Ernst & Young LLP 1 More London Place London SE1 2AF Tel: + 44 20 7951 2000 Fax: + 44 20 7951 1345 ey.com Directorate-General for Taxation and Customs Union European Commission Rue de Spa 3, Office 5/82 B-1049 Brussels Dear Sir / Madam 16 February 2017 Ref: ppds232/cjs/dsj Your ref: Direct line: 020 7951 0150 Email: csanger@uk.ey.com Excise duties applied to manufactured tobacco I am writing in response to the consultation document Excise duties applied to manufactured tobacco published by the European Commission. In our response, we have focused on the questions relating to e-cigarettes and heat-not-burn tobacco. In this section, the Commission poses the following question: The so-called electronic cigarettes are not covered by Directive 2011/64. Various Member States have introduced national tax regimes for electronic cigarettes and refill containers, adopting different tax structures and rates. The lack of a harmonised approach across countries may affect competition and the functioning of the internal market, and may also encourage informal (cross-border and online) trade. A precise estimation of such effects is difficult because of the lack of official market data for these products. This raises two key questions, namely: 1. Should e-cigarettes be included within Directive 2011/64; and 2. Should e-cigarettes be subject to excise? The Appendix to this letter provides our detailed response to these two questions, and elements of these arguments have been included in the Commission s questionnaire (space permitting). In both cases, we believe the answer is no, not least because e-cigarettes are not tobacco products. The evidence suggests that applying excise to e-cigarettes and e-liquids is likely to run counter to the aim of improving overall public health in the European Union, since e-cigarettes have been shown to reduce smoking and hence its social costs. Furthermore, while the e-cigarette market is growing rapidly, it is still very small, particularly compared to the tobacco market, and therefore excise is unlikely to raise significant revenue. At this stage in the market s growth, the unwarranted introduction of excise could destabilise the market, leading to growth in the illicit market. Should you have any questions please let me know. Yours faithfully Christopher Sanger Partner - Ernst & Young LLP United Kingdom Enc. The UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC300001 and is a member firm of Ernst & Young Global Limited. A list of members names is available for inspection at 1 More London Place, London SE1 2AF, the firm s principal place of business and registered office. Ernst & Young LLP is a multidisciplinary practice and is authorised and regulated by the Institute of Chartered Accountants in England and Wales, the Solicitors Regulation Authority and other regulators. Further details can be found at http://www.ey.com/uk/en/home/legal.
2 Appendix This appendix addresses the two questions at the heart of the Commission s consultation on Excise duties applied to manufactured tobacco as they relate to two new products, namely e-cigarettes and heat-not-burn. These two questions are: Should the product be included in the tobacco directive? Should the product be subject to excise and, if so, at what rate compared to tobacco? Further detail is available upon request. E-cigarettes E-cigarettes do not contain tobacco but instead heat an e-liquid which may or may not contain nicotine. The market for e-cigarettes is complex and evolving rapidly which would pose a challenge for defining e- cigarette products. The market has moved rapidly over the past few years, from the large disposable cigarette look-alike s available in 2012, to small box modular products that are now available. With consumer demand for more customisable and differentiated products and a market with many players, the future direction of these types of products is far from certain. For example in response to evolving consumer preferences, an extensive range of e-liquid flavours are now become available. Over three quarters of consumers use non-tobacco flavoured e-liquids, with only around 28% of users opting for tobacco flavour. Fruit (20%) and botanicals (23%) are almost as popular overall. Percentage of e-cigarette users 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Most often used e-cigarette flavour (percentage of users), 2015 10% 7% 11% 10% 13% 10% 11% 7% 13% 18% 12% 7% 8% 12% 17% 13% 6% 3% 8% 8% 8% 21% 22% 20% 24% 20% 22% 14% 22% 23% 26% 24% 2 22% 19% 2 21% 28% 20% 23% 28% 29% 30% 30% 34% All South Russia Poland Italy Germany United France korea Kingdom Tobacco Botanical Fruit Sweet (e.g., Caramel, Honey) Beverages Others Source: EY report on e-cigarettes sourced from a survey conducted by Kantar This section considers the two policy questions as they relate to e-cigarettes. 1. Whether to include e-cigarettes in Directive 2011/64 The first question facing the European Commission is whether to include e-cigarettes within the tobacco directive. There are a number of reasons not to include e-cigarettes in the Directive: Not a tobacco product Since e-cigarettes do not involve the burning (or heating) of tobacco, there would seem no reason to include e-cigarettes within a Directive that covers the structure and rates of excise duty applied to manufactured tobacco.
3 E-cigarettes do not have the same negative health implications A key rationale for the Directive is to allow the imposition of controls on a product that causes harm. In contrast, evidence indicates that e-cigarettes may be less harmful than cigarettes with one study indicating that they may be about 9 less harmful than smoking 1. A study from 2014 2 found that: e-liquids contain some toxicants in concentration much lower than in tobacco smoke and negligible concentration of carcinogens A report by Public Health England (2015) 3 further supported the view that e-cigarettes are 9 less harmful than cigarettes. This is supported by other literature, for example, the Royal College of Physicians (2016) 4 : Although it is not possible to quantify the long-term health risks associated with e-cigarettes precisely, the available data suggest that they are unlikely to exceed of those associated with smoked tobacco products, and may well be substantially lower than this figure. Most recently, a long term study in the Annals of Internal Medicine suggested a very low risk associated with the long-term use of e-cigarettes 5. E-cigarettes help reduce the number of people smoking In addition to the evidence of low levels of harm, there is emerging evidence 6 that e-cigarettes are a contributing factor in reducing the number of people smoking and reducing the amount of cigarettes that smokers consume. While the evidence is not yet conclusive, a survey from the Office of National Statistics 7 shows that the majority of people using e-cigarettes do so to help them quit smoking. West R., Shahab L. and Brown J. (2016) 8 states that: Evidence from RCTs and from surveys in England indicate that using an e-cigarette in a quit attempt increases the probability of success on average by approximately 50% compared with using no aid or LNP bought from a shop similar to use of a licensed medicine. A growing preference for no, or lower, nicotine strength e-cigarettes may also be emerging as the proportion of users, across the core markets, who opt for zero nicotine e-liquids has increased from 12% to 16% between 2013 and 2015 and nearly three quarters of users opted for lower nicotine in 2015 compared to 11% in 2013: 1 Nutt, D.J., et al. (2014). Estimating the harms of nicotine-containing products using the MCDA approach. European addiction research, 20(5):, 218-225 2 Hajek, P., et al..(2014). Electronic cigarettes: review of use, content, safety, effects on smokers and potential for harm and benefit. Addiction, 109(11), 1801-1810. 3 McNeill, A., et al. (2015). E-cigarettes: an evidence update. Public Health England. 4 Royal College of Physicians, Nicotine without smoke: tobacco harm reduction, 2016. 5 Lion Shahab, L., Goniewicz, M, L., PhD; Blount, B, C., Brown, J., McNeill, A., Alwis, K, U., Feng, J., Wang, L., & West, R. 2017. Nicotine, carcinogen, and toxin exposure in long-term e-cigarette and nicotine replacement therapy users: a cross-sectional study. Annals of Internal Medicine. 6 57% of e-cigarette users have tried to quit using e-smoking devices (2015 Reuters/Ipsos online poll of 5,679 adult Americans) 7 Office for National Statistics, Adult smoking habits in Great Britain, 2014, Statistical bulletin published in February 2016; Action on Smoking and Health, Use of electronic cigarettes (vapourisers) among adults in Great Britain, ASH factsheet, published on May 2015. 8 West R., Shahab L. and Brown J. (2016) Estimating the population impact of e-cigarettes on smoking cessation in England, Society for the Study of Addiction, Volume 111, Issue 6, pages 1118 1119.
4 Percentage of e-cigarette users 80% 60% 40% 20% 0% Nicotine strength (Mg) of most often used e-cigarettes (percentage of users), 2013-2015 73% 50% 39% 36% 27% 16% 16% 12% 11% 9% 8% 2% No Nicotine 1-11 Mg 12-18 Mg More than 18 Mg 2013 2014 2015 Source: EY report on e-cigarettes sourced from a survey conducted by Kantar (covering France, Germany, Italy, Poland, Russia, South Korea and the UK) Adding controls would risk undermining competition The imposition of revenue controls would be administratively costly and would stifle competition and the efficient market. Unlike the cigarette market, where there are four key manufacturers, the e-cigarette market is in its infancy and there are many more manufactures and suppliers. Indeed, the UK s Medicines and Healthcare products Regulatory Agency has currently been notified of over 14,000 products that are manufactured or imported into the UK. 9 The market is diverse and competitive The distribution channels for e-cigarettes are wide and varied, with no leading retail channel for e-cigarette devices and e-liquids, ensuring strong competition for market share. While specialist e-cigarette shops are the most common retail channel (3 of devices) online purchases are growing. Specialist e-cig shops Online Supermarket Tobacconist Kiosk in a shopping centre Chemist Newsagent Pub/bar Petrol station Other Purchase channel primarily used (percentage of users), 2015 0% 10% 20% 30% 40% 50% 6% 6% 4% 1% 2% 1% 0% 3% 3% 11% 12% 10% 21% Source: EY report on e-cigarettes sourced from a survey conducted by Kantar (covering France, Germany, Italy, Poland, Russia, South Korea and the UK) 2 Devices 3 40% Refills The impact of bringing e-cigarettes into the Directive, and of treating e-cigarettes more widely as a tobacco product, would be to restrict the places where e-cigarettes could be sold and to limit the ability of the European market to function efficiently. The development of the online market is providing customers with a wide range of choice, with thousands of different potential product choices (spread across a variety of different suppliers), compared to the hundreds of cigarette 9 Listed at https://www.gov.uk/guidance/e-cigarettes-regulations-for-consumer-products
5 products across the EU. The fact that approximately two thirds of all e-cigarettes are not tobacco flavour further distinguishes e-cigarettes from tobacco products. 2. Whether e-cigarettes should be subject to excise? Notwithstanding the recommendation that e-cigarettes should not be subject to the Directive, it could be argued that e-cigarettes should nevertheless be subject to excise. This paper suggests that e-cigarettes should not currently be subjected to excise, for the following reasons: E-cigarettes may help reduce smoking and taxing e-cigarettes would reduce the public benefit As noted above, there is emerging evidence that e-cigarettes help reduce cigarette smoking. As such, any tax, to the extent that the increase in price served to reduce the shifting from cigarettes to e-cigarettes would be reducing the public benefit of e-cigarettes. As noted in a study by The Royal College of Physicians (2016): A rational approach to nicotine taxation would be to apply tax in proportion to their hazard, in which case the tax on e-cigarettes and other non-tobacco nicotine products should be held stable or even reduced. Based on the above, there is a strong rationale for excluding e-cigarettes from excise at this time. This could be re-examined if the shift from cigarettes to e-cigarettes reduces. E-cigarettes are predominantly used by those seeking to quit smoking rather being a gateway to smoking Data from the Office of National Statistics show that only 3% of current e-cigarette users have never previously smoked. Furthermore, studies produced by Eastwood, B, et al. 10 shows that this number was even less for those aged 11-18, with only 0.2% of e-cigarette users in this age range being non-smokers previously. The small and highly elastic market would mean very little tax revenue The market for e-cigarettes is relatively small, with a retail value across the EU of only 2.84bn in 2015, compared to 125.07bn for cigarettes in the same year and a further estimated 23.24bn of illicit cigarettes. 11 There is evidence of high elasticity of demand for e-cigarettes 12, likely to be above -1.0 (for example -1.2 to -1.9 13 ), and could be expected to be even higher if cross-border (illicit) trade is stimulated by excessive taxation. Importantly, cross-border leakages and illicit production would be costly to fight within such a fragmented and digital market. Accounting for that and for the very small size of the e-cigarettes market, any e-cigarette tax increase is likely to result in little additional government revenues at the cost of strongly reducing official e-cigarette demand, which might undermine the health benefits of people switching from combustible cigarettes. E-cigarettes taxation would be very difficult to enforce and collect at the current time In addition to the principled reasons for not imposing excise at this time, it is worth noting that there would be significant practical difficulties of such an enforcement. Unlike tobacco products 10 Eastwood, B, et al. (2015). Electronic cigarette use in young people in Great Britain. Public Health, 129(9), 1150-1156. 11 Euromonitor International 12 Strong own-price elasticities were shown in the study of Stokłosa M., Drope J., Chaloupka F.J. (2016), Prices and E-Cigarette Demand: Evidence from the European Union, Nicotine & Tobacco Research 18 (10): 1973-1980. 13 Huang J, Tauras J, Chaloupka FJ. (2014) The impact of price and tobacco control policies on the demand for electronic nicotine delivery systems. Tobacco Control. 2014 Jul;23 Suppl 3:iii 41-7. doi: 10.1136/tobaccocontrol-2013-051515.
6 there is no established model for collecting a duty. This would mean that the administrative burden of enforcement of an excise on e-cigarettes would likely be high. Designing an excise regime is likely to be more difficult for e-cigarettes than for tobacco products due to: The nature of the market for e-cigarettes As noted above, unlike tobacco products, the e-cigarette market is currently highly fragmented with a variety of channels, products, brands and suppliers. With a large number of smaller producers and online suppliers, administration, enforcement and collection of tax is likely to be difficult and costly. The definition of e-cigarettes and e-liquids The e-cigarette market is diverse and fast moving with innovation driven by the consumer. This would raise difficulties in trying to define the scope of the product and tax base for tax purposes. For example, there are many different types of e-cigarettes available, ranging from disposable cig-alikes to closed systems to modular, open systems (where the device and liquids are sold separately, potentially by different suppliers). Current estimates of sales volumes 14 suggest that consumers are increasingly shifting toward modular systems which gives consumers a more customised experience. Some commentators have suggested that the nicotine content of e-cigarette liquid should be the basis of any tax. However, the recent experiences of Portugal (which recently announced a reduction in the excise from 0.6 /ml to 0.3 /ml for nicotine containing liquids 15 ) and South Korea suggest that care needs to be exercised with such an approach since, in both markets, consumers reacted to such a policy by purchasing nicotine-free liquids and adding a nicotine solution to them. It raised two practical problems in both instances: First, the home-made products were unregulated, with consumers potentially exposed to excessively high, hazardous, levels of nicotine per millilitre of e-liquid. Second, no tax revenues were being collected, since consumers circumvented the tax in a way that would be more difficult if the volume of e-liquid, regardless of its nicotine content, were subject to the tax. The potential issues above suggest that more research would be needed to be able to determine how a tax on e-cigarettes could be effectively designed. Furthermore the variance in products would make it difficult to implement. Taxing e-cigarettes is likely to drive illicit sales from third countries E-liquids are physically smaller than combustible tobacco and easily transported across borders. The introduction of taxation of e-cigarettes in the EU may not be effective where neighbouring jurisdictions are able to attract sales with lower prices. US data suggest that an increase in the price of e-cigarettes in one state increases cross-border shopping. In the case below 16, an increase in excise duty in Minnesota (to 70% of wholesale price in 2010 and 9 in 2013) seems to have stifled growth in official sales in the state. Additional evidence suggests that this fall in legal demand has been absorbed by neighbouring states with lower prices. The cross- 14 EY (May 2016) E-cigarettes: an emerging category, 7. 15 : Article 104C, No. 2. http://www.pgdlisboa.pt/leis/lei_mostra_articulado.php?nid=1598&tabela=leis&so_miolo 16 EY based on Nielsen data
7 border effects have also been identified for combustible cigarettes and their statistical significance is demonstrated, i.e., in the study of Goel and Nelson (2012) 17. 0.045 0.040 0.035 0.030 0.025 0.020 0.015 0.010 0.005 E-cig sales volumes per capita in e-smoking units 1 July 2013 Minnesota increases excise tax on e-cigarettes from 70 to 9 of wholesale price 0.000 Dec/12 Jun/13 Dec/13 Jun/14 Dec/14 Jun/15 30 US regions Minneapolis Source: EY based on Nielsen data. Heat-not-burn It should also be noted that the value of e-cigarettes market is significantly lower than the value of illicit sales of cigarettes. It would therefore seem unlikely that the policing of illicit sales of e- cigarettes and liquids would be a priority for law enforcement. Unlike e-cigarettes, Heat-not-burn ( HNB ) products do contain tobacco. HNB products heat the tobacco within the product rather than burn as with a cigarette, reducing the formation of harmful or potentially harmful constituents (HPHCs) that occur in normal cigarette smoke. HNB products therefore may reduce the number and level of HPHCs generated by tobacco products whilst retaining more of the sensory experience of cigarettes than e-cigarettes. HNB products are new products and whilst the science suggests that they are less harmful than smoking normal tobacco products, at this early stage there is limited evidence on long-term impacts. Based on the fact that HNB is a tobacco product, we suggest that it might be included within the Directive. However, given that the science suggests that HNB may be less harmful than traditional tobacco products, there is an argument for imposing duty at a lower rate than on cigarettes. 17 Goel R.K., Nelson M.A. (2012): Cigarette demand and effectiveness of U.S. smoking control policies: state-level evidence for more than half a century, Empirical Economics, 42(3), 1079-1095.