Author: João Sicsú

Source: Valor Econômico - São Paulo / SP - OPINION - 31/05/2010

The strengthening of the State through the hiring of personnel and the acquisition of equipment is of interest to all of society. To justify this statement, it is enough to deal with a case that is just a sample of the portrait of different sectors of the Brazilian economy.

The cigarette market in Brazil consists of two parts: the formal and the smuggled products. The size of the latter is 20% of the total market. His cigarettes are manufactured in Paraguay and sold in Brazil. They have an affordable price and good looking packaging. The smuggled cigarette has very low quality and, therefore, causes damage to health to a greater extent.

The contraband cigarette does not only cause damage to its consumer. The consumption of a smuggled item causes what economists call negative externality. Externality means the broadest result of an isolated attitude. When the consumer buys a contraband product he evaluates that he won (because he bought an item at a lower price) and the seller also evaluates that he won (because he obtained extra profit, since he will not pay taxes). However, this microeconomic transaction causes, for example, a reduction in tax collection and encourages the establishment of a wide informal network of transport and distribution of smuggled products in retail. So, it is said that the externality is of the negative type.

There is a cost for the production and distribution of smuggled cigarettes in Brazil. Therefore, when the price of cigarettes in the formal market rises, the incentive for smuggling increases, since competing items, legal cigarettes and smuggled cigarettes, are substitute goods. A figure that could represent this situation would be one that describes the formal cigarette market as a market surrounded by walls to prevent invaders from entering. But when prices in the formal market go up, it is as if they received a horse from Troia: their sales volume decreases because the invaders can now charge higher prices and then occupy part of the market and exterminate formal activity.

Statistical tests have already demonstrated the effects described. The price elasticity of formal market demand is negative, that is, an increase in the price of legal cigarettes causes a reduction in the size of its market. The price elasticity of demand in the informal market was also measured by these tests. She is positive. Therefore, increases in prices for cigarettes in the formal market cause an increase in the size of the smuggled cigarette market. The broader effects of an increase in the price of legal cigarettes have not yet been calculated. A possible effect that is worth highlighting: according to IBGE data, formal employment in the tobacco industry has dropped approximately 30% from 2005 to the present day.

It is in this context that anti-smoking policies are applied. The best known policy of this nature is the increase in tax and contribution rates. The average ICMS rate showed a slight increase between 2000 and 2007. In January 2000 it was 25%; today, it is 25,7%. PIS-Cofins increased in 2009 from 6,36% to 10,97%. In 2009, the cheapest cigarettes paid R $ 0,619 of IPI per packet; today, they collect R $ 0,764. The most expensive cigarettes paid R $ 1,131 that same year; today, they pay R $ 1,397. The average prices of cigarettes in the formal market are also readjusted as a result of the increase in these rates. More than 2005% were readjusted in real terms from 2010 to 40. The result is obvious: there was an increase in cigarette smuggling.

The cigarette market in Brazil has specificities. It is a market that causes discomfort for those who usually apply standard theories to understand a reality that has become very complex. Economists called by Luis Nassif “spreadsheet heads” would certainly think that: 1- an increase in prices in an oligopolized structure, where two companies have more than 90% of the formal market, would not reduce the volume of their sales and 2- The consumer substitutes goods that are the same or similar (such as margarine and butter), but would not substitute goods of quality as distinct as cigarettes manufactured by national companies and Paraguayan cigarettes.

One conclusion is that consumers are not as rational as they would be for the proper functioning of economies. In this sense, for whatever reason you want - to protect the collection of taxes and contributions, the profits of companies, formal employment or to increase the effectiveness of anti-smoking policies - there is only one alternative: to combat smuggling through inspection and the action of the federal police. Therefore, to meet the interests of companies (sales and profits), workers (jobs and wages) and government / society (collection and anti-smoking), it is necessary to hire inspectors, federal police officers and equip their institutions so that they can reduce cigarette smuggling. - since consumers make the substitution that “spreadsheet heads” do not believe.

This is just one example that shows that state qualification is a necessity for all social segments.

João Sicsú is director of Studies and Macroeconomic Policies at IPEA and professor-doctor at the Institute of Economics at UFRJ.