We use a 5-step model-based bottom-up method to estimate the tobacco tax gap. This approach considers the different ways tobacco can make it onto the Australian market and estimates the amount of illicit tobacco in each channel.
Overview
This approach is the most suitable given the body of cross-agency seizure data available. Data is sourced from:
- Home Affairs – international sea and air cargo and international post supply channels
- ATO – domestic chop-chop manufacture
- ATO and Home Affairs – customs warehouses (reflecting the involvement of both agencies in administering this part of the system).
Figure 2: Administrative responsibility and supply channels for illicit tobacco
Step 1: Estimate illicit tobacco arriving through importation
We estimate how much illicit tobacco is imported in the following 3 parts. Then we add the parts together to estimate the net amount before any seizures.
Volume of undetected illicit tobacco making it to the market
The Australian Border Force (ABF) provided intelligence for 2015–16 on tobacco seizures that excluded targeted detections and high-risk seizures. We used this to inform the volume of undetected illicit tobacco making it to the market.
Each subsequent year we use the total of undetected imported illicit tobacco that made it to market from the previous year as a base. That is done by combining steps 3 and 5. We adjust this quantity based on comparing illicit to legal purchase prices. A widening price gap indicates illicit tobacco supply is increasing.
Substitution for illicit supply lost through moving the taxing point upstream
These changes have effectively eliminated duty evaded through the warehousing system from 2018–19 onwards. But the availability of illicit tobacco is increasing. This demonstrates that suppliers have expanded through existing channels.
We have reflected this by increasing the undetected illicit tobacco in the importation channel by some of the illicit tobacco previously supplied through warehousing. See step 3 for detail.
Illicit tobacco seizures by ABF
This is the actual volume of illicit tobacco detected and seized by ABF.
Step 2: Estimate the size of domestic chop-chop cultivation
Licences are no longer issued for tobacco manufacture in Australia for either commercial or personal use. All tobacco grown in Australia is illicit.
We are responsible for managing the domestic manufacture of tobacco. We conduct crop seizures in partnership with other agencies such as the ABF and state police.
We estimate the tobacco supplied in this channel in 2 parts.
In the first part, we analyse the value of seizures, risk and intelligence referrals and create an uplift factor. This covers domestically manufactured tobacco that has not been detected or reported to authorities. We develop this uplift through referencing under-reporting of crime statistics from the Australian Institute of CriminologyExternal Link.
In the second part, we substitute for illicit supply lost through moving the taxing point upstream from warehousing to point of importation. These changes have effectively eliminated duty evaded through the warehousing system from 2018–19 onwards. But the availability of illicit tobacco is increasing. This demonstrates that suppliers have expanded through existing channels.
We have reflected this by increasing the undetected illicit tobacco in the domestic manufacture channel by some of the illicit tobacco previously supplied through warehousing. See step 3 for detail.
Step 3: Analyse the licensed warehouse system
Before July 2019 most tobacco duty on imports was deferred until it exited a licensed warehouse. Goods that entered ‘underbond’ were held in the warehouse system and the duty was payable when it left the warehouse.
While the tobacco was legally imported, duty evasion could occur when it entered the warehouse system but exited without duty being paid. It could occur because of:
- theft
- goods for export being diverted
- incorrect weights recorded during importation.
We would do an inventory reconciliation to understand the size of the problem.
From 1 July 2019, importers can no longer transfer tobacco into a bonded warehouse. They now must pay all duty and tax liabilities when tobacco enters the country.
These changes have effectively eliminated duty evaded through the warehousing system from 2018–19 onwards. But the availability of illicit tobacco is increasing. This demonstrates that suppliers have expanded through existing channels.
We have increased illicit tobacco supplied through the other channels to reflect this. See steps 1 and 2.
We did not increase it by the full amount that had previously been lost through the warehousing system. This is because some illicit suppliers would have stopped their activity when another channel was not available.
Step 4: Compare total illicit amounts to legal clearances
We combine the estimates from steps 1 to 3 to get the total of illicit tobacco from all the supply channels in Australia.
In total, 7,736 tonnes of tobacco were legally cleared in 2022–23. Adding the illicit amount gives the amount theoretically subject to tobacco duty.
A portion of this would not be realistically recoverable even if the illicit market was eliminated. This is because illicit tobacco smokers would likely smoke less if they had to buy more expensive legal tobacco.
Step 5: Deduct seizures to determine net gap
In this step we deduct the total of ATO and ABF illicit tobacco seizures from the gross gap to determine the net gap. This includes seizures across the sea and air cargo channels, international post and domestic crop destructions.
Summary of the estimation process
Table 2 shows each step of the estimation process. The results are given by tonnes and dollar value, as well as the gross and net gap percentages.
|
Step |
Description |
2016–17 |
2017–18 |
2018–19 |
2019–20 |
2020–21 |
2021–22 |
2022–23 |
|---|---|---|---|---|---|---|---|---|
|
1a |
Estimate of illicit tobacco importations (tonnes) |
878 |
978 |
1,367 |
1,375 |
2,299 |
2,881 |
3,532 |
|
1b |
Estimate of illicit tobacco importations ($m) |
659 |
866 |
1,441 |
1,739 |
3,522 |
4,606 |
5,783 |
|
2a |
Estimate of illicit domestic chop-chop cultivation (tonnes) |
195 |
281 |
287 |
300 |
306 |
374 |
302 |
|
2b |
Estimate of illicit domestic chop-chop cultivation ($m) |
146 |
248 |
302 |
379 |
469 |
598 |
495 |
|
3a |
Analysis of licensed warehouse leakages (tonnes) |
233 |
222 |
0 |
0 |
0 |
0 |
0 |
|
3b |
Analysis of licensed warehouse leakages ($m) |
175 |
196 |
0 |
0 |
0 |
0 |
0 |
|
4a |
Gross gap (total Step 1–3) (tonnes) |
1,305 |
1,481 |
1,654 |
1,675 |
2,605 |
3,255 |
3,834 |
|
4b |
Gross gap (total Step 1–3) ($m) |
980 |
1,310 |
1,744 |
2,118 |
3,991 |
5,203 |
6,278 |
|
4c |
Legal clearances of tobacco (tonnes) |
14,135 |
13,464 |
11,520 |
10,110 |
9,310 |
7,918 |
7,736 |
|
4d |
Legal clearances of tobacco ($m) |
10,612 |
11,914 |
12,147 |
12,781 |
14,264 |
12,659 |
12,667 |
|
4e |
Total theoretical clearances of tobacco (tonnes) |
15,440 |
14,945 |
13,174 |
11,785 |
11,915 |
11,173 |
11,571 |
|
4f |
Total theoretical clearances of tobacco ($m) |
11,592 |
13,224 |
13,891 |
14,899 |
18,255 |
17,862 |
18,945 |
|
5a |
Seizures and compliance outcomes (tonnes) |
478 |
535 |
671 |
620 |
1,364 |
1,789 |
2,179 |
|
5b |
Seizures and compliance outcomes ($m) |
359 |
473 |
708 |
784 |
2,090 |
2,860 |
3,567 |
|
5c |
Net gap (Gross gap less seizures and compliance) (tonnes) |
827 |
946 |
983 |
1,056 |
1,241 |
1,466 |
1,656 |
|
5d |
Net gap (Gross gap less seizures and compliance) ($m) |
621 |
837 |
1,036 |
1,334 |
1,901 |
2,343 |
2,711 |
|
5e |
Gross gap ($m) (%) |
8.5% |
9.9% |
12.6% |
14.2% |
21.9% |
29.1% |
33.1% |
|
5f |
Net gap ($m) (%) |
5.4% |
6.3% |
7.5% |
9.0% |
10.4% |
13.1% |
14.3% |
Limitations
For each of the 3 core components of the model, the following limitations apply:
Sea, air and international post statistical model
The methodology assumes the sampling data set is a truly random sample. Where the sampling method has changed from the original design, the methodology analyses the relationship differences between the historic and current intervention activities.
Domestic chop-chop analysis
The revenue forgone figure is approximate given the high-level nature of some of the referrals. Judgment is required regarding the likely yield for given acreages under cultivation. This includes plant spacing, the quality of crop management regarding fertiliser and pesticides and the quality of seed.
Warehouse analysis
Included for historical purposes. Previously warehouse analysis was contingent on the quality of data entry by each warehouse licensee or customs broker. Keying or inventory errors may affect the result. This reconciliation may not detect under-reporting of physical quantities of tobacco into the data system.
Pricing
The calculation of the available illicit tobacco in the market relies on the relative price differences between legal and illicit tobacco.
Legal tobacco market suppliers
The revenue integrity of large tobacco companies is monitored through transaction assurance warehouse checks, our client relationship management framework and continuing intelligence and monitoring activities. We assume any excise lost from legal market suppliers is immaterial.
Theoretical tax
Tobacco excise duty realistically recoverable
We recognise that illicit tobacco smokers may smoke less if they must pay the higher legal price that includes tobacco duty. This would impact on the amount of tobacco duty realistically recoverable if the illicit market was eliminated.
Gross gap is the amount of illicit tobacco attempting to enter the market.
If all work to combat illicit tobacco stopped, it is likely that the same volume of illicit tobacco would outstrip consumer demand and the profits would fall making it less attractive for illicit suppliers.
Likewise, if all tobacco attempted to enter the market was legal the volume would decline. This is because the profits would decline due to excise duty paid. We see behaviour in the fall of legal importations over the last 7 years.
See our glossary of terms used in tax gaps.
Updates and revisions to previous estimates
Each year we refresh our estimates in line with the annual report. Changes from previously published estimates occur for a variety of reasons, including:
- improvements in methodology
- revisions to data
- additional information becoming available.
The ATO is assessing additional information to supplement analysis of the tobacco market. We expect this to shore up for inclusion in future gap estimates.
The 2022 Program version revised the estimates for the previous 3 years. This considered the change in methodology regarding tobacco previously considered lost through the warehousing system. The change pushed up both the net and gross estimates. No further methodology changes have occurred in the following year's Programs.
Figure 3 shows the net gap from our current model compared to the previous estimate.
Figure 3: Current and previous tobacco duty tax gap estimates, 2015–16 to 2022–23
|
|
2015-16 |
2016–17 |
2017–18 |
2018–19 |
2019–20 |
2020–21 |
2021-22 |
2022-23 |
|---|---|---|---|---|---|---|---|---|
|
2024 program |
4.9 |
5.4 |
6.3 |
7.5 |
9 |
10.4 |
13.1 |
14.3 |
|
2023 program |
4.9 |
5.4 |
6.3 |
7.5 |
9 |
10.4 |
13.1 |
n/a |
|
2022 program |
4.9 |
5.4 |
6.3 |
7.5 |
8.9 |
10.4 |
n/a |
n/a |
|
2021 program |
4.9 |
5.4 |
6.3 |
6.3 |
6.2 |
n/a |
n/a |
n/a |
|
2020 program |
4.9 |
6.6 |
6.5 |
6 |
n/a |
n/a |
n/a |
n/a |
|
2019 program |
5.5 |
5 |
5 |
n/a |
n/a |
n/a |
n/a |
n/a |
|
2018 program |
5.6 |
n/a |
n/a |
n/a |
n/a |
n/a |
n/a |
n/a |