Duty Free

By Eric Crampton 29/11/2013


Otago’s Richard Edwards wants to close the “loophole” allowing duty-free import of tobacco and costing the country millions in lost excise revenue. Let’s look at this from first principles.

First, recall that excise is imposed not for the purpose of revenue generation, but rather (ideally) as a quasi-Pigovean charge to internalise external costs of consumption, noting however that current tobacco excise is roughly three times any cost smokers impose on the government through the public health system. “Lost revenue” matters a lot less than whether we’ve messed up relative prices.

Visitors to New Zealand bringing tobacco or alcohol products with them for their own consumption while here should not be subject to excise taxation on those imports where excise is intended to defray the costs to the public health system involved with the consumption of those products. Tourists will go home and eventually potentially impose costs on their own public health systems for tobacco consumed while here, but are not likely to impose costs in New Zealand. Alcohol could potentially lead to the imposition of social cost if someone flies here, gets drunk, and does silly things. We then need a balancing between the expected social cost per unit import and the cost of collecting duties and tariffs at point of import. Excise on spirits is $50 per litre of pure alcohol; the duty-free concession is three bottles of spirits that would likely contain about 1.35 litres of pure alcohol, or $67.50 in tariff. A very small portion of that would represent potential expected costs that could be imposed on the New Zealand government through the consumption of the imported product by foreign tourists. But note too that we make many other concessions to foreign visitors because the cost of charging them would be a hassle. Tourists are given free coverage for minimal accident treatment by ACC without paying premiums despite that a small ACC levy imposed at the border would be pretty straightforward. Any of these measures that slow down processing at the border and annoy tourists risk imposing cost rather in excess of the potential benefit.

Returning residents are a bit different. Whether a Kiwi consumes alcohol or tobacco brought with them from abroad or bought at the local shoppes, the external costs are the same. A duty free limit then should be set simply in recognition of that it can be more expensive to collect taxes at the border from returning residents than to run those taxes within the country. There are perfectly legitimate, non tax avoidance reasons for bringing in product from abroad. When I go home to Canada, I like to bring back ice wine that’s otherwise here hard to get. Smokers may wish to find products that are different from those commonly available here. We also have a personal goods concession allowing the import of goods valued up to $700. This gives us a bit of a benchmark on Customs’ expected hassle-cost of collecting taxes at the border. If it isn’t worth hassling an incoming returning resident for $100 in GST because of collection costs, it would be surprising if it were worth hassling an incoming returning resident for $67 in excise. Presumably the import allowances are set with a recognition of that returning residents will often have a combination of personal goods, tobacco and alcohol. The threshold for imposing hassles at the border is then pretty high, because hassle costs at the border are pretty high.

Where Edwards has a reasonable point is that as excise increases, the duty-free allowance should presumably change. The higher is excise, the lower should be the duty-free allowance because it will be easier to hit the break-even point where excise matches the transaction cost of collecting it. I’ve not seen the time path on the personal concession for tobacco product. If it isn’t lower now than it was a decade ago, there could be grounds for checking whether it should go down a bit. But were the personal limit to be lowered substantially, we’d need a separate and higher limit for incoming tourists. And that too imposes hassle costs.

Finally, it isn’t hard to imagine second-best arguments where, if consumption among higher income cohorts is less likely to impose substantial external harm – they tend to have private health insurance, for starters – then duty-free imports for jet-setters is one way of having excise rates that scale appropriately.

In other news, the NBR reports that changes are afoot for low-value GST exemptions on imports. I really hope that whatever regime they come up with recognizes the potentially large fixed cost imposed on any import when you make online shoppers go through an extra hassle step to collect the goods they’re buying. It would be very very easy for regulations here to turn into protectionism for local inefficient retailers.