement of the Budget and the number of pence it put on a packet of cigarettes. I imagined that the way it was arrived at was very simplistic; it is actually quite complicated.

There are two specific parts to tobacco duty. The first is called a specific duty, which is a set amount of duty. It translates into duty on a per-packet basis, but is assessed on a number of pounds per 1,000 cigarettes. As we see in clause 12, that is to rise to £114.31 per 1,000 cigarettes, up from £112.07 prior to 22 April. That is a rise of two per cent., which translates to the average packet of cigarettes—an interesting concept that I will come back to—to approximately £2.29 of specific duty.

Added to that is the ad valorem element, which is a percentage of the total price of the retail price of a packet of cigarettes. That was increased in the pre-Budget report from 22 per cent. to 24 per cent. That is important for our considerations, because that percentage is calculated after that has been applied to a packet.

As with the alcohol duties that we debated a couple of weeks ago, the context of clause 12 is last November’s pre-Budget report and the Government’s late-in-the-day efforts to offset the revenue they were going to lose through the cut in VAT by increasing tobacco duties. In the case of tobacco, it raised the ad valorem element of the duty on cigarettes by 2 per cent. to a total of 24 per cent.

The two figures were designed to be roughly equivalent, with the fall in VAT and the rise in ad valorem more or less offsetting each other when fed through to a change in the retail price of a packet of cigarettes. The pre-Budget report left the specific fix element of the duty unaltered and that change corresponded quite well to the VAT loss. However, like the alcohol duties when VAT returns to 17.5 per cent. in January 2010, there will be some important and significant effects on the overall pricing level of cigarettes.

It corresponded with the pre-Budget report because the ad valorem duty, as I have explained, is a proportional tax on the retail price of cigarettes. However, it has a unique feature: because it is a tax on the price of a packet of cigarettes, including the margin for the specific duty under VAT, this is a tax that taxes tax. In other words, the percentage of ad valorem is applied to VAT and other charges. There is therefore a consequent multiplier effect on the amount of tax paid as the cost of a packet of cigarettes increases.

That might seem esoteric, and perhaps not particularly relevant, but it has important consequences for the market price of a packet of cigarettes: the ad valorem duty widens the differential between the tax on cheaper brands and the tax on premium brands. That was true, of course, well before the pre-Budget report came along. The price gap between the cheapest cigarettes and premium brands, such as Marlboro or Rothmans, has increased from less than a pound to nearly two pounds in the last six years—a considerable change so far this decade.

The increasing element to the ad valorem tax has incentivised the new super low-priced brands that have either been around for many years, or those that have entered or re-entered the market, such as Pall Mall.

Is it also the case that the issue has probably incentivised organisations that want counterfeit tobacco, which is so prevalent on our streets, to focus on some of the higher priced brands so that there is more value in getting their counterfeit product on the market?

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.

I wonder whether, like me, he hopes that the Minister will be able to reassure us that lower price cigarettes do not have a higher tar content on average than higher price cigarettes, because that would certainly compound the already powerful case that my hon. Friend is making against this obviously ill-thought-through measure.

I thank my hon. Friend for that intervention. With the huge variety of brands out there—some of them new, others counterfeit or fake—I expect that it might be difficult to make that generalisation. However, I think that that is an important point. Another relevant point is the example of revenue—certainly, lower priced cigarettes generate less revenue for the Treasury.

I am happy to deal with the issues when I respond to the debate, but I say now that it will be helpful for all of us, for all sorts of reasons, if we did not mix up counterfeit with genuine, legally available cigarettes—the two need to be thought about separately. That would help us deal with some of the issues raised by the hon. Gentleman.

The Exchequer Secretary raises an important point, but to be fair, neither my hon. Friend nor I were mixing up the two. In terms of the actual impact of the amount of tar, I was saying that it would be difficult to effect some kind of generalisation because some fake brands do not tell us on the packet how much tar there is.

The fake brands do not always contain what they say they do, which is why it is important to separate the cigarettes made and sold legally from the counterfeit products. They are totally separate, and we will have a much clearer and more focused debate if we do not mix the two up.

Of course the Minister is right, but she is making my point for me. In response to my hon. Friend, I pointed out that it was difficult to effect some kind of generalisation about the overall tar content for all the cigarettes that are consumed in the UK. Due to those varied considerations, she is helping me to make my own point.

The nub of the matter is that the Government could have addressed the weaknesses of the pre-Budget report in the Bill. The Budget was an opportunity to replace a temporary measure with a sensible, overall structure. Unfortunately, they appear to have missed the chance. The Government can still consider re-balancing the structure of taxation in January 2010, when the VAT rise kicks in. I will be grateful if the Minister can confirm whether the Government intend to leave the ad valorem duty at 24 per cent. in January 2010. As I said, the rise in VAT will increase the tax on cigarettes by more than the VAT itself.

An argument could be made for that position, but why would the Government want to nurture super-low price brands at the expense of premium brands? I am interested in the Minister’s argument as to why she thinks that that should be the case in our tobacco duty structure.

It also, as I said, conflicts with the Government’s own reasoning in their response to the EU consultation. There is already a significant move in this country to low and super-low price brands from premium ones. According to ACNielsen, the market research company, the market share of premium brands has fallen from 28.5 per cent. to 25.9 per cent. in just the past two and a half years, between 2006 and 2008. Meanwhile, the super-low market share has gone from 41.6 per cent. to 45.1 per cent. in the same period—a pretty big increase in less than three years. That is most likely due to the changes in tax. Indeed, the tax differential between premium and super-low brands has increased from just 10 per cent. at the beginning of that period to 14 per cent. now—quite a significant change in a tax differential.

It is worth thinking about the impact that all that has on tax yields. For every 1 per cent. of consumption that trades down from premium to super-low brands, the Government lose approximately £11.5 million in tax revenue.

It is worth looking at the EU consultation and directive again in more detail because it will dictate the future of the tobacco duty regime in this country. The Commission, when setting out its consultation, broadly suggested four areas that it might pursue. The first one is replacing the most popular price category—the MPPC—with weighted average prices as a reference point for the whole European Community, claiming that it would address health objectives in a more efficient manner. It is saying that there should be higher specific duty, which is the point I started with. Secondly, it talks about aligning the taxation of cigarettes and fine cut tobacco or roll-your-own or hand-rolling tobacco—HRT as I believe it is called—to reduce the substitution effect. In other words, people give up smoking ready-rolled cigarettes in favour of hand-rolling tobacco. Thirdly, it talks about increasing the minimum rate requirement for cigarettes and fine cut tobacco to combat illicit trading—which we have already talked about—and to address health concerns, and finally amending the existing definition of cigarettes, cigars and pipe tobacco to deter tax avoidance and evasion.

In the light of the EU consultation, there are broadly seven proposals in the draft directive—indeed, abolishing the MPPC as the reference point, which is good news for those who prefer a higher rate of specific duties, with the alternative of a cash minimum to be applied to all cigarettes, not just to those in the MPPC, of around £50.50 for 1,000 cigarettes. It would not affect the price in this country because we are already above that. There are various other suggestions. I would be grateful to hear from the Minister what response the Government had made to the draft directive, which was cleared by the European Scrutiny Committee last autumn.

On a related topic, I wonder whether the Minister has looked at what various EU members do and what consideration she has given to a minimum duty on tobacco products. That is not a minimum price but a minimum level of duty. Twenty of the 27 EU countries already have such a scheme. Ireland, for example, has a minimum duty. What consideration has she given to the Irish experience? In Sweden and Denmark, having a  minimum level of duty actually raised tax revenue because it made cheaper brands more expensive, thereby increasing the overall tax revenue because the ad valorem part, the specific duty, would take in more—and indeed the ad valorem. It closes the differential between the cheaper brands and the premium brands and, in Sweden and Denmark at least, it showed an increase in tax revenue. It might also curb the increase in lower-priced tobaccos and thereby raise more duty. I would be grateful to hear whether the Minister had looked at the experience, in particular in Ireland, but also in the other 19 EU countries that have such a system.

Turning from the structure of tobacco taxation—although the structure does bear on my next question—we need to ask how close further duty increases will take us to the revenue maximisation point with tobacco duty. The Minister admitted in last year’s Finance Bill debates that we were close to this point, and I think she said the same in relation to the PBR and the debate on the statutory instrument in January this year that resulted from the PBR. In the Committee of the whole House the Minister talked about whether we might have reached the tax maximisation point with tobacco. We now have another increase, with a further increase in prices expected as a result of the VAT rise in January 2010. It would be helpful to have her current view on revenue maximisation. Discussing the PBR changes in the debate on the statutory instrument in January—which raised the ad valorem element from 22 to 24 per cent.—she said:

“If we are close to revenue maximisation, we might go closer to or just beyond that point and, in that context, there is a risk that smuggling might undermine the helpful revenue benefits of the real increase in tobacco taxes.”—[Official Report, Second Delegated Legislation Committee, 13 January 2009; c. 22.]

We acknowledge that progress has been made on smuggling. HMRC and UKBA have a joint strategy, although the tone of last year’s launch document was perhaps a little self-congratulatory given the levels of illicit tobacco that remained in this country. For example, when discussing hand-rolling tobacco, as loose tobacco is normally termed, the document put the illicit market share at a huge 53 per cent. Its estimate of a 13 per cent. illicit share for the much larger cigarette market also needs to be placed in context.

Imperial Tobacco, for example, suggests that 37 per cent. of the cigarettes smoked in the UK fall outside the UK duty regime. When we are debating the amount of duty that we might be taking in, that is an incredible amount. Imperial Tobacco, which is, I think, one of the largest three or four tobacco manufacturers, suggests that 37 per cent. of what is smoked in this country does not have UK duty paid on it. In other words, for more than one in every three cigarettes, the Treasury gets absolutely nothing. Clearly many of those are not illicit—the Minister was right to draw that distinction—but they all represent lost revenue to the Treasury.

We should also consider the effect of the exchange rate. Some of the pressure on tobacco imports of all kinds—illicit and legal—has been eased by the fall in sterling, which has meant that super-low brands have become cheaper in the UK than in France. That must be the first time that that has happened—certainly for 20 years, but perhaps ever since tobacco was discovered in the 17th century. Thinking about all-time historic changes, it is worth remembering that, at the moment, sterling is very close to its historic low against the euro and its predecessor currencies, such as the French franc.

We are living in interesting times, but we cannot rely on sterling remaining very low against the euro to reduce tobacco importation over a long time. I do not think that smuggling has been stopped or eliminated. We have to be aware of that. I would be interested to hear the Minister’s views about what the Government are doing. It would also be interesting to know what effect the Government think any significant recovery in sterling would have on the joint smuggling strategy and wider policy.

Another area of revenue loss that we should examine is the new threat of so-called non-domestic brands—or “cheap whites”—which we mentioned earlier. Those are brands that are not counterfeits, but that resemble those available in the UK. They are what I call in vernacular terms fake brands, which are ostensibly manufactured for the home markets of the countries in which they are produced—eastern Europe, Russia, China and elsewhere. Duty is often paid in those countries, even though it is never intended that those products will be consumed there. Anybody who knows anything about tobacco duty will know that it is very low in countries such as Russia and China. It can still make sense to produce the product there, even though it is intended for export from the very beginning. However, instead of being smoked there, after manufacture, the cigarettes are either smuggled directly to countries such as the UK, or moved legitimately via other hubs—particularly Poland, but also Germany—from where they find their way here.

Last November, which is the most recent month for which I have data from HMRC, interestingly, 47 per cent. of seizures were of those “cheap whites”. They are a significant part of the non-UK duty paid part of the cigarette market. I do not know whether other members of the Committee have come across those fake brands, but the industry is finding an ever-increasing number of those “cheap whites” when it conducts pack sampling of the rubbish left behind at events such as football matches and concerts. That might sound like an obscure thing to refer to, but it is standard practice in the cigarette industry to do pack sampling exercises. People from the industry go to somewhere where there has been a big assembly of people and look at the detritus left behind.

My hon. Friend is giving a fascinating exposition on a subject on which he is clearly an expert—doubtless he will build on his expertise. Has he ever considered or will he consider joining one of those pack expeditions, so that he can see for himself how it is done?

I have left my smoking days behind me, but I think it would be quite interesting. I have seen—as I am sure those involved in the issue and the Minister have—examples of what those packs look like. Superficially, they appear convincingly like a real brand of cigarettes and I suppose, in a sense, they are a real brand of cigarettes. Nevertheless, one packet in particular seems to be deliberately designed to look a little bit like Benson and Hedges Gold. If I were given the option, I would take up the offer of joining such a visit.

Further to the previous intervention, has the hon. Gentleman done any research on the propensity of supporters of different football clubs to  smoke non-branded or misleadingly-branded items? Indeed, if he wishes to cast aspersions on organisations other than football clubs, does he know whether those people who go to pop concerts are more or less likely than football supporters to smoke cigarettes that are inappropriate?

Order. May I ask the hon. Member for Hammersmith and Fulham not to be led down that path?

Thank you, Mr. Atkinson, for what I am sure is very correct advice.

I was interested by a piece in the Manchester Evening News last week about myself and the hon. Member for Taunton. Some journalist on the newspaper does a count of the number of words that MPs use that might be used by people in Manchester when talking about their everyday lifestyles; I think that that is the point. There is a word count of the use of words such as “beer” and “football”. I must say that the hon. Gentleman did extremely well. Normally, he features quite heavily in the newspaper. On this one occasion, however, thanks to my marathon speech on beer during a Committee of the whole House he was trumped completely.

I know that I am testing your patience, Mr. Atkinson.

For clarification, it might be useful to say that, as I understand it, the Manchester Evening News word count process applies only to the main Chamber.

Order. The hon. Gentlemen are testing my patience now.

I will not respond to that last intervention.

Returning to the issue of “cheap whites”—

Will my hon. Friend give way?

Yes, of course.

I know that my hon. Friend is just limbering up on this topic. [Laughter.] However, can he clarify whether the sale of these fake brands or “cheap whites” is legal or illegal in the UK?

That is a very interesting question, which I hope the Minister will respond to in due course. It is a very interesting question about how we control this level of activity. The person who has imported the produce is almost certainly committing an offence. However, it is unclear if the person at the point of sale is also committing an offence. I am told that most of the sales of these goods happens in places such as pubs or street markets. I would be grateful if the Minister gave a precise explanation of what illegalities have been committed in the sale process and, if there have been any, when and by who?

Returning to the issue of “cheap whites”, I am told that a brand called Jin-Ling is the most prevalent, but there are dozens of different brands. Oddly enough, it appears that smokers who buy their cigarettes on the  black market still appreciate a bogus aura of authenticity, which I have already referred to by giving the example of the lookalike B&H product.

Some of the eastern European manufacturers of these products oblige their customers by replicating the UK health warnings on the packet. I am not sure what that says about the effectiveness of the health warnings. However, it will be interesting to see if these manufacturers stop copying the health warnings when they start to include images, which I think will be used in due course.

So, non-domestic brands are a serious problem. They cannot be tackled through the agreement of the big UK suppliers that has helped to bring down the quantities of illicit tobacco in recent years. Getting the Governments who host these non-domestic brand manufacturers to take action is difficult, but it will be crucial.

Again, I will just give the example of Jin-Ling, which I think is manufactured in Kaliningrad. That itself raises an interesting question. Kaliningrad is part of the Russian Federation but it has a very interesting legal structure. I know that, having been there. I will not stray into the realm of discussing my wife’s family, but I happen to know a fair bit about Kaliningrad. Consequently, I would be interested to know what representations the Minister, or the Foreign Office on her behalf, have made to other countries—not only Russia but Poland—about strengthening the border controls near Kaliningrad, with reference to tobacco smuggling.

There is another interesting question. Which Governments have duty receipts that far outstrip the domestic consumption of these brands? That should certainly act as a warning signal for those countries; they will know at that point that they have a problem.

I know that the Treasury is aware of this issue and the joint smuggling strategy, published by HMRC and the UK Borders Agency in November, identified it as the key threat in the future. It would be helpful if the Minister could outline what steps have been taken since November in relation to the products’ countries of origin.

Returning to the structure of tobacco taxation, there are important questions outstanding to which we are owed a response. First, why have the Government seemingly reversed their own policy on ad valorem duty? Secondly, do they recognise the problems that has caused and which, in effect, they predicted in their submission to the European Commission? Thirdly, why did they not address them in the Bill? Fourthly, will they re-band the structure of cigarette taxation in January 2010, when VAT is raised again?

Ironically, the Commission’s draft directive supports the shift towards specific duty that the Government outlined in their submission. The draft calls for minimum rates of taxation to be increased and proportional rates to be lowered. In conclusion, do the Government still want what they asked for when they made their submission to the EU as part of their consultation in 2008?

I feel there is not much that I can add to that rigorously researched contribution, although I thought it was thin on the different types of tobacco  manufacturing in different parts of the Russian Federation. I would have appreciated greater detail before deciding whether I wish to support clause 12, but I will have to operate in the dark, so to speak, and make that decision less well informed than it might otherwise have been.

I will ask three brief questions. The first is on the issue drawn out at length by the hon. Member for Hammersmith and Fulham: differentials between premium brands and lower-price brands. He put figures on them, but—anecdotally—one can see displays of cigarettes in shops and the prominence afforded to the lower-price brands compared to 10, 15, or 20 years ago, when the big household name brands such as Marlboro would have been more prominent and consumed more space on retailers’ shelves. That is a serious problem, partly because young people who wish to smoke more are likely to be drawn to the lower premium brands for price reasons, and partly because the Government are losing revenue even if the total number of cigarettes sold is the same. The Minister needs to address that.

The second issue is smuggling. The hon. Member for Hammersmith and Fulham estimated that 37 per cent. of cigarettes smoked in the United Kingdom had not had UK duty paid on them. Some of those cigarettes would have been entirely properly brought into this country by someone returning from holiday, for example, but it is well known that a large number of cigarettes are smuggled into the country. A number of problems associated with that. One is that the Treasury makes no revenue on those cigarettes at all. The other problem is that smuggling penalises legal retailers of tobacco.

It must be extremely galling to sell cigarettes and comply with the law only to have someone outside the shop or round the corner selling the same cigarettes, or a very good replica, at a substantially reduced price, which risks putting the conventional retailer out of business. Even though it ought not to be a temptation, the inducement is for legal retailers to sell non-legal smuggled products under the counter. They might conclude that they would like to have a share of that market. If all the people in that locality buy cigarettes illegally, the only way that retailers can remain viable as a business is to seek to move into that illegal part of the market. That puts them in a severe moral quandary, and I do not want people put in that position.

If the Government decide that all cigarette displays are illegal, all cigarettes will be sold under the counter. There will probably be even less differentiation between smuggled, illegal cigarettes and legal cigarettes, when all are being bought in such a surreptitious way. The inducement to behave improperly, however regrettable, will probably be greater.

I note that the Minister and the Government talk—always—about measures to strengthen border controls, inspections and so on. That is important, but it would be interesting if the Minister also engaged on the question of price, because the biggest inducement for anyone to smuggle, or to behave improperly in any other area, is the financial incentive for doing so.

I would be interested if the Minister touched on what was not covered by the hon. Member for Hammersmith and Fulham, who had to cut short his remarks and was therefore not able to cover all the ground—the impact of the duties in clause 12 on different income groups. The Minister touched on young people, who tend to have less money than middle-aged smokers, but I would  be interested to know his assessment of the impact of clause 12 on the top decile by income, as opposed to the bottom decile.

My suspicion is that the duty brought about by clause 12 and similar clauses in previous years has a much more profound effect on people in the bottom decile, certainly in terms of the percentage of their overall disposable income, but I suspect even in absolute terms. That has a social impact on those people. It may be that the Minister regards the adverse impact on people’s finances to be justified in terms of the beneficial impact on their health, but there are problems with trying to effect behavioural change through pricing. Everyone recognises that, whether the attempt is made through congestion charges in London or the pricing of tobacco products, the economic impact on people with low incomes can be profound. I would be interested if the Minister touched on that point as well.

Albeit late in the day, as it has taken a day or so to get to my first response in the Finance Bill Committee, I welcome you to the Chair, Mr. Atkinson, probably just as you are dreaming of getting out of it as quickly as possible after a day of duty.

Clause 12 increases the duty on cigarettes and all tobacco products by 2 per cent. Together with VAT, that will add 7p to the price of a typical packet of 20 cigarettes and 3p to a pack of five cigars. The clause also puts into legislation the increases in tobacco duty announced in the pre-Budget report. Tobacco rates will remain unchanged after the VAT rate returns to 17.5 per cent. in January 2010.

Before I go on to answer some of the specific points made in the debate, it is wise to put on the record that smoking is the biggest single cause of preventable illness and early death in the UK. It contributes significantly to inequalities in life expectancy, which the hon. Member for Taunton may take as a signal of my response to the last of his points. Maintaining high levels of tobacco duty, alongside continuing action to clamp down on the threat of smuggling, is a proven part of the Government’s strategy to reduce smoking prevalence. Tobacco is also an important contributor to public finances.

We have heard varying figures, such as Imperial Tobacco’s that 37 per cent. of the UK market consists of cigarettes on which duty has not been paid in the UK. Have the Government looked at where illegal cigarettes—in the social deciles that the hon. Member for Taunton referred to—tend to be bought and sold? In other words, could it be that illegal cigarettes are going to a particular area of society and perhaps exacerbating the health impacts and social injustices?

There is more than one sort of illegality. There are counterfeit cigarettes and those that have been smuggled in, and they are not always the same. Legally produced cigarettes are smuggled but they are also brought into the country legally through cross-border shopping. There are also counterfeit goods, which, given the lack of assurance about what has gone into them, we would prefer were not available at all. There is a range of issues.

The only way of knowing in detail where the illegal product ends up is by undertaking the surveys that the hon. Member for Hammersmith and Fulham talked about earlier, and some spot checks. There are various  ways to attempt to get a handle on what by its essence is an illicit phenomenon and come up with a reasonable idea of its scale, but there are no Office for National Statistics figures on counterfeit products.

Can I come back again?

When I have finished answering the hon. Gentleman’s initial question, I shall of course let him intervene again.

There are no rigorous official statistics about such things simply because the phenomenon is illegal and underground. All we can do is have surveys carried out. We all probably have our own view, because we have had particular experience of what is going on in our constituencies or what is available in the communities in which we live.

The Minister is making a very fair point. If smuggled cigarettes were being used more extensively by the lower income decile groups, putting up duty could, in fact, exacerbate that tendency and thus the likelihood of such people, who are particularly vulnerable to all sorts of other social and health problems, to increase their smoking. It is a matter of teasing out whether the Government have looked at the matter seriously and whether it could be an issue, because it would go against all policy if it turned out that the most vulnerable in our society were ending up more likely to smoke as a result of the Government’s policy, which all of us here were thinking did the opposite.

That point overlooks the overall fact that all smoking is dangerous to health, whether one smokes premium brands, cheap brands or counterfeit brands. The Government’s policy is designed to reduce and minimise the number of people who smoke.

The previous intervention was good. People in higher income deciles might carry on smoking premium brand cigarettes, and that would be easily measurable through official statistics. However, if cigarettes bought legally—even lower premium brands—became prohibitively expensive for people on low incomes, there may seem through official statistics to be have been a reduction in smoking propensity in low income deciles, but those people may actually be smoking more because they are financially induced to buy smuggled or illegally produced cigarettes that are not showing up in official statistics. That is the point that was being made, and it is worthy of a reasonable answer.

I have two observations to make. One is that the way we measure the amount of smuggled or counterfeit products on the streets is not the same as the way we measure smoking prevalence. In other words, we know about smoking prevalence from social surveys carried out by ONS, but we do not always have detailed knowledge of precisely what brands are smoked. Some tobacco companies undertake their own surveys with respect to that, and we receive pieces of information that we put together to make an overall picture. I understand the hon. Gentleman’s point, but we should  focus on the larger issue because we wish to discourage people from smoking altogether and not lose sight of the big picture.

It is not the same point.

Of course not, but reducing the prevalence of smoking is the best way to tackle those inequalities, particularly in life expectancy.

I am not sure whether the Minister has really got to the heart of my question: is it Government policy to try to narrow that differential—to increase the specific amount of duty—or is it their policy to widen that differential by increasing the ad valorem part? At the moment there are conflicting signals between what they said in their response to the EU consultation and what they did in the PBR, so which is it?

I was going to come on to that. If the hon. Gentleman and other Opposition Members would let me get on, I might be able to answer some of the questions that the hon. Gentleman asked in his speech. First, though, I should like to congratulate him on being an ex-smoker. It is always an achievement when addictions are overcome, and I am glad that he has managed to move into the category of ex-smoker.

I thank the Minister for her congratulations. Coming from the hon. Lady, who is described as “a saint” in The Daily Telegraph today, I take that as a real tribute.

I hope that many others who smoke will follow the hon. Gentleman’s example.

The hon. Gentleman talked about the difference between the ad valorem and the specific elements of the current tax on tobacco. There is a point about sequencing. He quoted at great length from the consultation document issued by the Commission and our response to it. We are trying to change the structure of EU directives on tobacco to deal with some of the points that he made and to try to ensure that the specific element becomes more important than the ad valorem element. To do that, we have to persuade all member states to agree to change the directive. For the reasons that he read out as part of the Government approach to this renegotiation, that is clearly extremely important. However, while we attempt to achieve that very desirable shift, we have to work within the current directives.

When the changes were announced at the PBR, they were, as the hon. Gentleman pointed out, designed to try to keep the price of tobacco as broadly neutral as possible in the context of a temporary VAT cut. VAT is an ad valorem tax, and we got the closest fit to achieving the price stability that we wanted in that context by using the ad valorem parts of tobacco tax.

If we are successful in the EU directive negotiations, we want more concentration on the specific element of tax on tobacco across the whole of the EU, not just in the UK. For the reasons that the hon. Gentleman  quoted, it makes sense for us, as a Government, to put the matter to the EU Commission as part of that process. We will be able to make progress there, but he must recognise that there are 27 EU member states, with different tax rates on tobacco and many different approaches. The hon. Gentleman is a member of the European Scrutiny Committee, so he will know that trying to get agreement on EU directives is sometimes quite difficult—it can be like herding ferrets, especially where tax is concerned. However, we are doing our best to come up with a structure for tobacco tax that allows us more successfully and accurately to pursue some of the social and health issues that we talked about.

The hon. Gentleman asked whether we had thought about minimum excise taxes. Our lowest taxes are much higher than a lot of the minimum taxes in the EU. We are negotiating within Europe to give us more flexibility to levy a higher proportion of specific duty on cigarettes, as we wish to do. We are awaiting the development and evolution of those negotiations and their outcome before deciding how to change the structure of our own cigarette duties.

Can the hon. Lady answer the question about the PBR and the 2 per cent. ad valorem rise, on which we will also vote today? Surely the Treasury could have structured a rise in specific duty that would have raised the equivalent sum across the whole sector on a revenue-neutral basis, because it still appears that the ad valorem rise is entirely contrary to the policy—at least, the policy submitted to the EU and that she has just outlined—that she wants, which consists of a higher specific duty and lower ad valorem.

As I mentioned earlier, because VAT is an ad valorem tax, as is that part of tobacco taxation, when trying to have a simple approach to a temporary reduction in VAT, it makes sense to deal with it in that way, which is what we did.

The hon. Gentleman also mentioned revenue maximisation. It is certainly true that we would wish, as a matter of policy, to be somewhere around revenue maximisation, and he is right to quote the statements I have made in that context on earlier occasions in relation to previous pre-Budget reports and Budgets and in Committee. However, there are indications relating to our judgment, which is based on the available evidence, that we are close to that point, but can still expect some increase in revenue from the increases in clause 12. Some of those indications are: a strong receipts performance, a falling tax gap and a continuation and tightening of the anti-smuggling strategy. The hon. Gentleman mentioned another indication: the weak pound and the reduced demand for overseas travel, which change the elasticities around revenue maximisation calculations. Our best assessment is that we have not yet gone beyond revenue maximisation, but I have always made it clear that, as a matter of policy, we wish to stay as close to that as possible for the social and health reasons we talked about earlier.

I thank the Minister for being so generous in giving way. She said we have not reached maximisation point, but are quite close. It sounds as though she has a fixed idea of where that point is. It would be helpful if she would share that with the Committee.

I have just told the hon. Gentleman that the elasticities have changed and mentioned three of the reasons why, so the point is not fixed. Analysis of our receipts performance, what is going on elsewhere and the impact of those changes, such as the scale of smuggling and the strength of the pound, are all relevant. I have just gone through some of the factors that can be brought to bear when calculating the elasticities, so it is not a fixed point. We analyse it when we are doing our revenue calculations and do not just pluck it out of the air. We believe that some of the changes I have mentioned have had an impact on elasticities and allowed us to increase the duty rates without going beyond revenue maximisation. We always keep those calculations under analysis as we consider what future duty rates should be.

The hon. Gentleman talked about cheap whites. There is a limit on the import from non-EU countries of cheap whites for own use of 200 cigarettes per person, meaning individuals who come across the border with their own shopping. Commercial imports need to be properly imported with duty paid through excise warehouses. We therefore ensure that they have appropriate health warnings, as required by UK law. Goods not in either of those categories are classed as smuggled, and that is how the breakdown of cheap whites that are available or that one might come across at one’s local football match would be categorised.

Will the Exchequer Secretary clarify that? For example, when the Jin Ling, which is the most popular of the cheap whites, comes from Kaliningrad to the UK via Poland, at which precise point do the Government try to intervene? What discussions has the hon. Lady had with the Polish authorities? Surely one of the problems is that, as Poland is in the EU, the intervention could also happen at the EU external border.

It would depend on who brought in the pack of cheap whites and why. If they were imported via Poland, they would be dealt with at the excise warehouse. If the hon. Gentleman brought a pack in—even though he has given up—after visiting some of his family in Kaliningrad, he would be allowed 200 sticks before having to pay duty. Anything else that appears is smuggled.

The hon. Member for Taunton asked about the differential between premium brands and lower-priced brands. I understand his point. There is often switching, and even now we could say that there would be switching from potentially counterfeit to cheap, up to premium brand or not. We have to be aware of that and look at how it is going, but I emphasise that Government policy is to try to reduce the prevalence of smoking of any brand. That is the aim of the excise duty policy in clause 12.

The hon. Member for Hammersmith and Fulham asked about statistics and wondered whether it is true that one in three cigarettes smoked in the UK fall outside UK duty paid. Our statistics show that 13 per cent. of cigarettes smoked in the UK are smuggled and 8 per cent. are from legal cross-border shopping, so one in five—not one in three—are outside UK duty paid. We must never be complacent about our ability to tackle smuggling but we have made good progress,  often reaching targets years in advance and regularly discovering and destroying 2 billion to 2.6 billion cigarette sticks a year. That is our new target. We have made seizures of around 1.8 billion sticks, which is rather a lot, and, believe it or not, 450 tonnes of hand-rolling tobacco. We are getting the figures of smuggled cigarettes down, but it is a constant battle, which the UK Border Agency and Her Majesty’s Revenue and Customs are fighting well. In answer to the hon. Member for Hammersmith and Fulham, we co-operate a lot with our colleagues in other countries to protect borders as best we can.

Finally, the hon. Member for Taunton asked about the distributional effect. The best way to reduce the impact of duty increases, distributionally or otherwise, is to reduce smoking prevalence, which is why a lot of the work that is being done by health authorities to offer assistance and free Nicorette patches to those who wish to give up is having an effect. We have already dramatically reduced smoking prevalence and seek to drive it down further. Clause 12 and the changes in duty before us are one part of that, and I commend them to the Committee.

Question put and agreed to.

Clause 12 accordingly ordered to stand part of the Bill.