Almighty

During the sin tax debates last year, concern was raised over the possibility a steep rise in excise taxes could encourage massive smuggling. This outcome will distort the domestic market, produce super-profits for some, induce more corruption and generally deny government the revenues expected from excise taxation.

Revenues, not really public health, drives government policy on the sin taxes. The success of the policy will be measured by increments to public revenue rather than improvements in public health. This is why it is the Department of Finance rather than the Department of Health that reports on the progress of new excise taxes.

Some improvements in revenue collection have indeed been noted — although not impressive enough to overshadow the volumes of public funds lost to pork barrel politics.

When the specter of massive smuggling of sin products was raised last year, we imagined tons of contraband cigarettes being unloaded in isolated coastal areas in the dead of night. This was how it was done, after all, in the fifties and sixties when protectionist policies made smuggling well worth the risks.

In those simpler times, smugglers became powerful political brokers. They controlled entire provinces outright, maintained large private armies and intervened in national politics. They led storied lives of great wealth, indulging in ostentatious consumption while maintaining major politicians in their payroll (a la Napoles). They were the stuff of urban legend, glamorized or vilified in the movies.

These are, however, more sophisticated times.

There is really no need to bring in finished products in the dead of night, on lonely coastlines under the heavy guard of private armies. That stuff belongs to the old movies.

We have enough of the basic manufacturing capacity and a vulnerable Bureau of Customs to accomplish the same magnitude of super-profits by undervaluing imported inputs, working existing policies regarding imported goods destined for re-export, evading tariffs and excise taxes and other sophisticated means to defraud government. The same super-profits warlords used to make can now be made by accounting nerds.

Instead of relying on inefficient informal retail networks to disperse smuggled goods in the domestic market, the new brokers actually use the modern retail chains to dramatically capture market share.

This is what happened in the case of the local cigarette market. Since the new sin tax measures came into effect January this year, a small and previously negligible cigarette manufacturer based in Bulacan dramatically captured market share by selling its products at incredibly low prices.

This manufacturer, Mighty Corporation, selling cigarettes under the Mighty brand, captured a major portion of the domestic market. This was accomplished by seeming to sell at a loss. It arithmetic is, at best, suspicious.

Consider the arithmetic. The wholesale price of Mighty cigarettes is P14.70. Under the new sin tax regime, it is supposed to pay P12 per pack from the previous P2.72. In addition, it should (in principle) pay value added tax of P1.58 per pack. Discounting taxes due, Mighty nets only P1.12 for the product itself — the tobacco content, the filter, the packaging, the manufacturing overhead, warehousing and distribution costs, and income for the manufacturer and wholesalers.

It is either Mighty Corporation is incredibly efficient or our regulators are incredibly slack. This is a company that is selling its product at just over a peso per pack and apparently making money.

Mighty’s amazing business model has drawn the curiosity of the Secretary of Finance. He recently ordered both the heads of the BIR and the Bureau of Customs to “examine the questionable (import) entries, investigate the alleged smuggling of Mighty” and then to “proceed with the appropriate legal action on the findings.”

Initial inquiry shows that, according to BOC data (which might itself be incomplete), Mighty Corporation imported 10.616 million kilograms of tobacco leaves and exported 1.887 million kilograms as finished products and 361,615 kilograms as cut fillers. That leaves 8.367 million kilograms unaccounted for. Based on the conversion formula used by the Industrial Technology Development Institute, the unaccounted tobacco leaf could be used to manufacture 498 million packs of cigarettes.

The tobacco was brought in using a provision in the Tariff and Customs Code allowing tax- and duty-free importation of raw materials destined for re-export. If the tobacco brought in was not re-exported, Mighty Corporation owes government a huge amount in taxes and duties.

In addition, the DOF recently uncovered evidence Mighty Corporation illegally withdrew imported acetate tow (used for cigarette filters) from its bonded warehouses. This suggests the manufacturer has been producing more cigarettes than what it declared for taxation purposes.

Initial DOF computations using market analysis done by Nielsen Inc. indicate Mighty grossly under-declared its sales, avoiding the sin taxes due on the product. These computations indicate the manufacturer could have earned a whopping P2.2 billion in the first half of 2013 alone.

All in all, in taxes and duties alone, the company is estimated to owe government about P5 billion. If the computations could be supported by DOF, this will represent a major windfall for government — if collections could be made.

On the other hand, Mighty could be aboveboard after all. The company claims it is able to keep its low prices because it does not pay royalties, service or management fees. Because of that, it is able to make a killing out of selling cigarettes at just over a peso a pack. 

But if that is true, we might as well ask this almighty company to transform water into wine. That will surely make us an export superpower.