Cheaper cigarettes: how this idea got so far (and why it didn’t work out)

At the beginning of the Bolsonaro administration, an old demand from the manufacturer of the Lucky Strike and Kent cigarette brands formed part of the agenda in Sergio Moro’s Ministry of Justice. Joio had access to documents that help to understand this story

Less than three months after taking office as Minister of Justice and Public Security in the Jair Bolsonaro government, Sergio Moro signed an ordinance which brought the jitters among those who work in tobacco control in this country: the document dated March 23 2019 established a Working Group (WG) to assess the “convenience and the opportunity” of a tax reduction on cigarettes manufactured in Brazil. The ministry wanted to see if this could reduce the consumption of products smuggled from Paraguay, by making the competitor from Brazil cheaper.

But those familiar with the discussion were quick to suspect that the cigarette industry had a hand in the creation of the working group. The new era of “bolsonarism” was the perfect scenario to reestablish the same corporations into public debate who for decades had been tampering with scientific evidence about the problems brought on by smoking.

The work was to officially take three months. Right from the start, one fact that drew attention was that no one from the Health Department nor the Internal Revenue Service would be part of the hard core of the WG. It would comprise only representatives from the Federal Police, The National Consumer Secretariat (Senacon) and the Special Advisory Office for Legislative Affairs – all subordinated to the Ministry of Justice. According to the decree, the ministries of the Economy and Health were to be later invited to take part in the studies.

High taxes on cigarettes are an undisputed point among health researchers. The World Health Organization (WHO) points out that this is a highly effective measure to reduce the prevalence of smoking. On the other hand, smuggling is the cigarette industry’s favorite argument to try to slow down tax increases – despite the fact that the industry itself, in Brazil and in other countries, has been historically implicated in cigarette smuggling.

The WG followed its course and in the end put aside the idea of tax changes. In its final report, the Group concluded that there was not enough evidence to indicate the effectiveness of this strategy.

But there was never much information about what happened between the creation of the WG and the publication of the report, nor about what preceded the emergence of this WG. Therefore, Joio engaged the Access to Information Act (LAI) to obtain the documents relating to the case and better understand this story.

Why things are the way they are

Before getting into the WG itself, we need to understand how cigarette taxes work in Brazil. “It is important to tax cigarettes on account of their negative externality: they are a product whose consumption is to be reduced, and this consumption carries implications not only with regard to people’s health, but also for the government: health expenses, Social Security impacts due to reduction in the working life of those who get sick, etc. In other words, it is a public health problem that generates costs for the State. So by taxing them, you are at the same time  discouraging consumption and collecting resources for the State through taxes, to pay for the damage and loss caused by cigarettes”, summarizes economist Alan Towersey, an Internal Revenue Service auditor.

It is estimated that on average, a 10% increase in cigarette prices can reduce consumption by 4% in high-income countries and 5% in low- and middle-income countries. It is no coincidence that the Framework Convention on Tobacco Control – an international treaty to which Brazil is a party – says that signatory countries must adopt tax policies which contribute towards reducing consumption.

Major changes

But the percentage of cigarette sales prices that go towards paying these taxes has changed several times throughout history, as we have already reported here. Since the 1990s, many studies have shown that increasing cigarette prices is an effective way to reduce consumption. At the end of that decade, however, that tax burden was reduced in Brazil, instead of going up.

This is because the country was facing a problem with smuggled cigarettes, and Brazilian manufacturers claimed that if cigarette taxes were reduced, prices would go down as well. Thus, legal cigarettes could occupy the market that was being gobbled up by smuggled goods. Any similarity with the objective of the WG created by the Ministry of Justice in 2019 is not purely coincidental.

In 1999, the Internal Revenue Service did indeed decide to reduce the IPI tax. Cigarettes were broken down into categories, and the cheaper brands paid less tax. If this had really led to legal cigarettes taking the place of illegal ones, tax revenues would have increased. But exactly the opposite happened – and the problem with smuggling wasn’t resolved either.

More than a decade went by until a law turned the tables. Until 2011, IPI values were fixed according to each price category, varying between R$ 0.76 and R$ 1.35. The cheaper the brand, the lower the tax. Under the new law, IPI was divided into two parts: one part varies according to the sale price; the other is fixed, and since 2016 has stood at R$ 1.50 per pack or box pack of 20’s. This means that the more expensive the brand is, the lower the weight of the IPI tax. Additionally, a minimum price per 20-pack was established, starting at R$ 3.00, to be increased every year.

By 2016, the changes led the cigarette tax burden to increase. Along with other measures – such as the public anti-smoking health campaigns that were promoted –, the progressive increase in taxes helped to reduce smoking levels in Brazil, which dropped from 14.8% to 10.1% between 2011 and 2017. Except that since 2016 the federal government has never again readjusted taxes on cigarettes, and the minimum price of a 20-pack has remained at R$ 5.

Where did it come from?

The origin of the WG created by the Ministry of Justice is uncertain. But demands for lower cigarette taxes would keep coming up at meetings of the National Council for the Fight against Piracy and Crimes against Intellectual Property (Conselho Nacional de Combate à Pirataria e Delitos contra a Propriedade Intelectual – CNCP), according to the minutes which Joio was able to access.

This is a ministry advisory body which brings together the public and private sectors: there are representatives from secretariats, police, regulatory agencies, other ministries and five entities from the private sector. The tobacco industry is represented on two Council seats: the National Forum against Piracy and Illegal Activities (Fórum Nacional Contra a Pirataria e a Ilegalidade – FNCP) and the Brand Protection Group (Grupo de Proteção à Marca -BPG). The Forum has BAT Brasil (formerly Souza Cruz) among its associates, while Philip Morris is a member of the BPG.

One of the Council members is a long-time advocate of tax cuts on cigarettes: Edson Vismona, founder and president of the FNCP as well as executive director of the Brazilian Institute for Ethics in Competition (Instituto Brasileiro de Ética Concorrencial -ETCO) – another  entity of which BAT Brasil is a member. In 2018, for example, ETCO published a full – paid – special section in the Correio Braziliense newspaper about taxation. The text says the “government got it wrong by following the international trend and heavily taxing the tobacco industry, in an attempt to reduce consumption”, arguing that this practice “failed to achieve the its by opening the way for the illegal market”.

Vismona denies that ETCO, FNCP or CNCP asked the Ministry of Justice for the creation of a Working Group to study this issue. In an interview with Joio, he said only that these entities are “always ready” to foster discussions about the illegal market in each government, also to show they are present: “We will now take the matter to the new minister of Justice [Flávio Dino], show the importance of the Council, show how the Council interacts with society. This is what we have done and will now do the same before the new minister”, he announces. He states, however, that the debate on the tax issue in 2019 came from the government itself.

However, sources heard by the reporting team say that the issue reached the Ministry of Justice through lobbying promoted by the sector, more precisely by the ETCO.

Right at the beginning of the Bolsonaro government, tobacco-related organizations were able to hold at least three meetings at the Ministry of Justice, as revealed at the time by Folha de S. Paulo newspaper. Still in the month of January, Sergio Moro met representatives from ETCO and FNCP – although the official agenda only included a meeting with then congressman Efraim Filho, coordinator of the Parliamentary Mixed Front for the Fight against Contraband and Counterfeiting (Frente Parlamentar Mista de Combate ao Contrabando e à Falsificação).

On February 25, 2019, BAT Brasil and Japan International Tobacco (JTI) met with lawyer Luciano Timm, who had in January been appointed National Secretary for Consumer Affairs. Two days later, Timm took over as president of the CNCP. On the same occasion, he set up the creation of a Special Committee on Cigarettes on the Council’s agenda – we’ll get back to that later.

Still according to Folha, on March 25 the Ministry’s joint secretary for Integrated Operations, José Washington Luiz Santos, also met with entities linked to the tobacco sector. At the same time, the decree was published to create the WG. Luciano Timm was to be its rapporteur.

Controversial figure

Current senator Sergio Moro (União Brasil-PR) did not act as judge in any case involving tobacco companies, and two people with knowledge of the WG told Joio that when he took over the ministry his main interest was to approve the “anti-crime package” in Congress. Thus, Moro paid little attention to the WG, and the discussions were in fact steered by the second echelon – more specifically by Luciano Timm.

Corporate Law specialist Timm is a partner at Law Firm Carvalho, Machado e Timm Advogados (CMT). The firm’s practice is not to directly defend major tobacco companies in court, although it serves many agribusiness companies.

It is a curious fact that in 2017 Moro participated at an event held by the Brazilian Association of Law and Ecomomics (Associação Brasileira de Direito e Economia -ABDE), which was presided by Timm between 2016 and 2017. The event also featured speeches by Pery Shikida – a researcher who advocates the reduction of cigarette prices. His study on this issue was used by the WG to support the discussions.

Despite this previous contact, Timm apparently did not have any stronger ties with Sergio Moro until he took over at Senacon. “Nobody really knows how he gained this importance in the Ministry of Justice”, says a source who worked with Timm at a number of public hearings. “But the fact is that he knew how to make good use of this relationship after he joined.”

Timm’s time at the secretariat is controversial, to say the least. This is because his firm  assists companies in their relations with authorities connected to consumer protection, such as the offices of Procon and Senacon itself. He took leave from the law firm during the period in which he headed the agency. But the office evidently did not stop representing companies in conflicts with consumers.  

“While the Procon offices in São Paulo were fining supermarket companies, this law firm was filing a lawsuit to have the fine annulled. Timm was in charge of Senacon – he was a licensed lawyer, but his name still appeared on the petitions, since it is part of the actual name of the law firm”, exemplifies the source heard by Joio. “That is not a legal issue, but it certainly enters the realm of morality. It was quite obvious that he was seated there in the secretariat in order to expand his networking in corporate law practice.”

Timm left Senacon in August 2020 – and went back to practicing corporate law shortly thereafter. “He did not go into quarantine. He started to take part in meetings, representing companies, at the agency he had led only weeks earlier.” If that wasn’t enough, in the following year he was invited to be the rapporteur for changes in the laws of the Consumer Service Commission. “He followed the revolving door handbook to the letter and was able to establish solid relationships in Brasília. So much so, that as soon as he left Senacon, his firm opened a branch in the capital”, says the same source.

The reporting team attempted to speak to Luciano Timm to comment on his work heading the WG and CNCP, but he declined to be interviewed.

Taxes on the curve

One of the studies to sponsor the idea of reducing taxes is “an alternative to fight cigarette smuggling based on a Laffer curve estimate and discussion of the minimum price policy”, by Mario Antonio Margarido, Matheus Nicola and Pery Shikida.  

The basic idea of the Laffer curve is that tax increases on a product generate an increase in tax revenues, but only up to a certain value. There would be a tipping point – a rate value beyond which revenues would fall. For that very reason, this model is normally used to advocate tax cuts.

This work was presented in 2017 at a meeting of the Brazilian Association of Regional and Urban Studies, and according to the minutes of the CNCP meetings, the authors attended a meeting at the Council to talk about the topic in April 2019, with the WG already underway. Later, the trio published another article on the same topic. None of the three authors had written anything on the subject before 2017.

But the tactic of using the Laffer curve to advocate the reduction of tobacco taxes was already being used by ETCO since way back: in 2015, the executive president of the institute at the time, Evandro Guimarães, published an article in the Gazeta do Povo newspaper bringing up this base precisely.

Margarido and his colleagues estimated the Laffer curve for cigarettes in Brazil, calculating what the “optimum tax band” for the product’s IPI tax would be. They arrived at a value of 32.46% – very close to what is already in effect. But they say that since Brazil applies a minimum price policy, Brazilian cigarettes are much more expensive than the smuggled product, which would lead to a greater consumption of illegal cigarettes.

They defend, therefore, doing away with the minimum price policy and segmenting the cigarette market in this country, with the IPI tax increasing proportionally to the sales price. This way there would be a cheap cigarette segment which would compete with the illegal market. It is the same strategy which has already been tried in Brazil, unsuccessfully.

The authors argue that the increased consumption of legal cigarettes would increase tax revenues and the availability of resources “for programs that curb the smoking habit among youths”. In summary, an increase in cigarette consumption so as to be able to promote more anti-smoking campaigns.

There is another gem we cannot fail to mention: they say the measure would have beneficial effects on public health because people would no longer consume “low quality cigarettes and would start consuming products that respect the standards required by institutions that regulate this market in Brazil”. But the argument is contested by researchers. A Fiocruz study concluded that there is no evidence that illegal cigarettes have a greater impact on health than the legal variety.

The study by Margarido, Nicola and Shikida got a lot of criticism. At the request of the NGO ACT Promoção da Saúde, Consultancy firm LMV Consultoria Econômica carried out a technical review and critical analysis of the article and concluded that “it lacks theoretical and technical rigor, presenting no solid conclusions that would survive more elaborate questioning”. According to the analysis, there is no consensus with regard to Laffer curve studies and the study does not provide bibliographic references that have previously employed this methodology for the cigarette industry and illegal markets.

The economists responsible for the review also made several remarks about the questionable quality of the data used in the study and the lack of public health policy analysis.

The voice of the industry

In line with the Laffer curve study, a reduction of the tax burden on cigarettes is also defended in documents sent by tobacco companies to the WG.

ETCO (of which BAT Brasil is a member) commissioned a study to the Getúlio Vargas Foundation (FGV), and the document states that the Brazilian tax and price policy “contributed decisively to the expansion of the illegal market”. The proposal is precisely to segment the market and have cheaper products paying less tax. The study sent by BAT Brasil themselves, on the other hand, cites the Laffer curve to argue that a higher incidence of taxes can result in a reduction in revenue.    

The idea of reducing taxes and segmenting the market favors BAT Brasil for two reasons. Firstly, because the company has cheap brands, which currently pay proportionally a lot of tax and would start to pay less. Second, because it also has slightly more expensive brands, which could be placed on the threshold between two segments. This way they would be able to compete for the target audience of the more expensive products, but pay the taxes of middle-priced products.

That is not the case for Philip Morris, whose flagship product is Marlboro. In the case of market segmentation, this brand would definitely be in the upper stratum, paying more tax. It is no coincidence that the study submitted by the company concluded that reducing the minimum price and tax on cigarettes would not be enough to enable the legal market to swallow up the illegal market, and the measures would still have negative impacts on government revenues.

In their presentations to the WG, both the Federal Highway Patrol (PRF) and the Federal Police (PF) used contraband data provided by entities connected to the tobacco industry. The PRF did not position themselves with regard to the tax issue. But on presenting its attributions regarding the problem with smuggled goods, the entity only used data from ETCO and the Institute for the Economic and Social Development of Borders (Instituto de Desenvolvimento Econômico e Social de Fronteiras – Idesf), a strategic BAT Brasil partner.

In the document presented by the PF, the figures for smuggled goods are the ones estimated by the FNCP: almost 60% of cigarettes sold in Brazil are the result of smuggling. As we shall see, the data presented by the tobacco industry do not match official figures.

In the text signed by Commissioners Ronaldo de Góes Carrer and Allan Dias Simões Maia, the PF takes a favorable position regarding the creation of a range of “popular cigarettes” and says that “it’s not about incentive, but strategy”. The document states that “if 60% of consumers prefer Paraguayan cigarettes, it’s definitely not for the sophistication, quality or social status delivered by that merchandise. The choice factor is exclusively the price paid”.

It also states that “the effective way to fight cigarette smuggling should be through prices” and concludes, with no grounds, that the “effects will impact 60% of the cigarettes sold in Brazil, which if competitively priced, will no longer be smuggled and will become national (sic)”.

The arguments are mixed up with the position taken by Edson Vismona, who heads ETCO and FNCP. According to him, there is no point tackling the contraband issue by attacking just the supply side – in other words, repressing this supply through product search and seizure and dismantling clandestine factories.

“We cannot forget about demand; demand means price, impacted by taxes”, he told Joio. “You don’t need to be an economist to understand that. It’s just logics: price goes up, I’ll look for something cheaper. Especially low-income smokers. They have no choice. They’re going to choose something cheaper. And where do you think the cheaper alternatives are? In the hands of the “Smuggled Goods Industry” representatives. That, right there, is why they dominate the market.”

Strange atmosphere

“In my first WG meeting, I sensed that there was a certain amount of pressure to approve the understanding that reducing taxes would reduce smuggling”, says a source who took part in the group, but asked not to be identified. This person says that it was not a question of pressure exerted by an entity or a specific person, but a kind of general atmosphere – which, however, started to change after the Internal Revenue Service contributed to the conversation, representing the Ministry of Economy.

And the presentation made by the IRS dismantled the idea that cutting the price of legal cigarettes would have any beneficial effect vis a vis smuggling: “[If you add up the purchase cost, plus the cost of smuggling, we reach the amount of R$ 0.94 per pack of [Paraguayan] cigarettes. Since the average sale price of a pack of smuggled cigarettes in Brazil is R$ 2.50, we see that smugglers’ margin for maneuver (‘profit’) is currently 165.96%”, estimates the document issued by the entity, in an excerpt that was included in the final report by the WG. In other words, even if there were a steep reduction in the price of legal cigarettes, the Paraguayan version would still be much cheaper.

The document also opposes market segmentation because “there are no objective criteria that are sufficiently sound for setting price bands, in other words, there are no good criteria to establish which brands should be in this or that segment”. Additionally, the agency warns that companies may position their products at the limits of each range – taking advantage of the tax levied on a lower segment, but stipulating sales prices close to those of a higher segment.

Instead of changes in tax, the IRS suggested other measures, such as equating the crime of cigarette smuggling to that of narcotics trafficking, suspending driving licenses of drivers with seized cargo and expropriating real estate used for the manufacture or storage of illegal cigarettes.

Fernanda Villares, who represented the Ministry of Justice Special Advisory Office for Legislative Affairs, says that the resistance shown by the IRS to changes in the cigarette tax policy was probably motivated by resentment. “The Inland Revenue Service felt offended, because they understood that the issue could not be addressed without their opinion.”

However, the participation of the IRS in the discussion was not a whim. The agency is responsible for both the administration of federal taxes and the fight against smuggling. 

The same can be said for the Ministry of Health. As well as the IRS, the ministry was not included to comprise the WG in the ordinance that established its creation. Its arrival in the group happened after a warning by the IRS itself: “The person who told us about this was an IRS representative in Conicq who was part of the WG. He told us that he considered it absurd that there was no one from the Health sector in the Group”, says Tânia Cavalcante, a retired doctor from the National Cancer Institute (Inca), who at the time was the Conicq executive secretary, Conicq being the National Commission for the Implementation of the Framework Convention on Tobacco Control, which was extinguished by Bolsonaro in 2019, but continued to function informally.

So the Commission contacted then Health Minister Luiz Henrique Mandetta, and he requested that the ministry be represented in the WG. That is how the Ministry of Health – through Inca – made its considerations, in a  document that Tânia helped to build.

Similarly to the IRS presentation, the Inca text helped to debunk the myth that cutting taxes would be an improvement. The Institute also opposed the idea that tax changes would fight smuggling: it remembered that countries that reduced taxes on tobacco products for this purpose ended up experiencing an increase in tobacco consumption, with no actual effect on smuggling.

The text also refutes the idea that smuggled cigarettes are more harmful to health than the legal variety: “Quality is not an attribute that can be applied to any type of cigarette, whether sold legally or illegally. All are highly lethal, regardless of their origin.”

Additionally, the document highlights the importance of using official sources to estimate the illegal cigarette market. While ETCO claims that more than half of the cigarette market is dominated by contraband, official data shown by Inca says that in 2018 illegal cigarettes had a 31.4% share of the market. This is no surprise, since there is evidence that the tobacco industry systematically overstates the extent of cigarette smuggling worldwide.

The Foreign Affairs Ministry also  contributed to the WG, but did not touch on the tax issue – limiting itself to addressing relations between Brazil and Paraguay regarding contraband.

End of the line

The source who said they had noticed a change in atmosphere in the WG after the presentation by the IRS evaluates that there was no pressure from that agency nor from the Ministry of Health to close the issue. “Nobody got in a huff, there wasn’t a big fight. But there were discussions, and the members realized which were the most in-depth data on the illegal cigarette trade in Brazil. In the face of that, it’s the old maxim: you can’t argue with facts.”

At the same time, the mere proposal of evaluating tax cuts on cigarettes had not at all gone down well outside the Ministry of Justice. There was strong reaction from entities linked to the Health sector after the creation of the WG. Over 60 national and international organizations – among them the Brazilian Association for Collective Health (Associação Brasileira de Saúde Coletiva -Abrasco) – published an open letter taking a position against any tax cut proposal. The Psol bench filed an Information Request requesting explications from Sergio Moro.

Besides the fact that, as we have already pointed out, Brazil is party to the Framework Convention on Tobacco Control, and has therefore taken on the commitment to have a tax policy aligned to the guidelines of this treaty.

The fact is that even though at the beginning the Working Group seemed like it wanted to buy into the idea of tax changes, in the end that didn’t happen. In the final report, published in August 2019, the group concluded that there was not enough evidence to indicate the effectiveness of the strategy. The suggestion to create “popular” cigarettes was also discarded.

The report signed by Luciano Timm suggests other measures:

1. increased cooperation between the government agencies responsible for preventing and repressing cigarette smuggling;
2. stiffer penalties applicable to this crime;
3. strengthening the dialog with Paraguay;
4. and the re-establishment of the Committee for the Implementation of the Protocol for the Framework Convention to Eliminate the Illegal Trade in tobacco Products.

Fernanda Villares, from the Ministry of Justice, regrets that there were no “advances in a situation which gives rise to criminal behaviors and causes a public health problem”.  

With the decommissioning of the Working Group, the report was sent to the participants from the Federal Police, from Inca and the Internal Revenue Service. On September 30, 2019, Luciano Timm informed Sergio Moro that he had established a 30-day deadline for the agencies to send in contributions in order to continue the work of the WG.

In the same official letter Timm points out that the CNCP was in “permanent contact” with Inca with regard to recreating Conicq. After that, the Commitee for the implementation of the Protocol to Eliminate the Illegal Trade in Tobacco Products was resumed, as suggested by the Working Group. It was predicted that Conicq would be resumed by the end of that year – but that was only possible in January 2023, after Lula’s inauguration, when the decree which had extinguished the Commission was revoked.

According to the documents provided to Joio, apparently the Ministry of Health and the Federal Police did not forward the contributions requested by Timm. The Internal Revenue Office responded, on the other hand, simply reinforcing their position.

A topic that never dies

It is true that the final report by the WG does not go as far as burying the issue forever. It states that “it is important that there be no bias regarding studies and analysis on the topic, from any perspective”, pointing out that there needs to be more research to analyze best practices for the elimination of illegal trade.

On August 21, 2019 – days after the publication of the final WG report –, ETCO was already promoting in Brasília, jointly with Poder360, the seminar entitled “The fight against the illegal market – far beyond repression”. “Beyond repression”, in this case, included proposals for changes in tax rules, obviously.

With the incoming new government – and the promise of tax reform as a priority –, Vismona is paying attention. “People buy illegal cigarettes because they’re cheaper, and they’re cheaper because they don’t pay tax. So any tax reform proposal that relieves consumption is an interesting idea. We need to evaluate and see what the consequences will be. Which sector will pay less tax and which sector will pay more? Every company wants to know how much tax they’re going to pay to see if the business is viable or not, if they’re going to hand the market to the contraband sector on a plate or not. And in 2023 we should intensify this debate”, he predicts.

In parallel

Among the CNCP discussions that were on the minutes of the meetings obtained by Joio, a subject that ran parallel to the Working Group stands out: the creation of a Special Committee on Cigarettes – deliberated less than a month before the WG was created.

The decision was made at the first Council meeting with Luciano Timm as president, in February 2019. But the work was unrelated to the WG, and its discussions did not involve taxation. Instead, they were proposals to combat smuggling which included the creation of an integrated intelligence system and stronger punitive measures, for example. 

Also at a CNCP meeting, a decision was made to expand the scope of the commission, which was renamed the Special Commission to Fight Smuggling. As with all special commissions, it was to have a maximum term of operation. But the Council members decided to make it a permanent space – in 2021, it became the Center for Contraband Monitoring (Núcleo de Acompanhamento do Contrabando).

But it was only in March of that year that someone pointed out a problem: “the rapporteur for the commission was Edson Vismona, a representative of the private sector. I raised the question: ‘Look, smuggling and embezzlement are notoriously matters of public interest, and the agency that holds the information and the main prerogatives for fighting contraband is the Internal Revenue Service’”, remembers auditor Alan Towersey. From that moment on, the agency started to conduct the Center’s operations – initially with Towersey himself as rapporteur, with auditor Thiago Morello later taking on the role.

The Center follows the numbers related to smuggling in general, such as arrests in flagrante delicto and seizures, and presents its reports and referral suggestions to the CNCP.