Within a sensible tax regime, fine-cut tobacco works as a fender between factory-made cigarettes and the black tobacco market.
By Stefanie Rossel
In the nicotine ecosystem, fine-cut tobacco (FCT) fulfils an important function: More affordable than higher taxed factory-made cigarettes (FMC), it serves as a buffer between the latter and illicit smokes. For the past decade, however, sales of FCT have declined in line with those of FMC.
Across the European Union, home to some of the world’s leading markets for roll-your-own and make-your-own products, FCT consumption stood at 78,638 tons in 2021, down from 80,986 tons in 2020, according to the EU Commission. Germany led the European FCT market with a volume of 25,727 tons in 2021 compared with 26,328 tons in the previous year. Other major markets in 2021 were France (7,288 tons), Spain (6,219 tons), Italy (5,303 tons) and Belgium (5,036 tons). Each of them witnessed declines compared to 2020.
Due to the heterogeneous nature of the EU hand-rolling tobacco market, it is difficult to identify a unionwide FCT trend, according to Peter van der Mark, secretary general of the European Smoking Tobacco Association (ESTA). “The fine-cut tobacco market in Europe is characterized by a variety of very different markets, each with its specificities and level of maturity,” he told Tobacco Reporter in a recent conversation. “If one should, however, try and capture a general trend, I believe best is to say that FCT has been unstable with more ups and downs since we last talked than during the past 10 years during which the trend was a slow but steady decline.”
The ESTA observed that in mature FCT markets, such as the Netherlands, Germany, Belgium or France, the decline was sharper than elsewhere. Although recent economic conditions may have temporarily slowed down this decline, there is reason to believe the accelerated downward trend will continue in those markets, according to the trade group.
Van der Mark doubts that recent developments, such as the introduction of novel products such as nicotine pouches, has significantly changed the tobacco market in Europe. Meanwhile, the impact of Covid and the sanitary or economic measures to counter the pandemic depended heavily on the price levels of tobacco products.
“For example, we witnessed in many markets that FCT fully fulfilled its buffer function, especially following border closures,” says van der Mark. “In France, for instance, consumers could no longer access cheaper cross-border cigarettes or illicit ones. As a result, FCT sales went up significantly during that period, capturing consumers that otherwise do not source their tobacco on the French legal market. This, however, was very conjunctural as sales immediately reverted to ‘normal’ levels when travel restrictions were lifted. It was also not a phenomenon occurring in all member states but one linked to where an extensive parallel market existed—the higher [the typical sales in the parallel market], the more sudden was the shift toward FCT.”
Observations also confirm the buffer function of FCT in the economic crisis brought about by Russia’s invasion of Ukraine, according to van der Mark. “The downturn and inflationary period already put—and continues doing so—consumers’ disposable incomes under pressure to varying extents from one country to another,” he says. “When faced with higher budgetary constraints—and provided that FCT is taxed appropriately—consumers are more likely to switch to FCT. The alternative is that outpriced consumers source their tobacco outside of the legal domestic market. Our forecast therefore is that FCT sales will continue to slightly grow in countries where FCT taxation is not prohibitively high in comparison to cigarettes and that in other cases, consumption of nonduty-paid cigarettes will rise.”
France provided a case study of what happens when the buffer of fine-cut tobacco is removed. A major tax hike in 2020 caused the fiscal burden on FCT to rise far more than that of cigarettes, providing a significant boost to the country’s illicit cigarette market. According to KPMG, France remains the EU’s largest illicit cigarette market, with illegal sales of 15.1 billion sticks, or 29 percent of total domestic consumption, in 2021.
“The differential is not large enough anymore to ensure FCT can be seen as a valuable legal alternative for outpriced consumers, hence the ‘new heights’ in illicit trade,” says van der Mark. “As a result, French authorities have been grappling recently with illicit factories producing cigarettes on the French territory whilst this phenomenon was initially limited to eastern and central Europe. Last year, it was reported that about 100 illicit factories were dismantled throughout the union in 2021 alone, with most of their production, cigarettes, being destined to markets such as France or the U.K.”
Encouragingly, there are signs that French authorities are starting to appreciate how their fiscal policy is impacting revenues and disrupting health objectives. “After the experience of Covid, the French Assembly made a report on the size of the parallel market,” says van der Mark. “Interestingly, the report describes nothing else but the FCT buffer function, but it has a hard time acknowledging it.”
Van der Mark expects to see a similar rise of illicit cigarettes in the U.K. The country, which is no longer an EU member, remains an important market for fine-cut tobacco. Under the cost-of-living crisis the U.K. is currently experiencing, RYO products have come to account for 46 percent of the country’s tobacco market. In mid-March 2023, the U.K. raised cigarette taxes by 10.1 percent in line with the retail price index plus an additional 2 percent, bumping the price of a pack of 20 cigarettes to more than £14 ($17.39). Duty on hand-rolling tobacco was increased by 10.1 percent plus an additional 6 percent.
“It is not the first time that U.K. authorities establish an ‘escalator’ policy like this, each time leading to increased illicit trade and increased tax gaps and usually leading to authorities halting that policy after a few years,” observes van der Mark, citing a study by London Economics commissioned by the ESTA. The country has some of the highest FCT duties in Europe. In 2004–2005, these contributed to FCT illicit trade levels of up to 62 percent, according to the report. Following increased enforcement activities and more moderate duty increases, the illicit trade in FCT dropped to 28 percent—a record low—in 2016–2017. “There is no reason to believe that this policy being a mistake in the past will not be another one now,” says van der Mark.
By contrast, Germany’s tax model has reduced smoking prevalence while containing demand for illicit products, according to van der Mark. In January 2022, the country’s Tobacco Tax Modernization Act entered into force. It includes a four-stage tax increase between 2022 and 2026. Excise on fine-cut tobacco will increase between €0.13 and €0.16 per year whereas the average tax hike for a pack of 20 factory-made cigarettes will be €0.08. According to the German Federal Office of Statistics, the volume of duty-paid FCT rose by 0.9 percent in 2022 despite the tax hike compared to the previous year while sales of FMCs decreased by 6 billion units, or 8.3 percent, during the same period.
“If we compare the tax increase on a 1 gram versus 1 stick basis, which is the approach enshrined in the excise directive, the tax differential is essentially maintained throughout the period, specifically to allow FCT to fulfill its buffer function,” says Van der Mark.
A Hurdle for Exports
It remains unclear how the EU will tax FCT in the future. The European Commission failed to propose an expected update to the 2011 EU tobacco tax directive in December. Instead, leaked documents gave some indications of the commission’s intentions (see “A Blunt Tool,” Tobacco Reporter, February 2023).
Rumors suggest that the commission’s proposal sought to align the FCT minimum tax rate with that of cigarettes and that these minimum rates would be adapted to each member state’s level of affordability. “Obviously, we believe such a proposal would have severely impacted the FCT markets considering it would have forced a number of countries to ignore a tax differential above the minimum rates, leading to increases of illicit trade as was experienced in the countries that adopted such an approach, such as France, the U.K., Netherlands, Greece or Ireland,” says van der Mark.
Taxation aside, the FCT sector is still struggling with another issue: In line with the EU Tobacco Products Directive’s track-and-trace requirements, EU-made tobacco products must now carry an EU code regardless of the regulations and labeling obligations in the destination market. “If the destination market has a different and noninteroperable traceability system, this heavily disrupts production, increases cost, creates distribution hassles and as a result significantly disadvantages EU companies,” says van der Mark.
“As of May 2024, the scope of the EU traceability regime will be extended to other (niche) tobacco products. Some of them, such as pipe tobacco products, are typically manufactured in Europe and exported all over the world. At the same time, the World Health Organization Framework Convention on Tobacco Control and anti-illicit trade protocol require all parties to adopt a traceability regime but does nothing to ensure these systems are interoperable. Therefore, we do expect this issue to become more and more prominent,” says van der Mark.
In March 2023, the EU Commission published an implementation regulation amending the previous one for the functioning of the EU system. “This was obviously the opportunity to provide export products with more flexibility, but the commission refused to do so,” says van der Mark. “As you can imagine, this amended Implementing Act was developed by the commission without conducting a single evaluation before and without allowing for a discussion with the relevant stakeholders.
“Interestingly, whilst the commission always claimed that track and trace was about stopping illicit trade, the commissioner recently replied to a parliamentary question by stating that ‘the system does not provide any information on the illicit trade of these products.’ To us, this shows that the system was adopted and designed based on the assumption that the industry itself was organizing illicit trade—that policy choices were made with complete disregard for the impacts on smaller companies.”
The commission’s recent insistence that the system is not about illicit trade, says van der Mark, suggests it has realized its initial assumptions were wrong.