PWC Illegal Tobacco Costing Australia Millions November 2007

Illegal tobacco trade: Costing Australia millions

Strategies to curb the supply and use of illegaltobacco products

August 2007

Disclaimer

This study has been prepared by PricewaterhouseCoopers (PwC) at the request of BritishAmerican Tobacco Australia (“BATA”) in our capacity as advisors in accordance with theScope and the Terms and Conditions contained in the Consultant Agreement.

The information, statements, statistics and commentary (together the “Information”) containedin this report have been prepared by the Consultants from material provided by stakeholdersand from discussions held with stakeholders. The Consultants may in their absolutediscretion, but without being under any obligation to do so, update, amend or supplement thisdocument.

The Consultants have based this report on information received or obtained, on the basis thatsuch information is accurate and, where it is represented by management as such, complete.The Information contained in this report has not been subject to an Audit. The information mustnot be copied, reproduced, distributed, or used, in whole or in part, for any purpose other thandetailed in our Consultant Agreement without the written permission of BATA and PwC.

Comments and queries can be directed to:

Scott Lennon

Partner

PricewaterhouseCoopers

201 Sussex Street

Sydney NSW 2000

Phone: (02) 8266 2765

Email: [email protected]

Contents

Summary 3

1 Background 8

2 Illegal tobacco production in Australia 13

3 Characteristics of chop chop users 27

4 Additional regulatory options 31

5 Assessment of regulatory options 37

Appendix A ACS container profiling and inspection 51

Summary 2

Table of Acronyms

ABS Australian Bureau of Statistics

AFFA Department of Agriculture, Fisheries andForestry

AIHW Australian Institute of Health and Welfare

ANAO Australian National Audit Office

ATO Australian Tax Office

ATS Aggressive Tobacco Strategy

BATA British American Tobacco Australia

EBL Excise Business Line

GST Goods and Services Tax

ITWP Illegal Tobacco Working Panel

PIN Penalty Infringement Notice

PML Phillip Morris Limited

QTMGC Queensland Tobacco Marketing and GrowingCooperative

RYO Legal roll-your-own pouch tobacco

TCV Tobacco Cooperative of Victoria

TIG Tobacco Excise Industry Group

TMC Tailor-made cigarettes

Summary 3

Summary

The sale and use of illegal tobacco is a world wide problem,with illegal cigarettes estimated to comprise 11% of globalcigarette sales, and representing a loss to government revenueof $US40 to $US50 billion annually.

Latest intelligence shows that the illegal tobacco market remainsa serious problem in Australia, with an estimated 1.8 millionkilograms of illegal tobacco in circulation in 2007. This isequivalent to 6.4% of total cigarette consumption in Australia andrepresents taxation losses of around $A450 million. Thisavailability of low cost illegal tobacco undermines the AustralianGovernment policy to keep tobacco costs high to reduce theiraffordability and consumption level particularly for minors.

Despite recent changes to domestic tobacco production, thereis no evidence that the scale of the illegal tobacco problem isabating. There are no measures in place to deter demand forillegal products and aside from a penalty regime, no directmeasures to target any of the many sources of illegal tobaccosupply.

Given the returns to suppliers and price discounts toconsumers, eliminating illegal tobacco trade may be out ofreach. However, illegal trade needs to be moderated and newregulatory interventions are critical to ensure that the growth intrade is stopped and the availability of illegal tobacco productsin the community is curtailed.

Supply sources are adaptable to change

Until recently, Australia’s biggest source of supply wasdomestically grown ‘chop chop’ or loose leaf tobacco that hasbeen diverted off licensed farms and directed to the blackmarket.

However, as legal tobacco production ceases as a result of therecent buy-out of tobacco licences in Victoria, illegal tobaccosupply will shift to other sources (both domestic andinternational). All sources of supply are substitutable for eachother, and are highly responsive to changes in the broaderregulatory environment.

Around $450 million oftaxation revenue is lostannually due to illegaltobacco sales

Cessation of domestictobacco production willnot curb trade in illegaltobacco

Without newinterventions, illegaltobacco supply willcontinue to grow at itscurrent rate

Summary 4

Growing risk of increases in illegal imports

Based on international experience, imports are certain to rise,particularly in the form of counterfeit cigarettes which alreadyconstitute significant volumes in neighbouring countries. In2000 a report commissioned by the World Bank estimated thatbetween 6% and 8.5% of global cigarette consumption wassmuggled. Now smuggled cigarettes are estimated to comprise11% of global cigarette sales.

In Australia, the illegally smuggled tobacco market (both looseleaf and counterfeit cigarettes) is estimated to be 134,000kilograms in 2005/06, with around 655,000 kilograms illegallyimported between 2001/02 and 2005/06. The total volume ofsmuggled tobacco is estimated to comprise between 7% and9% of the illegal tobacco market in Australia.

Tobacco smuggling is becoming increasingly organised aroundthe world and international evidence indicates that it isincreasingly becoming smuggled alongside other illicit goodssuch as class A drugs, alcohol and counterfeit clothing byorganised criminal syndicates.

As well as presenting problems for the legal tobacco industryand for government revenue capture, the links of smuggled andcounterfeit product to organised crime make the social impactsof this diversion in supply more serious. Indeed internationalevidence suggests that the illegal tobacco market has begun torival drug trafficking as a relatively lower risk funding source forterrorist groups.

Drivers of supply and demand

Financial incentives drive illegal tobacco supply

Illegal tobacco suppliers (illegal importers or illegal growers) havea very clear financial incentive to supply illegal tobacco, given theability to circumvent tobacco excise and GST, which account forup to 70% of the cost of a cigarette. Without tax or excise,suppliers of illegal products are able to sell illegal tobacco at aprice premium and still supply a product to the market that isaround 65% cheaper than legal branded cigarettes.

Penalty arrangements do apply for supplying illegal tobacco.However, these only reduce the payoff for illegal supply ifimplemented in a way that discourages illegal trade. Currently,the risk of detection and prosecution is low, and penaltyarrangements do not inadequately deter illegal tobacco supply.

Illegal suppliers receivemore than 10 times theprice for illegal tobaccothan legal tobacco

Low detection risks andinadequately enforcedpenalties do not detersupply

Without action, illegalimports will grow

Summary 5

Avoidance of cigarette tax creates discount for consumers

The inability to levy taxes on illegal tobacco is a key driver ofillegal tobacco sales because it generates a significant pricedifferential between legal and illegal tobacco products. Illegaltobacco is sold for around a third of the price of legal tobacco atapproximately $13 per 100 grams (wholesale price), comparedto an average retail price of $36 per 100 grams for brandedtobacco.

Wrong perceptions of more ‘natural’ qualities

There is a perception among illegal tobacco users that illegaltobacco is ‘better for you’, as it is perceived to be more naturaland not subject to further manufacturing. This perception wasconfirmed in a 2007 ACNielsen survey of the purchasingpatterns and behaviour of illegal tobacco users.

The fact that many illegal tobacco smokers cite the perceived‘natural’ and unadultered nature of chop-chop as an attractionindicates the lack of awareness of the adverse health impactsof smoking tobacco that is produced by unregulated supplierswith higher levels of contaminants and more variable (andlower) quality.

Strategy to cut the illegal tobacco trade

There are a range of interventions that could address thesupply and use of illegal tobacco, from strategies which targetthe profitability of illegal supply to those that affect consumerdecisions to purchase and use illegal products.

This report evaluates a series of regulatory interventions, whichall improve community welfare compared to the status quo oflimiting intervention to the cessation of domestic legal tobaccoproduction. However, none on their own effectively curb theillegal tobacco trade.

What is needed is a mix of strategies that: disrupt the distribution chain for illegal tobacco; make tobacco smuggling more difficult; increase the risks and reduce the rewards of supplying

illegal tobacco; and tackle the demand for illegal tobacco.

The package of regulatory interventions that are recommendedby this review are illustrated in Figure S.1. These were selectedfrom an assessment of 8 different interventions.

A package of initiativesis recommended toreduce the incentives tosupply and use illegaltobacco

Tax avoidance reducesprices to consumers

Illegal tobacco iswrongly perceived as'healthier'

Summary 6

Figure S.1 Recommended regulatory interventions

Recommendations were based on the assessed impact on thevolume of domestically available tobacco, the risk adjustedprofitability of tobacco supply, curtailing demand, and the abilityto meet government objectives including taxation revenuecapture.

Cost estimates and the net benefit assessment of allinterventions are provided in Chapter 5.

Payoff from interventions

The benefits of each recommended regulatory intervention aresummarised in Table S.1.

While these indicate that around $A160 million could berecoverable, interventions should not be summed as someimpacts would be shared if (as recommended) interventions areundertaken simultaneously.

More ATO resources for aerial surveillance to spot illegal growing A ban on future growing licenses to help detect illegal growing

Targetsupply 1

Private inspectors to detect distribution from high risk outletsTargetdistribution 2

Additional counter smuggling initiativesTargetimports 3

Equalisation tax for hollow tubes to reduce price differential Advertising campaign to undermine appeal of illegal tobacco

Targetdemand 4

More ATO resources for aerial surveillance to spot illegal growing A ban on future growing licenses to help detect illegal growing

Targetsupply 1

Private inspectors to detect distribution from high risk outletsTargetdistribution 2

Additional counter smuggling initiativesTargetimports 3

Equalisation tax for hollow tubes to reduce price differential Advertising campaign to undermine appeal of illegal tobacco

Targetdemand 4

Summary 7

AssessmenTable S.1: Assessment of regulatory interventions

Intervention Benefits Preliminary

Estimate of

Excise revenue

gains to

Commonwealth

Government

Ban on future growing licences Simplified identification and prosecution Improved tax and excise revenue protection Removal of incentives to farmers to seek tobacco markets

and associated potential to trade in illegal market Unambiguous message to growers and the community Improved health benefits from reduced use of chop chop Improved revenue protection for legal tobacco manufacturers

$10 million

Additional aerial surveillance

measures

Greater risk of detection Reduced risk adjusted return on illegal supply Improved tax and excise revenue protection Improved health benefits from reduced use of chop chop Improved revenue protection for legal tobacco manufacturers

$45 million

Private sector investigates to

detect distribution from high risk

outlets

Greater risk of detection Reduced risk adjusted return on illegal supply Targets all sources of illegal supply sold by main distributors Improved tax and excise revenue protection Improved health benefits from reduced use of chop chop Improved revenue protection for honest retailers where

retailers selling illegal tobacco are penalised Improved revenue protection for legal tobacco manufacturers

$40 million

Additional counter smuggling

initiatives

Greater risk of detection Reduced risk adjusted return on illegal supply Higher probability of detecting other serious illegal imports Undermines source of organised criminal activity Improved tax and excise revenue protection Improved health benefits from reduced use of chop chop Improved revenue protection for legal tobacco manufacturers

$15 million

Equalisation tax for cigarette

tubes

Reduced demand for illegal tobacco for tube users Improved tax and excise revenue protection Improved health benefits from reduced use of chop chop Improved revenue protection for legal tobacco manufacturers

$10 million

Advertising of risks of supply and

use

Reduced demand for illegal tobacco Improved tax and excise revenue protection Improved health benefits from reduced use of chop chop Improved revenue protection for legal tobacco manufacturers

$40 million

1 Background 8

1 Background

The Australian tobacco industry makes a significant contributionto the economy in terms of government revenue, retail sales,and employment. Retail sales of tobacco and cigarettes were$9.31 billion in 2004,1 with $5.37 billion collected in exciserevenue in 2006/07. 2 Tobacco manufacturing contributed to the$19 billion gross value added to GDP by the food, beverageand tobacco manufacturing in 2004/05.3

There is currently no domestic legal tobacco production inAustralia. Prior to 2007, around 4 million kilograms of tobaccowas produced domestically, which had continually declinedfrom a production peak of 17.2 million kilograms in 1970. Thecontinued rationalisation of domestic tobacco production hasbeen largely driven by:

the 1995 deregulation in the tobacco industry, whichterminated the Tobacco Industry Stabilisation Plan and theLocal Leaf Content Scheme;

international price competition; and

the contraction of demand for tobacco products.4

There are three tobacco manufacturers and distributors inAustralia, including British American Tobacco Australia (BATA)and Philip Morris Limited (PML) which manufacture in Australia,and Imperial Tobacco which does not have its ownmanufacturing capacity but contracts BATA to produce itscigarettes in Australia which are supplemented by imports.

Tobacco products are distributed by approximately 48,000tobacco retailers in Australia, ranging from tobacconists,supermarkets and convenience stores, to newsagencies andpetrol stations. These retailers conduct trade in tobaccoproducts under State laws and regulations and havecompliance obligations under excise and taxation legislation.

1 Sales of Cigarettes and Tobacco Products by Type of Retail Business,

PricewaterhouseCoopers, 2005.2 Commonwealth 2007/08 Budget Paper No. 1, Statement 5: Revenue, Table 4.3 ABS 2007, Year Book Australia, p.486.4 ANAO 2006, p. 24.

1 Background 9

Cessation of domestic tobacco production

As of the end of 2006, legal tobacco production in Australiaceased, following the joint compensation package from theAustralian Government, BATA and PML for the cessation ofoperational activities in the Tobacco Cooperative of VictoriaLimited (TCV). The TCV comprises of 138 growers/shareholdersin the Myrtleford area of Victoria.

Under the arrangement, BATA offered growers $12 million forthe cessation of operational activities alongside payments madeby PML, with the Australian Government offering an additional$16.8 million in conditional adjustment assistance capped at$150,000 per farmer. This funding is part of a wider $40.9million Australian Government package designed to also assistthe former tobacco growers in Mareeba, Queensland followingthe cancellation of their growing licences in 2004.5 The decisionto accept this joint buy-out package was formally accepted andannounced in a meeting organised by the TCV on the 26th

October 2006.

Under existing regulatory arrangements, licences to producetobacco are issued and administered by the Australian TaxOffice (ATO), and are contingent on having a legitimate marketfor sale, i.e. formal arrangements to sell to licensed tobaccomanufacturers and distributors. Following the abovementionedoffers from BATA and PML, TCV had no commercial contracts,and the ATO was obligated to terminate the farmers’ producerlicences.

A number of Victorian farmers have lodged an appeal to theATO to reissue their licenses for export purposes, based on thepremise that there is a potential international market fordomestically grown tobacco. There is some scepticism aboutthe legitimacy of this ‘export market’ from a number ofstakeholders consulted during the course of this study, due tothe high price of Australian tobacco compared to overseasmarkets.

5 Peter McGauran MP, 2006, $40 million to help tobacco growers look to the future, mediarelease, 26 October 2006.

1 Background 10

Tobacco excise and regulation

Tobacco growing, curing, processing, distribution, and sales arehighly regulated industries in Australia, subject to extensivelicensing and tax and excise regulations. Tobacco is subject toexcise, customs and sales tax. It is estimated that up to 70% ofthe cost of cigarettes in Australia is accounted for by combinedexcise and GST.

The ATO is responsible for the collection and administration oftobacco excise duties. Excise duties are levied on certainexcisable goods manufactured or produced in Australia, suchas petroleum, tobacco, most alcohol, and crude oil. Theestimated $5.37 billion tobacco excise tax collected in 2006/07comprises almost 24% of total excise tax collected by the ATO.6

Under the principle of self-assessment, the calculation of exciseduty is the responsibility of the manufacturer or dealer inexcisable goods. The excise is payable to the ATO when theproduct leaves the manufacturer’s bonded warehouses.

The ATO is also responsible for administering and monitoringlicenses necessary to: manufacture tobacco

produce tobacco

deal in tobacco, or

store and freight tobacco or excisable goods withpermission to sell duty-free.

The Field Services Branch of the ATO is responsible formonitoring tobacco growing areas, and ensuring that theamount of tobacco grown does not exceed that specified in anycontracts with manufacturers. Only 1 person is currentlyresourced by the ATO for this function, who will monitorproduction over the phase out period. From now on, ATOresources will only be required to police any (and all) illegalproduction.

Customs is responsible for administering and collectingcustoms tariffs on imported tobacco. It plays a key role indetecting and administering penalties for smuggled tobaccoproducts. Smuggling involves the illegal transportation,distribution and sale of large consignments of cigarettes andother tobacco products that avoid all taxes. Customs does notdistinguish between legitimately produced but illegally imported

6 Commonwealth 2007/08 Budget Paper No. 1, Statement 5: Revenue, Table 4.

1 Background 11

tobacco products, and imported illegal tobacco as both types ofimports have illegally evaded customs tariffs. Where Customsdetects an illegal shipment of domestically produced illegaltobacco, it would be under the jurisdiction of the ATO, andreferred to it for enforcement.

In recognition of the continued growth in the illegal tobaccotrade in Australia, the Excise Amendment (ComplianceImprovement) Act was introduced in September 2000. The Actintroduced tougher penalties for those dealing in the illegaltobacco trade, and extended the powers of the ATO to facilitateits enforcement activities. Persons dealing in illegal tobacconow face a maximum of two years imprisonment or fines of upto $55,000. As an alternative to prosecution, the TaxationCommissioner may issue Penalty Infringement Notices. TheTaxation Commissioner’s Annual Report states that 34 noticesto retailers amounting to $74,800 were issued in 2004/05,7

which is a tiny fraction of the estimated tax lost and indicatesthat more needs to be done to redirect trade into legalchannels.

The ATO’s Compliance Program for 2005/06 also identifiedillegal tobacco operations as a key priority in the area ofevasion and serious fraud.

Impact of the buy-out on curbing illegal trade

The cessation of the TCV contracts has clearly had a majorimpact on licensed domestic production volume. Given thatsome illegal tobacco supply was the result of illegal diversionsoff licensed farms, there will also be a positive impact onreducing illegal tobacco volumes. For instance, seized illegaltobacco by ATO fell nearly 70 % following the closure oftobacco plantations in north Queensland in 2003/04.

However, this intervention alone will not curb illegal production.

There is anecdotal evidence of a stockpile of illegaltobacco from previous harvests, which according to somestakeholders is believed to be sufficient to supply the blackmarket for several years.

A number of seeds remain in the hands of growers, and 1teaspoon of seed is enough to grow 10 acres of tobacco,with particular fears of new plantations in ‘old growing’ areas

7 ANAO 2006, s3.34 p. 28

1 Background 12

including North Queensland, South East Queensland, NewSouth Wales, Western Australia, and Victoria.

The buy-out has no impact on imports of illegal tobacco orproduction from illegal growers, which offer a readysubstitute for previously diverted supply.

A number of the Victorian farmers have lodged an appealto the ATO to reissue their licences for export purposes toallow them to test potential export markets. Given theuncompetitive world price of Australian tobacco andexisting high returns to illegal domestic tobacco sales, anyreissue is likely to lead to some increase in domestic chopchop production.

Study scope

This study, commissioned by BATA, worked in conjunction withstakeholders to identify the scale and scope of the illegaltobacco market in Australia and to provide meaningful optionsfor regulatory intervention to prevent illegal tobacco trade.

This study is an updated version of the original ResearchReport on the Illegal Tobacco Market report, commissioned byBATA and produced by PricewaterhouseCoopers in March2005. This updated version incorporates all new and relevantinformation relating to illegal tobacco in Australia, includingcomprehensive survey information and legal advicecommissioned for this report.

Structure of this report

The remainder of this report is structured as follows:

Chapter 1 provides background on the cessation of legaldomestic tobacco production and the approach to tobaccoregulation.

Chapter 2 provides a profile of the scale and scope of theillegal tobacco market in Australia and the drivers of supplyand demand.

Chapter 3 provides an overview of the characteristics ofillegal tobacco users.

Chapter 4 canvasses the range of possible regulatoryinterventions to curb the illegal tobacco trade.

Chapter 5 assesses the costs and benefits of eachregulatory intervention and recommends a series ofstrategies to curb the supply and use of illegal tobacco.


2 Illegal tobacco production in Australia

Types of illegal tobacco products

Illegal tobacco products in Australia include counterfeitcigarettes and illegally imported or domestically produced looseleaf tobacco commonly referred to as ‘chop chop’. The namechop chop is derived from the fact that this tobacco is oftenproduced in amateur conditions and roughly cut into fine strips.8

Illegal tobacco products have become an entrenched problemfor government, retailers and the tobacco industry with 1 in 17cigarettes smoked in Australia believed to contain chop-chop.All forms of illegal tobacco avoid tax and excise.

Chop-chop is generally sold in cheap packaging (e.g. clearplastic bags) as loose leaf tobacco in half-kilogram and one-kilogram lots and carries no health warnings or other labelling.Chop-chop may also appear on the market as tailor-madecigarettes (TMCs) and has been known to be sold in counterfeitpackaging of legitimate manufacturers.

Chop-chop is consumed either in the same way as legal RYOpouch tobacco or via ready-made cigarette tubes. Tubes can bepurchased from some tobacco retailers and supermarkets.When used in conjunction with a tubing machine (a smallinserting device, available from tobacconists) many chop-chopusers are making a product equivalent to mainstream TMCs ata fraction of the usual packet price.

Continuous improvements in the quality of chop-chop and amarked increase in average retail prices (partly as a result ofincreases in tobacco excise) make the illegal business morelucrative to new and existing players, including some retailers.

Sources of chop chop

The sources of chop-chop include: tobacco grown on licensed farms but diverted to the black

market (prior to 2007);

illegal tobacco grown in backyard or other unlicensedplantations; and

tobacco imported illegally.

8 Bittoun, R. 2004, The Medical Consequences of Smoking “Chop-Chop Tobacco”, Prepared forthe Commonwealth Department of Health and Ageing, p. 3.


The cessation of Australian tobacco production activity will havea positive impact on reducing domestic illegal tobacco supply,given some proportion of legal production has historically beendiverted to the black market. However, it will have no impact onillegal production by illegal growers or on imports of illegaltobacco.

Distribution outlets

Illegal tobacco enjoys widespread availability and is sold atnumerous retailers including licensed tobacconists, milk bars,hotel bars, convenience stores, and newsagents.9 Most recentresearch indicates that around a third of all chop chop isprovided to users via friends and family members who purchasechop chop from any one of the range of outlets (see Table 1).Anecdotal evidence suggests that a large proportion of supplyvia ‘friends’ is from under-counter sales at local markets.

Table 1: Distribution channels for Chop ChopDistribution channel % of reported distributionTobacconist 40.4Friend or family member 33.1Supermarket 6.6Milk bar 6.0Convenience store 3.6Othera 11.3a includes liquor stores, service stations, newsagents, hotels and motels, restaurants, clubs,discos.Source: ACNielsen Survey of Chop Chop Users June 2007.

The size of the illegal tobacco market

The sale and use of illegal tobacco is a world wide problem,with illegal cigarettes estimated to comprise 11% of globalcigarette sales, and representing a loss to government revenueof $US40 to $US 50 billion annually.

In 2000, the World Bank estimated that between 6% and 8.5%of global cigarette consumption was smuggled.10 Now they areestimated to comprise 11% of global cigarette sales.11

9 The Current Economic and Public Environment for the Australian Tobacco Industry, PricewaterhouseCoopers, 2001, page 47.

10 Merriman, D., Yurekli, A. and Chaloupka, F., How Big is the Worldwide Cigarette Smuggling

Problem? In Jha, P. and Chaloupka, F. (eds), Tobacco Control in Developing Countries, Editors

Oxford University Press, 2000, pp 365 – 392.

11 Framework Convention Alliance (2006), How big was the global illicit tobacco trade problem in

2006?, prepared for the second session of the Conference of the Parties to the World Health

Organisation FCTC, June 30-July 6, 2007 Bangkok, Thailand.

Reduction in legaltobacco production willnot curb trade in illegaltobacco


In Australia, illegal tobacco, mainly chop chop, is sold on theblack market in large quantities and are of serious concern tothe Australian Government. The Australian National Audit Office(ANAO) and the ATO have recently reiterated their concern“that the risk of illegal tobacco operations is currently severe.”12

Given the illicit nature of the product, it is difficult to estimate thesize of the illegal tobacco market with absolute certainty. Arange of estimates exist, ranging from 0.4 and 1.8 millionkilograms, with corresponding ranges in losses in excise andtaxation revenues (Table 2). At the upper end (as estimated bythis review), approximately 1 billion cigarette sticks and 550thousand kilograms of loose tobacco are diverted from legal toillegal channels.

Table 2: Estimates of the illegal tobacco market in AustraliaSource Excise revenue

loss for C’wlthGovt ($M)

Quantity of

illegal tobacco

(‘000 kg)

ANAO1 98 347

Tube and paper importation model2 450 1,830

Consumption model3 450 1,825

Crop yield model4 175 535

[1] 2004/05 estimate based on ATO model referenced in ANAO 2006, p. 54.[2] 2006 estimate based on PwC model of tube and paper imports[3] 2007 estimate based on ACNielsen survey of chop chop consumers.[4] 2006 estimate based on PwC model of yields from areas under crop less contracted volumes.

The various estimates are summarised below. In the future, it isrecommended that the consumption model be maintained andused as the best guide to the size of the illegal tobacco market.

ATO estimation

Estimates by the ATO indicate that the quantity of illegal tobaccowas 346,000 kilograms in 2004/05. While this estimate is thelowest available, the ATO measures growth in the quantity ofillegal tobacco of 11% over the previous year, following on from6% and 21% growth in the preceding two years. The quantity ofillegal tobacco seized by the ATO (cut and leaf) has fluctuated,with a 67% reduction in 2004/05 attributable to the closure oftobacco plantations in north Queensland in 2003/04, whichfollowed two years of strong increases (15% and 77%) in theprevious two years.13 Based on these estimates, the ATO has

12 ANAO 2006, Administration of Petroleum and Tobacco Excise Collections: Follow-up Audit,Australian Tax Office, p.513 ANAO 2006, Table 3.4, p. 54.


calculated that excise revenue lost from illegal tobacco in2004/05 was $98 million — an increase of 14% on the previousyear, and following on from growth in lost revenue of 9% and25% in the preceding two years.

The ATO model of the illegal tobacco market is based onestimates of the quantity of cigarette papers and tubes togetherwith a ‘wide range of relevant data’. It also states that there area range of uncertainties inherent in these estimates, and thatdata limitations mean that it is not possible to accurately statethe amount of tobacco diverted each year using the ATO’smethodology.14

Table 3: ATO estimates2001-02 2002-03 2003-04 2004-05

Legally grown tobacco (kgs) 4,068,180 3,808,148 3,496,505 3,598,880

Est. of diverted tobacco (kgs) 243,000 295,000 313,000 347,000

Total seized illegal tobacco(cut and leaf) (kg)

33,637 59,525 68,205 22,444

Source: ANAO 2006, Table 3.4, p. 54.

Tube and paper importation model

Another method of estimating the size of the illegal tobaccomarket is based on the volume of imported cigarette tubes andpapers imported into Australia which are not used in conjunctionwith legal tobacco. According to the tube and paper importationmodel (Table 4), illegal tobacco volumes fell from 2.9 billion sticks(3.3 million kg) in 2004 to 1.6 billion sticks (1.8 million kg) in 2006.

Table 4: Tube and paper importation model2004 2005 2006

Total value of importedpapers/tubes

$16,528,927 $16,290,673 $11,921,978

Estimated value ofpapers/tubes used inchop-chop

$10,226,662 $9,946,083 $5,621,350

Total chop-chop volume(‘000 sticks)

2,871,750 2,792,960 1,578,532

Total chop-chop volume(kilograms)

3,328,187 3,236,875 1,829,424

Source: PwC

14 ANAO 2006, Note a: to Table 3.4, p. 54.


Tobacco crop yield model

The quantity of the chop chop diverted from licensed farmsprovides another estimate of market size, although this estimateis only applicable prior to 2007.

The tobacco crop yield model estimates the difference betweenknown production volumes on licensed farms and the volumepurchased under contract by Australian manufactures. Prior to2007, this showed total annual volume of chop-chop from licensedgrowers was around 540,000 kilograms in 2006 (Table 5).

This has fallen considerably since 2003 reflecting a reduction inarea under crop in Victoria, and a closer alignment betweenestimated grown volumes and output purchased under the TCVcontracts.

Table 5: Crop yield model2003 2006

Area under crop in Victoria 1,600 1,509

Multiplied by average yield perhectare

2,800 2800

Expected yield (m tn) 4,480,000 4,226,537

Less actual Co-op volume (m tn) 3,100,000 3,690,000

Implied “excess” tobacco (m tn) 1,380,000 537,000

Source: PwC

Model of consumer purchasing behaviour

This study introduces a new methodology for estimating thesize of the market based on an ACNielsen survey of thepurchasing patterns and behaviour of illegal tobacco users. Thisresearch represents the most comprehensive assessment ofchop chop consumers ever undertaken in Australia, and hasbeen obtained for the purposes of this report.

Information derived from quantified purchasing patterns of chopchop users indicates that the current maximum total marketvolume of illegal tobacco in Australia is 1.8 million kilograms(Table 6). This estimate is derived by estimating the quantity andfrequency of chop chop purchased by consumers in the survey,and extrapolating to the national smoking population. Thisvolume is equivalent to around 50% of the quantity of legallygrown tobacco in Australia as measured by the ATO for2004/05.15

15 Based on the volume of chop chop estimated by the survey compared to the quantity ofAustralian manufactured tobacco reported by the ANAO 2005/06.


Table 6: Consumption modelUnit Detail Size

Quantity of chop chop purchased per occasion (g) [1] 365

Frequency of chop chop purchase per annum [2] 9

Per chopchop user

Quantity of chop chop purchased per annum (g) [3] 3,300

Number chop chop users in Australia (‘000) [4] 555

No. tobacco users in Australia (‘000) [5] 3,500

Chop chop users as % of Australian tobacco users [6] 16%

Quantity of chop chop used in Australia (‘000 kg) [7] 1,827

NOTES:[1] Based on ACNielsen survey data: weighted average of grams purchased per number ofpurchasees, providing an estimate of 377 grams of loose chop chop or 175 sticks purchased onaverage per occasion, weighted to reflect composition of loose versus sticks purchased in thesurvey sample.[2] Based on ACNielsen survey data on weighted average frequency of purchases (frequency ofpurchase weighted by number of purchasees)[3] Based on [1] & [2] combined to an annual quantity[4] Based on extrapolating [5] to [6][5] ABS 2004/05 estimated tobacco smoking population (ABS 2006 cat no: 4831.0.55.001)[6] Based on ACNielsen survey result of 16% of tobacco users smoking chop chop[7] Based on [3] and [4]

Illegal smuggled tobacco

Tobacco smuggling involves the illegal transportation,distribution and sale of large consignments of cigarettes andother tobacco products, generally avoiding all taxes. In 2004/05,the Australian Customs Service (ACS) made 17 separateseizures of tobacco products in sea cargo, comprising almost10 tonnes of tobacco and more than 21 million cigarettes. Thecurrent approach to container profiling and inspection issummarised in Appendix A.

Customs sea container examinations and tobacco seizures

In 2005/06 Australian ports handled approximately 2 millioncontainers of which approximately 100,880 or (5 per cent) weretargeted for inspection.16 Table 7 shows the number ofcontainers targeted for inspection by the ACS and details ofillegally smuggled tobacco seizures over the period 2001/02 –2005/06.

Between 2001/02 and 2005/06 some 327,514 containers wereinspected by ACS officers and 1 in every 4,983 containersinspected by the ACS contained illegal tobacco. Theseinspections resulted in 84 illegal (disclosed) tobacco seizuresyielding some 315,000 kg of tobacco.17

16 ACS Annual Report 2005/0617 This figure contains both loose tobacco leaf and cigarette sticks. Cigarette sticks have beenconverted to a kilogram volume according to the conversion rate of 1 cigarette stick equals0.77 grams.


Table 7: ACS sea container inspections and tobacco seizures

2001/02 2002/03 2003/04 2004/05 2005/06

Targeted container inspections 11,000 25,500 80,600 100,880 120,00018

Actual container inspections19

10,285 23,843 72,937 105,110 115,340

Tobacco seizures 17 12 17 26 12

Ratio of seizures to inspections 1:4,983 1:1,987 1:4,290 1:4,043 1:9,612

Volume of tobacco (kg) 59,330 46,765 17,965 148,693 41,946

Each of these seizures collected an average of approximately3.75 tonnes of tobacco, equivalent to over $850,000 in avoidedtax and excise per container, or a total of $70 million in avoidedtax and excise.

Size of the smuggled tobacco market

The size of the smuggled tobacco market can be estimated byexamining the quantities of tobacco discovered in randominspections, assessing the probability of illegal tobaccodiscoveries as the number of inspections increases, andextrapolating to wider container imports.

The rate of discoveries of illegal tobacco will be affected by theACS’s risk profiling and inspection arrangements in targetingcontainers deemed to be at a high risk of containing illegallyimported cargo. The channelling of resources to ‘high risk’containers means that we should expect the number of illegaldiscoveries to decline as the number of inspected containersincreases.

The total size of the illegally smuggled tobacco market has beenestimated by applying the average volumes of tobacco seized ineach of the past five years to the proportion of total containersestimated to conceal illegal tobacco in each year, making anallowance for the declining rate of discoveries. The modelassumes that the current ACS risk profiling and targetingarrangements approximate a level at which outputs (seizures) aremaximised for the given level of inputs (inspection resources).

18 This figure has been calculated as approximately 6% (average of target figures of 5% and 7%given by the ACS in previous years) of total sea consignments.19 The ACS reports TEU (Twenty-foot Equivalent Unit) inspections in its Annual Reports. Aconversion rate of 1 TEU is approximately 0.75 containers has been applied to calculate theequivalent number of container inspections.


The size of the illegally smuggled tobacco market is estimatedto be 134,000 kilograms in 2005/06, with approximately655,000 kilograms illegally imported between 2001/02 and2005/06 (see Table 8). This is consistent with other researchthat has estimated that smuggled tobacco comprises around10per cent of the chop-chop market.20

The sharp rise in illegally imported tobacco between 2003/04and 2005/06 likely reflects a shift in demand for illegallyimported product following the cessation of tobacco growing inNorth Queensland in 2003.

Table 8 Illegally smuggled tobacco market size estimate

2001/02 2002/03 2003/04 2004/05 2005/06

Total sea containers(1) 1,380,000 1,580,000 1,720,000 1,800,000 2,000,000

Sea container inspections (2) 10,285 23,843 72,937 105,110 115,340

Illegal tobacco seizures (3) 17 12 17 26 12

Vol. of tobacco seized (kg) (4) 59,330 46,765 17,965 148,693 41,946

Average vol. of tobacco seized perseizure (kg) 3,490 3,897 1,057 5,719 3,496

Est. total containers concealingillegal tobacco (5) 36 37 37 38 38

Est. additional containers concealingillegal tobacco (6) 19 25 20 12 26

Est. additional volume of illegallyimported tobacco (kg) (7) 64,620 95,723 21,367 66,175 92,233

Total volume of tobacco - actual &estimated (kg)

123,950 142,488 39,332 214,868 134,179

Total volume of tobacco – actual &estimated (millions of sticks) (8)

177.07 203.55 56.19 306.95 191.68

Total value of tax and excise(A$m) (9)

$28.14 $32.34 $8.93 $48.78 $30.46

(1-4) Data sourced from ACS Annual Reports

(5) Estimated along the inspection/seizure relationship curve by plotting the number of containers estimated to conceal illegal tobacco for

the total number of containers in each year.

(6) Calculated by deducting the actual number of containers concealing illegally smuggled tobacco in each year from the total estimated

number of containers concealing illegally smuggled tobacco

(7) Calculated by multiplying the estimated number of additional containers concealing illegally smuggled tobacco by the average volume

of tobacco seizures in each year.

(8) Calculated by dividing the total volume (actual and estimated) of illegally smuggled tobacco by 0.7 grams.

(9) Calculated by multiplying the total kg (actual and estimated) of illegally smuggled tobacco by $227.

20 “Chop-Chop: The Illegal Cigarette Market in Australia”, Geis, 2002, pp. 10-11


Only 315,000 kg or 48 per cent of this amount was seized by theACS over 4 year period. With only half detected, this amounts to$77 million in lost and undetected tax and excise. It is estimatedthat more than 134,000 kilograms of illegal tobacco was smuggledinto the country in 2005/06 alone, representing a value of over $30million in tax and excise. With only 30 per cent seized by the ACS,uncaptured taxes total over $20 million in 2005/06.

Increased risks of smuggled tobacco

Imported chop chop remains a ready substitute for domesticallygrown chop chop, and tobacco smuggling is predicted tobecome a more serious issue over the medium term.

Any diversion in supply towards illegal imports poses high risksto the community due to its links with organised crime andexpected associations with terrorist groups.21

Imports of illegal tobacco are often large in scale. Forinstance, in November 2004, customs foiled asophisticated attempt to import 9 tonnes of loose tobaccofrom the Philippines in a seizure at Port Melbourne.22

Another 4.3 million cigarettes were seized in April 2004 thatwas consigned from Malaysia.

The potential to avoid high proportions of excise with lowerrisks than drug trafficking creates substantial profit marginswhich attracts the interest of organised crime both inAustralia and overseas.

This highlights the need to reinvigorate the focus on reducingthe size of the illegal tobacco market in Australia.

Impacts of illegal tobacco use

Foregone government revenue

The tobacco industry is a dynamic industry that represents alarge source of taxation revenues. Tobacco sales represent thesecond largest single source of excise revenue for theAustralian Government.

The cost to Government of illegal tobacco trade is substantial,with estimates of foregone revenue ranging from conservativeATO reports of around $100 to $450 million. Previous estimatesby PricewaterhouseCoopers (2005) estimated that in 2003 the

21 United States General Accounting Office, ‘Terrorist Financing: US Agencies Should Systematically

Assess Terrorists Use of Alternative Financing Mechanisms’, Report to Congressional Requesters

GAO-04-163 (November 2003), available online at http://www.gao.gov/new.items/d04163.pdf.

22 Customs Media Release 10 Nov. 2004, “Technology helps foil massive tobacco smuggling attempt”.

Tax revenue lossespersist as reducing legalproduction only targetsone source of illegalsupply


trade in illegal tobacco accounted for between $382 and $450in lost taxation revenue. The extent of lost taxation revenuedepends entirely on the quantity of illegal tobacco trade andhence the range in estimates reflects differences in estimatedvolumes.

The problem of lost taxation revenue becomes even moresignificant as tobacco excise becomes a greater proportion oftotal excise, which as shown in Table 9 has grown from 11.8%in 1999/00 to 24.3% in 2005/06.

Table 9: Trend growth in tobacco excise

Year Tobacco excise

collected ($m)

Tobacco excise

as a % of total

excise

% change

1999-2000 1,659 11.8%

2000-01 4,637 24.4% 179.51%

2001-02 4,841 24.7% 4.40%

2002-03 5,212 25.1% 7.66%

2003-04 5,240 24.9% 0.54%

2004-05 5,293 24.1% 1.01%

2005-06 5,290 24.3% -0.06%

2006-07 5,370 23.6%. 1.51%

2007-08(f) 5,390 23.5% 0.37%

While some tax revenue foregone will have fallen as a result ofthe cessation of licensed tobacco production, without furthermeasures any reduction will be short lived due to: the continued importation of illegal product; the substitutability of domestically produced illegal product

for (a greater volume of) illegal imports; and the continued profitability of illegal domestic production and

the likelihood that only illegal production will continue.

Risks to public health

Another major cost of illegal tobacco use is the negative impactof chop chop use on public health. The Department of Health

Chop chop posesunacceptable risks topublic health


and Ageing highlights that illegal tobacco grown in Australiapresents serious additional health risks to those of legaltobacco.23 This is due to the fact that illegal tobacco typicallycontains a number of contaminants and is not subject to qualitycontrol. Further, illegal tobacco does not display healthwarnings as is the case with legal tobacco.

Chop-chop is frequently cut with straw or dampened to increaseits weight. This practice can increase the prevalence of mouldspores which could enter the lungs, and also increases thepresence of fungal contamination. Indeed illegal tobacco is oftenwet, sometimes to the extent that excess water has to be pouredoff. Twigs and pulp from raw cotton, hay, cabbage leaves andgrass clippings are some of the vegetable matter that may beadded to illegal tobacco in order to bulk up the weight for sale.24

Some products are also fumigated with chlorine bleach, meaningusers are at risk of inhaling chlorine gas.25

The illnesses caused by these fungal agents range from allergicreactions, chronic bronchitis, asthma, asperillosis, alveolitis,pneumonitis and lung cancer to Legionnaire’s disease.26

Support for organised crime and terrorist associations

The illegal tobacco trade poses significant costs to thecommunity as a result of its links to organised crime. The ATOsuggests that the illegal tobacco market is organised byindividuals actively involved in other forms of criminality such asdrugs, money laundering, identity fraud and car rebirthing. Thistype of highly organised involvement in the illegal tobacco marketis also believed to have intensified over the past three years.

A contributing factor is the growth in ‘vertical integration’ bycriminal groups having an associate obtain a licence to growtobacco. The ANAO suggest that the chop-chop supply chain isbecoming more sophisticated and involves crime syndicates andother criminal organisations.27 The application of pressure byorganised crime has also been cited by the ANAO as one of thefactors influencing greater illegal trade in tobacco products.

23 Department of Health and Aging Website 2007, “Fact Sheet: The facts about ‘chop-chop’ tobacco”,

http://www.health.gov.au

24 ANAO 2006, p. 17

25 Smoking Research Unit, Department of Psychological Medicine, University of Sydney NSW 2003

26 ANAO 2006, p. 17.

27 The ANAO confirmed that Commonwealth law enforcement authorities have evidence to link

organised crime groups to the trade in chop-chop. (ANAO 2002, 1.31).

Links to organisedcrime worsen socialimpacts of illegaltobacco trade


The ANAO notes that organised crime groups involved in themanufacture and sale of chop-chop have sophisticateddistribution networks which use trucking firms and long haulcoaches to transport the illegal product.28 Hire vehicles are alsoa preferred means of transporting illegal tobacco. The nature ofthe criminal activities identified by the ATO included thepresence of “…criminal activities involving cash-basedtransactions, with sophisticated tobacco sourcing,transportation and distribution.” 29

Evidence from the United States of America suggests that thelucrative illegal tobacco market has also begun to rival drugtrafficking as a relatively lower risk funding source for terroristgroups.

Drivers of supply and demand

There are several characteristics of tobacco products that makethem susceptible to illegal production and distribution. Forinstance, legal tobacco products: are highly taxed – providing generous margins to illegal

dealers, especially as taxes on cigarettes account foraround 70% of the total cost of cigarettes in Australia;

are relatively easy to distribute – a shipping container cancarry 10 million cigarettes and a B-double truck can carryup to 14 million cigarettes; and

are susceptible to counterfeit, with counterfeit cigaretteproducts dominating illegal sales in many countries aroundthe world.

Financial incentives drive illegal tobacco supply

Tobacco growers have a very clear financial incentive to supplyillegal tobacco, given the ability to circumvent tobacco exciseand GST, which account for up to 70% of the cost of acigarette. Without tax or excise, producers are able to sell illegaltobacco at a price premium and still supply a product to themarket that is around 65% cheaper than legal brandedcigarettes. Best estimates are that producers receive up to$10,000 per 100 kg bale on the black market compared toapproximately $700 per 100 kg bale which is payed by tobaccomanufacturers.

Penalty arrangements apply for supplying illegal tobacco, whichreduces the payoff for illegal supply, but only if implemented ina way that discourages illegal trade. Under criminal law,

28 ANAO 2002, 3.64.29 ANAO 2002, 3.60.

Risks that illegaltobacco is also fundingterrorist activities

Illegal producers receivemore than 10 times theprice for illegal tobaccothan legal tobacco

Detection risk too low todeter supply

High taxes maketobacco products proneto counterfeit


penalties for the importation of illegal tobacco are imprisonmentof up to 10 years and/or a fine. The maximum penalty for theimportation of illegal tobacco under civil law is a fine of up tofive times the amount of duty not paid.

Under the Excise Act, growers found to be trading illegally andcontravening their licence conditions risk losing their licenceand may be liable to pay fines of up to $55,000 and two yearsimprisonment. The Excise Act also provides for PenaltyInfringement Notices (PIN’s) for sale of tobacco on which theexcise tax has not been paid. Amendments to the Excise Actwere passed in 2004 that were designed to provide the ATOwith greater compliance and administrative powers to enforceexcise payments and vary individual licence conditions.

Despite the merits of this enforcement regime, by all accounts,the risk of detection and prosecution is low, which acts as aninadequate deterrent to illegal tobacco supply. Only 5% ofimported containers are targeted for inspection by the ACS. Ofthose containers that were inspected between 2001/02 and2005/06, only 1 in every 4,983 contained illegal tobacco. Thisshows that risk assessment processes for identifying containersfor inspection do not target illegal tobacco and discoveries arecoincidental in the search for more serious illegal goods andsubstances.30

Detection is difficult and not helped by anecdotal evidence thatup to three days notice may be given by the ATO prior to a farminspection which may provide opportunity for growers involvedin the illegal trade to conceal evidence of illegal activity.31

No cigarette tax creates price differential for consumers

The absence of taxation on illegal tobacco is a key driver ofchop chop sales, given the price differential between illegaltobacco and legal tobacco products, either tailor madecigarettes or roll your own tobacco. Illegal tobacco is sold foraround a third of the price of legal tobacco at approximately $13per 100 grams (wholesale price), compared to an average retailprice of $36 per 100 grams for branded tobacco.32

30 When illegal tobacco is found, penalties are substantial, with 7 customs prosecutions for

cigarette smuggling offences in 2001, including a 6 month jail sentence and fines of $666 000

and $266 000.Manifest: Journal of the Australian Customs Service, vol. 5, no. 1, June 2002

31 Source consultations with TCV. Geiss 2002, p 25 confirms the practice of notifying growersprior to an ATO inspection.32 ANAO 2006, p.17

Tax avoidance lowersprices to the consumer


The results of a survey of 44 consecutive patients attending theSmokers’ Clinics of the Central Sydney Area Health Servicefound that 84% of patients purchased chop-chop because ofthe price differential to legal tobacco.33 The Australian NationalAudit Office (ANAO) concurs, citing anecdotal evidence that thecost is a key motivation for illegal tobacco purchase.34

Table 10 shows that illegal tobacco in a cigarette tube costsapproximately $0.19 compared to approximately $0.27 for a legalRYO cigarette - a cost difference of $0.08 per cigarette. This isdespite the fact that tubes generally use more grams of tobaccothan RYO cigarettes, and that tubes are nearly double the priceof papers. The price difference between illegal tobacco cigarettesand tailor made cigarettes is even greater, with the cost of thelatter between $0.45 and $0.65 depending on brand.

Table 10: Cost of chop chop versus legal cigarettesCost analysis RYO

cigaretteChop-chopcigarette in atube

Assume total number of cigarettes is equal to: 40 40

Total number of grams of legal/illegal tobacco per cigarette 0.70g 1.25g

Total number of grams of legal/illegal tobacco for 40 cigarettes 28g 50g

Cost of 50g tobacco pouch ($) $18.00 $6.50

Proportionate cost of tobacco for 40 cigarettes ($) $10.08 $6.50

Cost of 50 papers/tubes ($) $ 0.80 $1.50

Proportionate cost of papers/tubes for 40 cigarettes ($) $ 0.64 $1.20

Total cost for 40 cigarettes $10.72 $7.70

Cost per cigarette $ 0.27 $0.19

33 Bittoun, R, ‘“Chop-chop" Tobacco Smoking’, Medical Journal of Australia, vol. 177, p. 686-68734 PwC 2001, “The Current Economic and Public Environment for the Australian TobaccoIndustry, p. 47


3 Characteristics of chop chop users

Until now, very little has been known about the characteristicsof chop chop users, or their purchasing patterns. Groundbreaking research commissioned by BATA and undertaken byACNielsen for this report provides the first detailed look at thechop chop smoking population. It shows that: 50% of smokers surveyed are aware of chop chop; and

16% of smokers surveyed have used or are regulator usesof chop chop.

The characteristics of chop chop users and their usage patternsare illustrated in Figures 1 to 7.

Figure 1: Level of awareness of chop chop among smokers

50 percent of smokers are aware of Chop Chop

0%

10%

20%

30%

40%

50%

60%

Aware but not purchased Purchased Chop Chop Total Awareness of Chop Chop

%o

fa

lls

mo

ke

rs

50% of smokers areaware of chop chopand 16% consume it


Figure 2: Gender of chop chop users

Most Chop Chop users are male

62%

38%

Female

Male

Figure 3: Incomes of chop chop users

Chop Chop users generally have lower incomes

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

$9,999k or less $10k - $19,999 $20k - $49,999 $50k or more

%o

fC

ho

pC

ho

pu

se

rs

All Smokers

Chop Chop Smokers

62% of chop chopusers are male

Chop chop usersgenerally havelower incomes


Figure 4: Type of chop chop products bought

Chop Chop usually purchased in loose form

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Loose Tobacco Cigarettes

%o

fil

leg

al

tob

ac

co

pu

rch

as

es

Figure 5: Average quantities of chop chop purchased

Both small and large quantities purchased per occasion

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Below 100gms 100 - 250gms 251 - 500gms Above 500gms

Quantity purchased

%o

fp

urc

ha

se

s

Chop chop isusually purchasedin loose form

Both small and largequantities arepurchased per occasion


Figure 6: Number of chop chop cigarettes smoked per day

Most Chop Chop users smoke up to 15 Chop Chop cigarettes each day

0%

10%

20%

30%

40%

50%

60%

< 5 per day 5 - 15 per day 16 - 20 per day 21 - 30 per day > 30 per day

%o

fC

ho

pC

ho

pu

se

rs

Figure 7: Type of legal tobacco also consumed

Most Chop Chop smokers also smoke cheaper cigarettes

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

Value Brands Mainstream Brands Premium Brands

%o

fC

ho

pC

ho

pu

se

rs

Similar estimates were found by the Australian Institute ofHealth and Welfare (AIHW) (2001), which found that almost onein five (19%) Australians aged 14 years and over had seenunbranded tobacco (chop-chop); over 290,000 smokersoccasionally or regularly use illegal tobacco, and in the majority ofjurisdictions, around 60 per cent of smokers and ex-smokerswho had seen unbranded tobacco had smoked it more thanonce.35

35 Australian Institute of Health and Welfare 2001, p21-22.

Most chop chop userssmoke up to 15 chopchop cigarettes eachday

Most chop chopusers also smokecheaper cigarettes


4 Additional regulatory options

There are a range of additional regulatory options foraddressing the supply and use of illegal tobacco in Australia.These can be categorised as the following.

Options that target domestic production, including banson future growing licenses and associated enforcementregimes, and additional ATO resources for aerialsurveillance for detection of illegal production.

Options that target distribution, including improvedinspection of key high risk distribution outlets.

Options that target illegal imports, including additionalcounter-smuggling initiatives aimed at detection or strongerpenalties for illegal importation, and import permits for tubeimporters.

Options that target consumer demand, including bans oran excise on cigarette tubes, penalty arrangements such asthose that apply to consumption of other illegal products, ortargeted advertising campaigns on the adverse healthimpacts of illegal tobacco use.

Options targeting illegal domestic production

Bans on future growing licences

Preventing future issues of tobacco growing licences wouldrequire legislative amendment to the Excise Act to prohibit anyfuture tobacco producer licenses to be issued. Such a movewould prevent any former or potential grower from applying forlicence even if they were able to secure a legitimate market forthe sale of their tobacco in Australia or overseas (as isconditional for production under existing arrangements).

Increased surveillance of potential growing sites

Tobacco plants have a distinctive leaf pattern and colourationwhen ready for harvest, which makes it well suited to aerialsurveillance techniques. The ATO currently has limited

Bans on future licenceissues would facilitatedetection of illegalgrowing


resources for such surveillance, which is undertaken on anoccasional basis. The ATO has reduced their on-groundpresence from 3 people to 1 person, creating a perception thatthe ATO presence in terms of farm visits has all but ceasedsince the buy-out announcement.

This option would involve improving the resourcing for suchfield officers, which offers a low cost way of having a substantialimpact on illegal detection and prosecution.

Options targeting illegal distribution

According to the 2007 ACNielsen survey of tobacco users,almost 40% of chop chop is purchased from tobacconists,which are the single largest supplier of illegal tobacco products.Around a third is then purchased from friends and familymembers, with anecdotal evidence suggesting much of this isunder-counter sales at local markets.

This option would involve resourcing the ATO to provideundercover inspectors who would enter premises suspected ofsupplying illegal tobacco to identify, and then prosecutedistributors.

Options targeting illegal imports

Additional counter smuggling initiatives

Counter smuggling initiatives to increase surveillance anddetection would directly target illegal tobacco imports. Someoptions could include: international agreements/cooperation to provide an early

warning system for high risk imports, which could bepursed through the World Trade Organisation;

improvements to current risk profiling, container scanningand physical inspection procedures;

introduction of harsher penalties regime for the importationof illegal tobacco products, which could for example, bebrought closer in line with penalties for the importation andsupply of cannabis for which there is a maximum fine for anindividual convicted of importing a trafficable quantity of

An increase in the riskof illegal importationwould reduce thevolume of illegaltobacco in Australia


cannabis of $250,000 compared to the maximum penaltyfor an individual convicted of illegally importing cigarettes offive times the amount of duty not paid; and

tighter ASIC regulations around the establishment of importbusinesses, given the view among some stakeholders thatit is too easy to set up a bogus business with an legitimateABN and use it as a vehicle for illegal importation.

Implementing this option may involve some redistribution ofresources from other areas of surveillance, or in the case oftechnical solutions such as utilisation of a device such as thevoice100, some recalibration of instruments to detect tobaccorather than some other substance.

The voice100 is able to identify trace amounts of Volatile OrganicCompounds (VOCs). Australian Customs already uses thevoice100 to detect the illegal importation of various products,with one machine installed at container inspection facilities ineach of the major Australian ports – Fremantle, Brisbane,Melbourne, Sydney and Adelaide, at a cost of approximately$400,000 plus costs for training and support, installation, andsampling equipment.

Import permits for tube importers

Cigarette tubes are blank cigarette casings that are made up ofpaper cylinders with filter rods and filters attached. Tubes areused by consumers to make finished cigarettes by inserting finecut tobacco into the tubes, usually with the aid of a smallmachine or injector. Cigarette tubes are legally imported andwidely available from tobacconists and other retailers.Anecdotal evidence suggests that blank cigarette tubes arealmost exclusively used in the consumption of chop chop.36

However not all (nor most) illegal tobacco users use tubes forconsuming chop chop.

This options involves the introduction of an import permitsystem for cigarette tubes by adding cigarette tubes to the list ofrestricted imports contained in Schedule 2 of the Customs Act.This would also require legislative change to the Customs(Prohibited Imports) Regulation 1956, which contain provisions

36 Although the availability of make your own (MYO) cigarette kits, which contain tobacco, tubesand cigarette stuff machines indicates that legal RYO could also be used in tubes. Such kits areavailable from tobacconists and online retailers see http://www.cigarettetobacco.com/

Tube importers could berequired to obtain apermit and comply withits conditions in atransparent way


that require permits for the importation of certain products.Regulation 4 provides that certain goods cannot be importedinto Australia unless permission has been granted by theMinister or an authorised person.

To avoid unnecessarily restricting imports of cigarette tubesgenuinely required for the legal sale of cigarettes, conditionscould be attached to the permit to only allow importers withdocumentation of product orders from customers to importtubes. Hence those supplying to the black market would not begranted a permit.

Options targeting consumer demand

Bans on cigarette tubes

This option would involve a ban on the importation, distributionand sale of imported hollow cigarette tubes in Australia. Theaim of the ban would be to make illegal tobacco use lessdesirable for consumers that prefer tubes rather than papers forconsuming tobacco. A ban on tubes is expected to generatesome switch in tobacco use from illegal to legal products, andsome substitution out of the tobacco market for thoseconsumers that are not willing to pay for (only) brandedcigarettes.

Such a ban would require legislative amendment to Section 50of the Customs Act, which enables the Governor-General toprohibit the importation of goods into Australia. The specificgoods subject to importation restrictions are contained inCustoms (Prohibited Imports) Regulation 1956.

A compliance monitoring and penalty regime would also berequired for importers, distributors and retailers of cigarettetubes. Given tobacco tubes are all imported, the AustralianCustoms Service (ACS) would be the most likely administratorof the ban with support from police.

This option is similar to recent changes in State basedlegislation targeting ‘ice pipes’ in response to the growing use ofcrystal methamphetamine.37 It is believed that up to 80 per cent

37 The Australian Capital Territory, Northern Territory and Tasmania have not imposed suchlegislation.

Bans on hollowcigarette tubes wouldreduce the availability oftubes often used forillegal tobacco use


of ice users use a pipe, and the ban makes it illegal in mostStates to display or sell any device capable of being used foradministering ice.

Equalisation tax on cigarette tubes

This option involves the imposition of an equalisation tax oncigarette tubes to make the cost of a tube filled with illegaltobacco more comparable to that of tubes or papers filled withlegal tobacco.

To prevent the tax being incurred by legal tobacco providersand consumers of legal loose tobacco used in tubes, legaladvice has suggested it would best be implemented using aCigarette Tube (CT) tax based on a goods a services tax styleindirect tax model.38 Under this model, legitimate entities wouldbe entitled to input tax credits, and illegal users would incur thetax without any credit eligibility.

The rate of tax would be set to eliminate the discrepancybetween the tax paid on tobacco products consumed in thelegal and illegal supply chains.

Legal advice on the operation of such a model hasrecommended a hybrid approach based on the upstreamcomponents of the GST model and sales tax concepts. Allentities would be required to account for output tax on cigarettetube sales (the CT tax) which is offset by credits where thetubes are acquired for a creditable purpose (CT input tax).Credits for CT input tax would only be available to importersregistered for GST or manufacturers licensed for excise. Allother purchasers would not be entitled to the CT input tax andwould bear the full CT tax cost in the purchased goods.39

38 Baker and McKenzie 5 April 2007 Re: Tax Equalisation Model for Cigarette Tubes.39 Note that PwC has sought further clarification on the arrangements proposed by Baker andMcKenzie in the draft advice to BATA of 5 April. This option is therefore considered at theconceptual level.

An equalisation tax ontubes could removeprice disparity betweenlegal and illegalproducts


Government advertising campaigns on adversehealth impacts of chop chop use

This option involves informing current and potential users ofillegal tobacco of the increased health and other risksassociated with the use of unregulated tobacco producedwithout any quality control. This could involve targetedadvertising campaigns and other such methods.

This option was raised by the ANAO which suggested that theATO engage with the Department of Health and Ageing toexamine opportunities to better inform current and potentialconsumers of illegal tobacco of the serious health risksassociated with consuming illegal tobacco.

Despite the heightened health risks, results from a study by theAustralian Research Group confirm the perception of illegaltobacco as somehow more healthy, as shown by the followingexcerpts.

“I think with that stuff doesn’t it do less harm, what they call it chopchop…straight from the farm isn’t it…that’s right you wouldn’t have thechemicals in it”

“It is probably better…probably less chemicals in them”

“I don’t think it has all the chemicals in it, like they put in the tailormade”

“I would say it has a lot less chemicals in it than the cigarettes you buyfrom the shops”

“Its tobacco, but it hasn’t got all the chemicals in it. But it is illegalbecause the government is not making any money”

“It's just a normal tobacco, it's got no chemicals in it, or other rubbish…but it's illegal because the government can’t make any money out of it.That is the only reason its illegal”.

40

40 Australian Research Group, ‘Participant comments surrounding fake tobacco and ‘chop chop’,

May 2007, unpublished.

Bibliography 37

5 Assessment of regulatory options

The effectiveness of various regulatory options depends ontheir ability to target incentives to supply and to use illegaltobacco products, and the ability and willingness of consumersto substitute one type of illegal tobacco for another.

Each of the regulatory options has been subject to net benefitassessment of regulation based on their assessed impact on:

the volume of domestically grown chop chop; smuggled volume of illegal tobacco; the risk adjusted profitability of illegal tobacco supply; the price differential between legal and illegal tobacco; the availability of illegal tobacco products; tax revenue capture for government; and enforcement of packaging controls for tobacco products.

Options are also assessed in terms of appropriateness andefficiency, and the alignment of the severity of restrictions withthe scale and scope of illegal tobacco activity. This includesconsideration of the complexity and ease of implementationrelative to the benefits.

Base case: Large reduction in legal tobaccosupply due to TCV buy-out

The shut down of legal tobacco growing operations in Victoriawill have a positive impact on reducing the supply of chop chop,given the likelihood that some legitimate producers have beendiverting output for sale on the black market. By effectivelymaking production illegal, it also has a positive impact onreducing the risk adjusted profitability of illegal tobacco supply.

However, it does not on its own curb illegal tobacco supply. It hasno impact on the production of chop chop by unlicensed (illegal)growers, and it is known that many tobacco seeds remain in thehands of growers. Evidence from within the industry also suggeststhat growers have stockpiled tobacco from the last harvest, whichcan be used to supply the black market for the next several years.The buy-out also has no impact on the substitutability of chopchop for other forms of imported illegal tobacco.

Options are assessedon ability to reduceincentives to supply orpurchase illegalproducts

Without additionalintervention, illegaltobacco supply willcontinue to grow at itscurrent rate

Bibliography 38

Moreover, the Tobacco Growers Adjustment AssistancePackage (TGAAP) arrangements which determine theconditionality of the buy-out stipulate that:

tobacco growers are not required to surrender their licenceto the ATO. The arrangements are based on therequirement to exit the tobacco growing industry and sellthe farm (or use the land for a non-agricultural purpose) fora minimum period of five years;

payments are conditional on growers exiting the tobaccoindustry for only 5 years, and growers are not preventedfrom re-applying after that period;

because payments are linked to individual growinglicences, growers are not prevented from accessingTGAAP then re-applying for a growing licence as aseparate collective entity.41

Stakeholders generally agree that there is a continued risk ofillegal tobacco growing and an increase in demand for otherforms of illegal tobacco.

Some reduction in illegal imports from the buy-out could bepossible if the resources of the ATO were reallocated frommonitoring tobacco growing licenses to more effective detectionand prosecution of offences related to smuggled and importedchop chop. However, without any formal change to theregulation of imported goods, these benefits are likely to benegated by the substitution in demand from domestic chopchop to imported or smuggled illegal products.

Overall, the impact of the TCV buy out is expected to providelow order benefits in terms of the reduction in illegal tobaccosupply. The TCV buy-out reflects the reorientation ofmanufacturers to overseas sources of supply. It is not atargeted measure for reducing chop chop supply. It is hopedthat some supply impacts will be felt, but the impact on anytransfer to legal tobacco products is not likely to be substantialenough to recapture lost taxation revenue.

If chop chop supply was to reduce in line with the reduction indomestically grown tobacco, chop chop prices would increase,reducing its attractiveness to consumers. However, the scopefor continued substitution to illegal imports reduces these priceimpacts and other sources of domestic supply are expected tocontinue. Any price impacts would be temporary.

41 Australian Taxation Office, Tobacco Restructuring Grants - fact sheet 16 March 2007

Negligible impacts onreduced availability anddemand

Bibliography 39

Bans on future growing licences

Banning future growing licences of Australian growers wouldeliminate any conjecture over the current and future status ofgrowing licences. This option would enable the Government tocommunicate a clear and unambiguous message to formergrowers and the broader community that tobacco growinglicences will not be renewed. This would simplify theprosecution of people found to have produced tobacco seed,plant or leaf.

Because any additional growing would be illegal, any cropswould need to be concealed to avoid scrutiny (a disincentive forgrowers) and risks of discovery would be greater because alladditional production would be contra banned. Hence, thisoption would also target current growing from unlicensedgrowers, because surveillance measures would need to coverall possible growth areas, not just those associated withformerly licensed farms.

While monitoring and compliance activities by the ATO andother relevant authorities would need to be increased,prosecutions of anyone growing tobacco would be simplified.

As with the base case, this option also has no discernibleimpacts on supply of illegal imports.

Commensurate with the greater risks of detection for growersand associated reduction in domestic chop chop supply, theprice of chop chop would rise. This would further suppressdemand, although substitutability for imported illegal tobaccoremains a problem.

To the extent that demand for illegal tobacco is diverted to legalproducts, the market share of legal suppliers would increase,and with it, all associated tax revenue capture. The ban onfuture growing licences would particularly target potential illegalsupply from formerly licensed growers. Illegal supply from thesegrowers prior to 2007 was estimated at approximately $180million. In the absence of a ban, there remains a risk that someof this volume will resurface. Preventing the re-emergence ofjust 5% of this value would broadly generate $10 million inrecaptured tax revenue.

Reduction in domesticsupply due to greaterprobability of detection

Positive impact ondepressing demand forillegal tobacco

Tax revenue capturewould rise, with gains ofaround $9 millionestimated

Growers never beforelicensed would also betargeted

Bibliography 40

Success in regaining this tax take depends on the success ofmonitoring and compliance initiatives, the implementation ofother measures to target imported sources of supply (to avoidsubstitution), and the willingness of consumers to substitutechop chop for legal tobacco. The inspection program envisagedfor this function is estimated to cost $3.6 million.

Ease of implementation

This approach is administratively complex and costly. A blanketban on future licences is not permissible under existinglegislative arrangements, and changes to the Excise Act wouldbe required. Currently, the ATO only has the power to refuse togrant a licence on certain grounds, such as where it isconsidered that the applicant is not a ‘fit and proper person’based on the results of a criminal background check. Undercertain circumstances the ATO can add further conditions to alicence or it can suspend or cancel a licence, although theconditions for cancellation are based on certain criteria outlinedin the legislation and are done on a case by case basis.

Future licence bans would constitute a regulated barrier tomarket entry, which under COAG guidelines would require netcommunity benefit to be demonstrated above and beyond anyalternatives to achieving the objectives of the ban. To meet thistest, monitoring and compliance support would need to besufficient to capture more growers than those subject to existingTGAAP arrangements.


Improving ATO resourcing for aerial surveillance offers a lowcost way of identifying illegal producers and would offersubstantial payoffs in terms of deterring illegal growing. Tomaximise the probability of discovery, surveillance efforts mayneed to be mapped to land areas with ample water suppliesand be frequent enough to coincide with the growing cycle oftobacco when detection is more likely.

In the current regulatory environment in which legal growinghas been phased out, the utilisation of field offices in this waywould be particularly fruitful. The benefits in terms of reducedsupply would be increased if these measures wereaccompanied with a ban on future growing licences.

Aerial surveillanceprovides a low cost wayof deterring illegalgrowing

Legislative changewould be required

Bibliography 41

Any and all impacts on reduced chop chop supply would feedinto higher prices to consumers and also help dampen demandfor illegal product. Any resultant transfer of demand to legalproducts brings with it added benefits of tax revenue captureand ensuring consumed tobacco products meet appropriatestandards.

The benefits of aerial surveillance in terms of tax revenuerecapture depend on the underlying permissions for tobaccogrowth. They are maximised in the environment where nogrowing is allowed (ie a ban on future growing licences). Withan estimated $415 million worth of illegal tobacco grown inAustralia, detection of 10% should be achievable with moreeffective surveillance.


Implementation would be straightforward and simple. The ATOhas historically undertaken aerial surveillance so all administrativeprotocols would already be satisfied. A DASH 8 would need to behired, with an estimated 1400 hours of surveillance required perannum at a total cost of around $8 million.

Random inspections of tobacco distributors

According to the ACNielsen survey of chop chop users, 65% ofusers source their chop chop from a single supplier. Thisindicates that shutting down key distribution points has clearpotential to reduce the circulation of chop chop.

Undertaking random inspections of known distribution outletsfor illegal tobacco is another low cost strategy for targetingillegal supply. The actual and potential threat of discovery andassociated penalties would help shut down key distributionchannels for illegal tobacco, which according to ACNielsen(2007) include tobacconists and friends and family (knownanecdotally to include markets and public bars, which togethercomprise over 70% of reported illegal tobacco suppliers.

Addressing the supply problem at the point of distribution alsooffers the promise of addressing all sources of supplyconcurrently (imported and domestic), which no other regulatoryoption provides.

Demand would betempered as reducedsupply feeds through tohigher prices

Tax revenue gains of$40 million should beachievable

Unique measure totarget supply ofdomestic and importedillegal tobaccoconcurrently

Bibliography 42

Reductions in supply and more severe risks for distributorswould both result in an increase in prices paid by consumers,and if distribution outlets are closed down, availability of illegaltobacco is also targeted.

Attacking both facets of demand drivers would have a verypositive impact on diversion of trade to the legal tobaccomarket, resulting in substantial revenue capture for legalmanufacturers and tax revenue capture for government.Implementation issues should be negligible, particularly ifoutlets are selected on a random basis, offering a cost effectivemethod for addressing the problems of chop chop trade.

The value of this option depends on how extensive the randominspections are, how well publicised, the severity of thepenalties imposed on any breaches, and the substitutepossibilities to other suppliers. Initially, random inspectionsshould be of high risk distribution outlets, including tobacconistsand suspected sources of supply from ‘friends’ such as marketstalls. If implemented effectively, up to 10% of chop chop salesshould be preventable (around $45 million).


Implementation would be simple and straightforward. Somerecruitment and training would be required for randominspectors. Quarterly inspections for 700 outlets (tobacconistsand suspected market stalls) is likely to be required, at anestimated cost of $0.7m pa. The program could be rolled out toother distributors if required.

Additional counter smuggling initiatives

The effectiveness of greater detection (actual or potential) ofillegal tobacco imports on total illegal supply depends on themarket share of imports in the black market for tobacco.Currently it is expected that the primary source of supply ofillegal tobacco products is domestically grown chop chop, whichis supplemented by illegally imported or smuggled unbrandedtobacco. However, in the current environment where domesticchop chop supply is likely to be reduced, illegal imports presenta growing risk to the problems associated with illegal tobaccotrade.

Minor (but potentiallygrowing) impact onillegal tobacco supply

Targeting distributionreduces chop chopavailability

Around $45 million intax revenue could berecaptured

Bibliography 43

Any increase in detection and surveillance effort would have adirect impact on smuggled illegal imported tobacco, both as aresult of withdrawal of discovered product from the market andthe added deterrent to supply. The size of the illegally smuggledtobacco market is currently estimated at 134,000 kilos in2005/06, representing steady grow in smuggled tobaccoproducts over the past several years.

The emphasis of additional counter smuggling initiatives is ondetection rather than penalties, given that existing penalties arelikely to be appropriate to penalise illegal imports of this kind,with comparable maximum imprisonment terms with cannabistrafficking. However, consideration could be given to strongerfines, which are currently linked to tax revenue foregone ratherthan a high ceiling amount.

There is no tangible evidence of consumers’ awareness of theorigin of illegal tobacco, particularly loose leaf tobacco such aschop chop. However, in an environment of potentially fallingdomestic supply, any impact on curbing illegal tobacco importswould positively affect the price differential between legal andillegal tobacco products and help curb demand. If anti-smuggling initiatives successfully reduce price disparities,consumers will shift to legal tobacco use or reduce tobaccoconsumption.

The value of this option again depends on the simultaneousadoption of domestic measures. Currently around $44 million inlost excise is attributable to illegal imports. Recapturing around30% of this should be achievable if more resources wereapplied to assessing illegal tobacco, versus other risks. Thiswould provide revenue gains of around $15 million.


Ease of implementation depends on the types of countersmuggling initiatives adopted. If changes to current riskassessment procedures were adopted and/or ACS resourceswere reallocated from other areas, implementation issues wouldbe more complex. The expected required size of the illegaltobacco customs fleet along with associated training isestimated to cost around $2.2 million per annum.

Significant benefits interms of reducingdemand for part ofmarket supplied viaimports

Around $13 millionshould be recoverable

Bibliography 44

Ban on cigarette tubes

The effectiveness of a ban on tubes as a deterrent for chopchop supply is likely to be indirect. That is, it will depend on thebehaviour of consumers, including the number of consumerswho prefer to use tubes to smoke illegal tobacco, and those thatwould cease or reduce their consumption of illegal products iftubes were not available or were more difficult to acquire.

Survey evidence suggests that awareness and usage of chopchop is most significant amongst RYO users, and chop chop ismostly used with RYO paper. This means that the impact of atube ban would have a positive but minor impact on reducingillegal tobacco demand (and thereby supply).

A ban on tubes would generate some switch in tobacco usefrom illegal to legal products, and some substitution out of thetobacco market for those consumers that are not willing to payfor (only) branded cigarettes.

Would it work? There have been mixed results in introducingbans on illicit drug paraphernalia due to the ability of somedevices to be used with legal products (e.g. bongs and normaland flavoured tobacco) and because some paraphernalia iscomprised of everyday items (e.g. cocaine kits).42 Queenslandand Western Australia have successfully made the sale ofbongs illegal, while Victoria has banned the sale of cocaine kits.

The tubes ban would affect availability (for consumers whoprefer tubes) but not price, hence targeting only one driver ofdemand. Potential tax revenue recapture benefits would reflectthis. Up for grabs is potentially $100 million, which is the totaltax loss for the proportion of consumers that are currently usingtubes. Given substitute possibilities, this option might recapturearound 10% of this amount, or $10 million.


From an implementation perspective, a ban on cigarette tubeswould require amendment to legislation and supportingregulations at the state (prohibiting sales) and federal(prohibiting imports) level. This would make the processcomplex and potentially lengthy.

42 Settelmaier, D. 2006, eMU Online News, “Chrystal Clear but Coke Kits “Vague”, April 18,2006.

Ban on tubes is a highcost, but effective wayof addressing onecomponent of the illegaltobacco problem

Ban on tubes will targetillegal use by a quarterof chop chop users

Tubes ban couldrecapture around $10million in lost taxes

Bibliography 45

A ban on hollow tubes would require the amendment of Section50 of the Customs Act to enable the Governor-General toprohibit, by regulation, the importation of goods into Australia.This prohibition could be absolute, applied in specificcircumstances, or unless specific conditions are complied with.Items that are subject to import restrictions in Schedule 2 of theCustoms (Prohibited Imports) Regulations 1956 includes thosein the category “chemicals and drugs”. In order to implement aban on the importation of tubes, the Minister for Customs andJustice would need to enact an amendment of the Customs(Prohibited Imports) Regulations 1956.43

The current list of goods in Schedule 2 carry risks in terms ofpublic and product safety. This does not preclude the inclusionof cigarette tubes, however, the lack of fit between illegaltobacco and goods currently listed under Schedule 2 of theCustoms (Prohibited Imports) Regulations 1956 may make itdifficult to convince the Governor-General and CommonwealthMinister for Customs and Justice to prohibit the importation ofcigarette tubes.

In addition to the ban, it would also be necessary to amendrelevant state and territory legislation to make it illegal to sell ordisplay cigarette tubes. The following pieces of specific statelegislation were amended to make the sale and display of icepipes illegal, and may be relevant to make the sale of cigarettetubes illegal: Tobacco and Other Smoking Products Act 1998

(Queensland);

Drug Misuse and Trafficking Act 1985 (New South Wales);

Drugs, Poisons and Controlled Substances Act 1981(Victoria);

Misuse of Drugs Act 1981 (Western Australia).

To achieve full coverage, the ban would require consensusamongst the state and territory governments given thatinconsistencies and different approaches would undermineoverall effectiveness. The lobbying which would be required toachieve such a consensus would be likely to prolong theimplementation process.

Achieving national consensus would be difficult. As seen withthe ban of the sale of ice pipes, it was not possible to get

43Specific provisions might be required if manufacturers imported tubes for legitimate

production purposes.

Bibliography 46

nationwide consensus despite the fact that ice pipes are notused for any purpose other than to use an illegal anddangerous drug. Similarly, bongs which are predominantlyused to smoke cannabis are only prohibited in two states.There is likely to be even stronger resistance to banning aproduct that is used for what is essentially a legal drug, albeitprovided in a way that contravenes tobacco regulations.

The ban would also disadvantage legal users of cigarette tubes,which are contained in legal RYO kits along with tobacco and astuffing device. It is understood that RYO tobacco is reportedlytoo moist for use in tubes. However, it is possible that someusers dry out the tobacco first in order to use tubes. Retailersand distributors of tobacco products, particularly internet storesthat sell RYO kits, will oppose any regulations to ban or limit thesales of tubes. Manufacturers are likely to support the ban tothe extent that their current and potential future importation oftubes is not impacted.

Estimated cost of banning tubes is $1.6 million, which includesestimated staff costs for developing regulatory amendmentsand ongoing inspection and enforcement of the ban atdistribution outlets.

Import permits for hollow cigarette tubes

Import permits for hollow cigarette tubes would be effective inimproving intelligence gathering and monitoring of cigarettetubes. Improved monitoring of imported tobacco products wouldmake it more difficult to divert tubes to the black market that arenot used in legal production or to consume legal tobacco. It isalso possible that awareness among tobacconists,supermarkets and other retailers that the government knowsthey are selling cigarette tubes will make them less likely to takethe risk of selling illegal tobacco.

It may be necessary to engage with importers and distributorsto ensure that they are aware of the new regulatoryrequirements to ensure their awareness and compliance.Where importers / distributors are not aware of the newregulations, the effectiveness of this option will be limited.

As with the tube ban, import permits would not affect the pricedifferential between illegal and legal tobacco products, but they

Positive, but smallimpact on reducingillegal tobacco supplyand use

Bibliography 47

would affect demand for the proportion of the population thatuses tubes to consume chop chop if the regime wassuccessfully implemented.

Import permits would impose costs on cigarette tube importers,and while confidentiality arrangements preclude ACS fromrevealing the number of tube importers in Australia, they areexpected to be few in number. The costs to importers wouldrelate to the burden of applying and complying with the importpermit requirements.

Depending on sourcing arrangements, manufacturers would faceadditional compliance activities and costs to obtain import permits.Tobacconists and retailers may also resist the proposal due to theincrease in regulations that they must comply with and decreasein product offering and profits. While compliance costs depend onthe administration regime, they are expected to be minimal.

Import permits would be a relatively low cost way of obtainingadditional information and intelligence with associated revenueprotection benefits. There are also additional synergies withimproving the effectiveness of existing regulatory interventionsaimed at detecting and preventing trade in illegal tobacco.

The tax recapture opportunities are valued as some proportionof the $100 million currently lost due to illegal tobaccoconsumption via tubes. The intervention is less heavy handedthat the ban on tubes, although it is unlikely to be quite aseffective in ensuring tubes are not used for illegal tobaccoconsumption. The potential revenue gains are estimated to bein the order of $5 million.


Implementation should be simple and straightforward. Theprocess for including tubes in the import permit regime inregulations under the Customs Act is straightforward, andnumerous amendments are made to the regulations each year(up to 7 per year).

This indicates that the Government is willing to consider and acton recommendations affecting the regulations. Conditions couldalso be established to prevent any unnecessary restriction ofimports that are genuinely required for the legal sale ofcigarettes. Based on the estimated size of the customs fleetrequired to implement this intervention, it is expected to costaround $1 million annually.

Extra compliance costswould be imposed onlegal marketparticipants, but theywould be low

Benefits of improvedmonitoring andcompliance outweighimplementation costs

Benefits valued at $5million

Bibliography 48

Equalisation tax for cigarette tubes

An equalisation tax for cigarette tubes is the only regulatoryoption that directly targets the price differential between legaland illegal tobacco products, albeit only applying to theproportion of tube users.

As shown previously in Table 1, the price discrepancy betweenchop chop and legal cigarettes is significant. Tubes are alreadymore expensive than papers, so the threshold of the tax wouldhave to address the total price paid for chop chop rather thanthe differential between tubes and papers.

Substitutability between tubes and papers remains an issue,and the tax will only be an effective deterrent to demand forconsumers that are unwilling to substitute papers for illegaltobacco consumption.

There is also some residual risk that a tax on tubes wouldcreate a market in smuggled imports or encourage inaccuratedeclaration of imports of cigarette tubes in an effort to avoid theequalisation tax.

The benefits of this option again relate to the proportion of chopchop use that is transferred to the legal tobacco sector. Thesame substitute issues apply as with other tube options, andthe benefits are similarly valued at around $10 million.


The introduction of the equalisation tax would be complex andtime consuming. Assuming the legislative framework of theCigarette Tube (CT) tax will reflect the GST framework, Baker &McKenzie (2007) advise that the Australian Parliament wouldneed to pass, and the Governor-General provide royal assentfor various pieces of primary legislation creating the CT tax.These include: A New Tax System (Cigarette Tube Tax) Act 2007; A New Tax System (Cigarette Tube Tax) Regulations 2007; A New Tax System (Cigarette Tubes Tax Imposition -

General) Act 2007; A New Tax System (Cigarette Tubes Tax Imposition –

Customs) Act 2007; A New Tax System (Cigarette Tubes Tax Imposition –

Excise) Act 2007.

Tube tax is a direct andeffective method forreducing chop chopdemand

Benefits of $10 millionshould be achievable

Implementation costscould be large andongoing compliancecosts would be imposed

Bibliography 49

The Taxation Administration Act 1953 would need to beamended to provide for the assessment and administration ofmatters relating to the CT tax. The process of amendingprimary legislation can be quite involved and time consuming.However, the suggested approach is based on precedent GSTand sales tax arrangements and is designed so as not to beclassified as a customs duty which would attract additionalcomplexity around free trade agreements.

The tax would exempt legitimate users of the tubes viaentitlements, although it does impose ongoing compliance coststo legal tobacco market participants. The criteria for tax inputcredit eligibility would require some mechanism by which tubeimporters, distributors and retailers could provide evidence thatthe tubes are being acquired for a “creditable purpose” to beeligible for the tax input credit, which may be difficult to prove.

While there is likely to be some government appetite for thisoption, the case would need to be compelling for changes to taxlaws that increase regulatory burden to be introduced.Manufacturers are likely to support the proposed reform,particularly where it provides some level of revenue protection.Evidence that tubes are non-substitutable for papers in theconsumption of chop chop would enhance prospects forstakeholder consensus.

The cost of this invention is expected to be around $1 million.

Advertising campaign to dispel ‘health’myths of chop chop

The fact that many chop chop users cite the perceived ‘natural’nature of chop chop as an attraction to the product indicatesconsiderable lack of awareness of the additional health risks thatchop chop consumption involves. Developing an advertisingcampaign to dispel perceptions that chop chop is qualitativelysuperior to legal tobacco products would help circumvent this keydriver of demand. Advertising should also convey the risks ofdetection and the severity of penalties to help deter supply.

There is a residual danger that greater awareness of chop chopcould encourage greater use, despite the health risk messagethat accompanies it. For instance, anti-smoking campaigns havea positive impact on reducing tobacco consumption but some

Bibliography 50

people chose to continue using tobacco products despite suchwarnings. A campaign that targeted smokers only may be betterthan one targeting the wider community in this regard.

There is no information on the relative importance of the ill-conceived health effects of chop chop use to consumptiondecisions, making this option difficult to quantify. It is one ofknown three drivers (along with price and availability). If itreduced demand by even 10%, the value of tax recapturedwould be around $40 million. In addition to this is any savings inmedical and other costs associated with improved healthoutcomes.


No significant implementation issues. A brief would need to beprepared and tenders sought for the campaign. Based on thecost of similar types of campaigns, this initiative is expected tocost around $3 million.

Benefit cost assessment of interventions

A summary of the benefits and costs of each initiative issummarised in Table 11.

AssessmenTable 11: Assessment of regulatory interventions

Intervention Preliminary estimate

of additional excise

revenue

Estimated

operational cost

Benefit cost

ratio

Implementing

agency

Ban on future growing licences $10 million $3.6 million 2.5 ATO


measures

$45 million $8.2 million 5.0 ATO

Private inspectors to detect

distribution from high risk outlets

$40 million $0.7 million 65.0 ATO

New counter smuggling initiatives $15 million $2.2 million 6.0 ACS

Equalisation tax for cigarette tubes $10 million $1 million 10.0 ATO, Treasury

Advertising of risks of supply and use $40 million $3 million 13.3 Dept of Health and

Ageing

Ban on hollow tubes $10 million $1.6 million 6.6 ACS, ATO

Import permits for tubes $5 million $1.3 million 4.0 ACS

Could result in taxrecapture of around $40million plus savingsassociated withimproved healthoutcomes

Bibliography 51

Appendix AACS container profiling and inspection

Bibliography 52

Target selection of containers by the ACS involves the day-to-day process of screening cargo data for indicators of risk.Minimising losses to revenue from smuggling is one componentof the ACS risk assessment targeting arrangements which arealso designed to prevent the flow of illicit drugs, weapons andother harmful goods, protect legitimate industry from non-compliant importers and exporters through detection anddeterrence and improve the security of sea cargo trade inAustralia.

Target Selection Officers (TSOs) use their judgement to identifyrisks. Their ability to do so is based on a mix of experience,understanding of the sea cargo environment and up to dateknowledge of trends (ANAO 2004, 36). Risk indicators can beinformation such as: the origin of the consignment;

the port of loading; and/or

concealment potential of the cargo.

Risk indicators are dynamic and are the basis for developingprofiles in the Sea Cargo Automation (SCA) system. A riskprofile is one or a cluster of risk indicators that, when groupedtogether, present the risk characteristics of a consignment. Thedatabase sorts and categorises the electronic risk groups orqueues. The risk queues are then assessed by the TSO on apriority basis in order to target high-risk consignments.The introduction of Container Examination facilities (CEFs)44 atAustralia’s four major ports since 2004 has significantlyincreased the ACS capacity to examine sea cargo. CEFsintegrate container technology with physical examination and arange of other technologies such as pallet and mobile x-rayunits, ionscan technology and radiation and chemical warfareagent detectors.

TSOs are required to ‘select’ sufficient containers to ensure thatCEF inspection targets are achieved while still maintaining the‘quality’ of these selections. The TSOs select and prioritisecontainers in accordance with the following priority ratingsystem:

Priority 1: x-ray and physical examination

Priority 2: x-ray with a view to physical examination

Priority 3: x-ray with a view to verifying commodities

44Container Examination Facilities (CEFs) were established in Melbourne,

Sydney, Brisbane and Freemantle in 2004. Combined these ports handleapproximately 94 per cent of imported sea cargo containers.

Bibliography 53

Priority 4: this category is used to adjust CEF workflow

The CEFs are required to physically examine all Priority Oneselections regardless of the x-ray image presented. Priority Twoselections are unpacked only where the image has an obviousconcealment or anomaly. If no concealment is identified in aPriority Three or Four selection, it is to the discretion of theimage analyst whether the container is unpacked.

In its audit of CEFs, the ANAO45 concluded that ACS CEFs areadministratively effective and that ACS had implementedeffective systems and processes for target selection anddevelopment. This finding was endorsed during consultationswhich revealed a view that outputs (seizures) were beingmaximised for the current level of inputs (inspectionresources).46 This is a key assumption in the following approachto estimating the size of the illegally smuggled tobacco market.

45ANAO 2004, p. 19.

46Consultations 15 February and 28 February 2007

Bibliography 54

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ACNielsen, 2007, Survey of Chop Chop Users, June 2007.

ANAO, 2006, Administration of Petroleum and Tobacco Excise Collections:Follow-up Audit, Australian Tax Office.

Australian Government, 2007, Commonwealth 2007/08 Budget Paper No. 1.

Australian Bureau of Statistics, 2006, Estimated Tobacco SmokingPopulation, cat no: 4381.0.55.001.

Australian Bureau of Statistics, 2007, Year Book Australia.

Australian Customs Service, 2002, Manifest: Journal of the AustralianCustoms Service, vol. 5, no 1, June 2002.

Australian Customs Service, 2004, Technology Helps Foil Massive TobaccoSmuggling Attempt, Media Release, 10 November 2004.

Australian Department of Health and Aging, 2007, The Facts About ‘Chop-Chop’ Tobacco, Fact Sheet.

Australian Institute of Health and Welfare, 2001, Report, p.21-22.

Australian Research Group, ‘Participant comments on fake tobacco and‘chop chop’, March 2007, unpublished.

Australian Taxation Office, 2007, Tobacco Restructuring Grants – FactSheet, 16 March 2007.

Bittoun, R., 2004, The Medical Consequences of Smoking “Chop-ChopTobacco”, Prepared for the Commonwealth Department of Health andAgeing.

Bitoun, R., 2002. “Chop-Chop” Tobacco Smoking, Medical Journal ofAustralia,

vol. 177, p. 686-687

Merriman, D., Yurekli, A. and Chaloupka, F., How Big is the WorldwideCigarette Smuggling Problem? In Jha, P. and Chaloupka, F. (eds), TobaccoControl in Developing Countries, Editors Oxford University Press, 2000, pp365 – 392.

Framework Convention Alliance (2006), How big was the global illicittobacco trade problem in 2006?,. prepared for the second session of theConference of the Parties to the World Health Organisation FCTC, June 30-July 6, 2007 Bangkok, Thailand.

Geis, 2002, Chop-Chop: The Illegal Cigarette Market in Australia.

McGauran, Peter M.P., 2006, $40 Million to Help Tobacco Growers Look tothe Future, Media Release, 28 October 2006.

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PricewaterhouseCoopers, 2001, The Current Economic and PublicEnvironment for the Australian Tobacco Industry.

PricewaterhouseCoopers, 2005, Sales of Cigarettes and Tobacco Productsby Type of Retail Business.

United States General Accounting Office, ‘Terrorist Financing: US AgenciesShould Systematically Assess Terrorists Use of Alternative FinancingMechanisms’, Report to Congressional Requesters GAO-04-163 (November2003), available online at http://www.gao.gov/new.items/d04163.pdf.

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Documents

PWC Illegal Tobacco Costing Australia Millions November 2007