Eliminating Duty-free Tobacco—What Went Wrong?

International commitments to curb duty-free sales of tobacco under the Framework Convention for Tobacco Control have been largely ineffective, despite their potential to contribute to tobacco control as well as fiscal goals. The downturn in international travel and duty-free sales during the Covid-19 pandemic provides a window of opportunity for policy makers to remedy the situation. This would generate additional tobacco tax revenues of $7 billion a year which could help finance the Covid-19 fiscal response.

The problem—duty free tobacco is a glaring tax anomaly that undermines public health goals, erodes tax revenues, and encourages illicit trade of tobacco products.

Despite 8 million premature deaths per year attributable to tobacco-related diseases and 1.4 percent of global GDP in annual health costs and productivity losses from tobacco-related illnesses, tobacco products are still sold tax-free in almost all international airports. Worldwide duty-free sales of tobacco products were US$8 billion in 2018 and rising. (Here, we focus only on restricting or eliminating duty-free tobacco sales to travelers. We do not discuss the commercial export of tobacco products duty-free, tobacco imported to free trade zones, duty-free sales to diplomats allowed under the Vienna Convention, or on transport in international territory, e.g. cruise ships.)

These sales benefit from a tax loophole created in concession areas created to sell goods to outbound international travelers. As the international norm is that sales taxes and excises are levied in the country of consumption (see OECD guidelines and WTO rules) these sales to travelers heading to other countries are tax free.  However, at the destination almost all countries allow duty-free importation of tobacco up to a limit—so no taxes are paid at either origin or destination.

This glaring anomaly is wrong on many levels, it:

• Undermines national public health and tobacco control goals as duty-free sales are less regulated than duty-paid sales in terms of product packaging and product promotion. As one observer remarks: “airports may represent one of the last remaining havens for the tobacco industry”;
• Provides a large regressive subsidy to consumption of a product that is known to be harmful to consumers. The subsidy largely benefits high-income individuals who travel far more than low-income individuals;
• Reduces tobacco tax revenues by about US$7 billion per year.* On average, taxes on duty paid tobacco are about half of the retail price. To put the lost revenue in perspective, it is estimated that the global funding gap for tobacco demand-reducing  strategies is less than US$2 billion per year;
• Fosters illicit trade. While duty-free sales are intended for personal consumption, they also incentivize black market sales, undercutting destination country efforts to tax tobacco. For example, traders cross from Peru to Chile several times a day making use of the legal allowance each time and resell on the illicit market.

The solution—international and national efforts to restrict duty-free tobacco

The 182 countries accounting for more than 90 percent of world population have ratified the 2005 World Health Organization Framework Convention on Tobacco Control (FCTC). This inter-governmental agreement recognizes the importance of implementing tax and price policies on tobacco products to reduce tobacco consumption. As regards tax-free sales, the FCTC recognizes the sovereign right of countries to determine tax policies while taking account of national health objectives and recommends to:

“adopt or maintain measures which may include … prohibiting or restricting, as appropriate, sales to and/or importations by international travellers of tax- and duty-free tobacco products. (Article 6. 2(b))”

Yet to date there has been remarkably slow progress in implementing tax policies aimed at reducing or eliminating duty-free tobacco consumption, perhaps in part because the recommendation sets a low bar. While WHO reports that 64 percent of all Parties (to the FCTC) have prohibited or restricted imports of tax and duty free tobacco products by international travelers, almost all these restrictions predate the FCTC and there is no systematic monitoring of progress on this commitment.

Policy choices

The most direct approach to tackling duty-free tobacco is to eliminate duty free allowances for tobacco importation. Four countries do not allow duty-free importation (Barbados, Brunei, Djibouti, and Sri Lanka), as well as Bhutan which prohibited all cigarette imports until the outbreak of Covid-19.  Another five allow limited amounts of up to 50 duty-free cigarettes (Australia, New Zealand, Palau, Romania, and Singapore). The remaining 159 jurisdictions for which data is available typically allow 200 cigarettes or tobacco equivalent of duty-free imports or more. (Figure 1).

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Source: https://www.shopdutyfree.com/en/custom-allowances

From the export angle, governments have the authority to decide what can and cannot be sold in duty-free concessions either through regulations or legislation. For example, the United Kingdom removed duty-free sales of electronics, clothing, bags and fragrances (but not tobacco) in the run-up to Brexit. Only Australia, Brunei, Hong Kong, New Zealand, Singapore, and Sri Lanka have removed tobacco products from the list of goods that may be sold duty-free at airports.

What explains the widespread failure to act upon FCTC commitments on duty-free tobacco? 

In general, a majority of non-smokers and a significant proportion of smokers support higher cigarette taxes. Support for higher taxes increases if they are linked to health promotion or tobacco control initiatives. Nonetheless, removing duty-free sales of tobacco is not likely to be popular as it represents a longstanding perk for travelers.

On the import side, the main argument against eliminating duty-free allowances is that it would be costly to levy small duties on duty-free imports. But this argument does not stand up to scrutiny as customs officials need to enforce duty-free allowances ceilings just as much as a prohibition of duty-free imports. A fixed penalty for duty-free tobacco importation would be an important deterrent, as adopted in Hong Kong.

Strong opposition to the removal of duty-free sales on the export side comes from duty-free retailers and airport authorities because duty-free stores only partially pass-through the tax saving to consumers, allowing relatively high sales margins and profits. Airports share in these profits through the rents they charge to duty-free retailers (See Box 1). Even if airports need subsidies to continue to operate—and it is unclear why they should—the use of non-transparent duty-free sales is not the best fiscal instrument to use.

Another argument used by duty-free retailers—without evidence—is that the sale of tobacco leads to additional non-tobacco sales. Of course, the counter argument would be that non-tobacco duty-free goods for sale leads to incidental—or impulsive—purchases of tobacco.

Could eliminating duty-free tobacco help fund the Covid-19 fiscal response?

There are many good reasons to abolish duty-free sales and imports of tobacco: to signal the health benefits of tobacco cessation; to remove less regulated tobacco sales in airports; to raise additional tax revenues; and provide a level playing field for numerous domestic (duty-paid) tobacco retailers which are typically small businesses; and remove incentives for illicit tobacco trade.

Counter arguments appear largely unsubstantiated or unfounded: that retail employment would suffer; that airports need a tax subsidy from duty-free sales; or that it is administratively costly to enforce payment of taxes on duty-free imports.

The Covid-19 pandemic has dramatically reduced international air travel. 2020 duty-free sales are down by 65-75 percent which means governments are already reaping additional tobacco taxes from duty paid purchases. Eliminating duty free sales/imports would raise about US$ 7 billion a year in additional tobacco taxes—sufficient to nearly cover the US$ 7.8 billion 2021 funding shortfall for tests, vaccines, and monoclonal antibodies for poor countries under the Access to COVID-19 Tools Accelerator (ACT-A).

Additional countries should follow the example of countries and territories like Australia, Hong Kong, New Zealand, Romania, Singapore, and Sri Lanka that have stopped their airports being used as a haven for tobacco companies, and help fund the needed fiscal response to Covid-19.

The author gratefully acknowledges research support from Eleni Smitham.

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*Estimate for 2018 duty free tobacco sales of US$8 billion. Assumes a retail mark-up of 25 percent on tax free product and that foregone taxed sales have a tax share of 52.4 percent of the retail tax-included price which is the estimated average global tax share for most-sold brands of cigarettes by country (from Tobacconomics Cigarette Tax Scorecard).