The taxman cometh

As more jurisdictions start taxing e-cigarettes, the vapor industry and its customers can only hope for reason and restraint in the world’s revenue departments.

By Shane MacGuill

Increasingly, global and regional governments appear willing to look to e-cigarette consumption as a source of public revenue, with taxation, particularly on e-liquid, becoming an ever more prominent policy issue in jurisdictions worldwide.

Of course, the drive to taxation is increasingly at odds with a more positive scientific view of the products from the health community—it is hard to reconcile the relatively safe, potentially lifesaving product described in the recent Public Health England report with almost any level of taxation, much less the tobacco-style taxation often mooted. Assuming the industry manages to sustain itself in the face of the restrictive regulatory developments that 2016 promises, what (perhaps even greater) challenges await in the form of excise taxation?

In most instances the rationale for taxation of e-cigarette products appears to be either administrative or speculative. In the case of the former, where e-cigarettes and vapor products have been legislated for “as tobacco,” the logic of excise taxation follows as night does day. (The Minnesota, USA, state revenue service advances the straightforward proposition: “E-cigarettes and e-juice are considered tobacco products and are subject to the tobacco tax.”) In the latter scenario, an explicit connection is made between dwindling tax revenue from combustible products and the need to “fill the gap” through taxation of products that are, at least in part, contributing to this decline.

For example, ruminating on the drop in Italian tobacco tax revenue, Giancarlo Scotta, member of the European Parliament, asked the EU Council in 2013 “what action it intends to take to address the differences in tax revenue materializing in state coffers following the proliferation of electronic cigarettes, which currently appear to be free from any form of duty.”

While these twin logics are potent drivers in themselves, it is a point of some optimism for the e-cigarette sector that, outside some nongovernmental organizations, there appears to be little outright support for e-cigarette sin taxation in itself—in other words, framing them as products that uniquely require disincentivization (rather than simply inheriting taxation as a function of a broader regulatory categorization). Indeed, there are encouraging signs that governments eventually may be willing (or may be forced) to tax along a continuum of risk in order to retain an advantage, of kinds, for e-cigarette and vapor products against their more harmful combustible competitors.

STILL SCARCE

Currently, only a few countries explicitly levy tax on e-cigarette or vapor products. Togo reportedly applies an ad valorem rate of 45 percent to the products, while in South Korea products containing nicotine fall under the purview of Ministry of Strategy and Finance and are taxed at an elevated level of around $1.50 per milliliter of liquid. In the EU, Italy and Portugal have also experimented with e-cigarette taxation.

In the absence of federal regulation and direction, a number of U.S. state legislatures have sought to pass e-liquid taxes. Most of them have failed. While some states have passed e-cigarette taxation, sometimes at substantial levels (67 percent rate on all products in Washington, D.C., for example), others have rejected excise or in certain cases actively sought to protect e-cigarettes from taxation. If consensus on e-cigarette taxation appears difficult to achieve at a state level, the trend to impose excise on vapor has moved to the municipal level as the city council of Chicago, Illinois, USA, prepares to adopt a tax of $1.25 per cartridge and $0.25 per milliliter of e-liquid, as proposed by Mayor Rahm Emanuel.

BACKFIRING IN PORTUGAL AND ITALY

In this respect, where Chicago leads, other large U.S. cities and international jurisdictions are likely to follow with predictably deleterious results. While the effect of taxation on liquid nicotine in Korea is perhaps obscured by the length of time it has been in place—and indeed, huge recent excise increases on tobacco mean that consumption of e-cigarettes is surging there—the impact of taxation on an established, developing vapor market can be seen in the only other two markets that currently apply excise to the products.

At the end of 2014, Portugal imposed taxation of €0.60 ($0.64) per milliliter of e-liquid—in many cases, more than doubling the price per bottle to the consumer. Virtually overnight, the market for e-liquid, which had seen huge growth in 2014, collapsed, with expectations that it contracted well over 75 percent by the end of 2015.

In Italy, meanwhile, after several years of substantial growth during which the user base swelled to some 750,000 vapers by 2013, the imposition of an excise tax has had a substantial impact on the market. The tax was initially set at an outright 58.5 percent in mid-2014, and then a rate of 50 percent of the “tobacco equivalent” was imposed in its stead (after the earlier “tobacco-comparable” rate was suspended following a—ultimately successful—legal challenge).

Between 2013 and 2014 the Italian e-cigarette market lost some 40 percent of its value, and while it is now showing signs of stabilizing (and the current “tobacco equivalent” rate is likely also to be challenged), the advent of the revised Tobacco Products Directive (TPD2) in 2016 promises fresh difficulties. It should be noted that the success of the legal challenge to direct comparison, in effect a validation of a graduated excise regime, is a positive to emerge from the Italian experience.

FRAGMENTATION IN THE NEAR TERM

A further cause of some hope (at least in regard to the overall impact of taxation) is the immediate likelihood that e-cigarette taxation will remain fragmented and geographically limited. While a measure like the impending Chicago tax would undoubtedly make life difficult, if not impossible, for vape stores in the affected urban areas, it would arguably have little impact on the consumption of consumers, because in the absence of a wider state or federal measure, consumers will simply travel to acquire tax-free products or order from vendors online. The same is undoubtedly true of the world’s second largest e-cigarette region—Europe—where individual country taxes like those in Portugal and Italy may be less impactful than an EU-wide measure reportedly being investigated by the EU’s Fiscalis project (and for which Article 20 of the TPD2 may well lay the groundwork).

There are a range of markets globally where e-cigarette products are either explicitly banned for all commercial sale (e.g., Brazil, Mexico, Turkey) or where a twin-track approach exists (e.g., Australia, Mexico, Scandinavia). In the latter markets, often nicotine-free products are widely available while nicotine e-liquid cartridges and refills are banned or nicotine-containing cartridges and products require a medicinal license (which in most cases amounts to a de facto ban). It is reasonable to suggest that developments in these markets could serve as a proxy for developments in markets where products are made less accessible through the imposition of taxation.

BENEFITTING COMBUSTIBLES AND ILLICITS

Demand for vapor products, most of which are manufactured in China and distributed online, is surging. Restrictions on their availability and affordability are sustaining consumption of combustible products and creating a black market for e-cigarette products and nicotine liquids. As demand grows and restrictions and taxation increase, this phenomenon is likely to become a substantial challenge for authorities, as well as the vapor and tobacco industries.

Surveys in the U.K. and the U.S. indicate that a large minority of e-cigarette users use e-cigarettes to save money. Eliminating the cost advantage of vapor products versus combustible tobacco through the levying of excise would have a predictable impact on the balance of consumption between the categories.

TWIN CERTAINTIES

Further, one can foresee informal markets developing. In July 2014, the results of an E-Cigarette Forum survey suggested that about 80 percent of e-cigarette users would “look to the black market” if products they used were banned. It is reasonable to extrapolate from this expressed inclination that, to some extent, the same would be true if products were rendered less accessible through taxation.

Reports suggest that markets such as Denmark, where nicotine-containing e-liquid is banned, already boast black markets in the products, an effective illicit trade in e-liquids. Anti-illicit enforcement would be made difficult by the fact that products required for e-cigarette use can be reduced to components that, individually, authorities may not be able or want to restrict.

We appear to be left then with a dual set of certainties. In the absence of a rapid (and unlikely) official recognition of the potentially substantial public health benefits of the wider availability and use of e-cigarette products, governments will lurch toward the default application of excise on the category. The second certainty—that the sector will be impacted—is a truism, qualified only by the possibility that enlightened governance in this respect may be limited to the level of variation in rates as against combustible products.

Shane MacGuill is senior tobacco analyst at Euromonitor International, a market intelligence firm.