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Chile � Taxes On Alcoholic Beverages

Report of the Panel

(Continued)


    (f) Cross-Price Elasticity

    (i) Market developments

  1. The European Communities alleges that sales of pisco have consistently tracked changes in factors that have a direct impact on the prices of other spirits (and in particular of whisky) but not on the prices of pisco itself, such as changes in the ILA rates applied to those spirits, changes in the level of the import duties on distilled spirits and fluctuations of the exchange rate between the Chilean peso and the US dollar. This evidences that the demand for pisco is responsive to changes in the prices of the other spirits and, therefore, that they are directly competitive or substitutable products.
  2. According to the European Communities, the Chilean spirits market is largely dominated by pisco. As set out in Table 18 below, in 1996 sales of pisco accounted for as much as 74 % of the total quantity sold in that market. The same table shows that sales of pisco have increased considerably (by more than 400 %) since the early 1980s. 100
  3. Table 18 101

    Chilean spirits market 1982 � 1996: sales (thousands of litre) and market share*

    1982

    1984

    1986

    1988

    1990

    1992

    1994

    1996

    Pisco

    Sales Share

    1,100.00

    44.1 %

    1,600.00

    59.0 %

    2,075.00

    68.8 %

    2,650.00

    70.4 %

    3,190.00

    72.5 %

    3,675.00

    70.6 %

    4,347.00

    72.9 %

    4,501.00

    73.8 %

    Whisky

    Sales Share

    497.00

    19.9 %

    258.00

    9.5 %

    223.50

    7.2 %

    249.00

    6.6 %

    224.50

    5.1 %

    224.50

    4.3 %

    249.50

    4.2 %

    264.00

    4.3 %

    Vodka

    Sales Share

    48.00

    1.9 %

    52.00

    1.9 %

    52.00

    1.7 %

    52.00

    1.4 %

    54.00

    1.2 %

    65.00

    1.2 %

    79.00

    1.3 %

    93.00

    1.5 %

    Gin

    Sales Share

    55.00

    2.2 %

    59.00

    2.2 %

    56.00

    1.8 %

    55.00

    1.5 %

    56.00

    1.3 %

    63.50

    1.2 %

    70.00

    1.2 %

    56.50 0.9 %

    Rum

    Sales** Share**

    54.00

    2.2 %

    50.00

    1.8 %

    48.50

    1.8 %

    53.00

    1.4 %

    61.75

    1.4 %

    80.50

    1.5 %

    99.50

    1.7 %

    101.00

    1.7 %

    Brandy

    Sales Share

    55.00

    2.2 %

    80.00

    2.9 %

    130.50

    4.2 %

    164.00

    4.4 %

    209.00

    4.7 %

    265.25

    5.1 %

    289.25

    4.8 %

    194.50

    3.2 %

    Tequila

    Sales Share

    1.00

    0.0 %

    Nil

    0.25

    0.0 %

    1.25

    0.0 %

    3.75

    0.1 %

    14.00

    0.3 %

    32.50

    0.5 %

    72.50

    1.2 %

    Liqueur

    Sales*** Share***

    347.00

    13.9 %

    318.50

    11.7 %

    291.50

    9.4 %

    249.50

    6.6 %

    262.25

    5.7 %

    260.00

    5.0 %

    245.50

    4.1 %

    230.00

    3.8 %

    Other

    Sales Share

    340.00

    13.6 %

    295.00

    10.9 %

    230.00

    7.4 %

    290.00

    7.7 %

    340.00

    7.7 %

    560.00

    10.75 %

    555.00

    9.3 %

    585.00

    9.6 %

    Total

    2,497.00

    2,712.50

    3,107.25

    3,763.25

    4,401.25

    5,207.75

    5,967.25

    6,097.50

    * Source: ISWR report (EC Exhibit 19)

    ** Includes cachaca

    *** Includes liqueurs, bitters, aperitifs, aniseed and fruit eaux de vie

  4. The European Communities notes that all pisco sold in Chile is, by definition, produced domestically. Imports of pisco from Peru and other sources (which must be sold as aguardiente) are marginal. 102
  5. The European Communities further states that whisky is the best selling spirit after pisco. As shown in Table 18 above, in 1996 sales of whisky accounted for 4.3 % of the spirits market. Domestic production of whisky is negligible. 103 It can be estimated that imports represent approximately 94 % of total sales of whisky. 104 In turn, Scotch whisky accounts for 95 % of all imports. 105
  6. The European Communities also notes that until the mid-1970's, imports of whisky remained very small. Thus, in 1975 imports of Scotch whisky amounted to barely 165 thousand litres, based on UK Customs and Excise Export Statistics. 106 During the second half of the 1970s, imports of whisky grew spectacularly. As of 1981, when they peaked, sales of Scotch whisky had reached a volume of 5.9 million litres. 107 This increase was the result of a combination of factors. In the first place, the progressive reduction of import tariffs from 80 % at the beginning of 1976 to 10 % as of May 1979. 108 Second, a parallel reduction in the ILA from 40 % plus the recargo in 1974 to 30 % in 1977, i.e., only 5 percentage points more than the rate on pisco, as Table 6 above. Finally, imports of whisky benefited from a rapidly expanding economy with very high growth rates as well as, between 1979 and 1981, from a strong peso pegged to the US dollar. 109
  7. The European Communities further asserts that during the first half of the 1980s this trend suffered a dramatic reversal. In 1982, the Chilean economy entered into a deep recession 110 and the peso underwent the first of a series of devaluations. 111 Import duties on distilled spirits were increased from 10 % to 20 % in 1983 and again to 35 % the following year. 112 Last but not least, the ILA rate on whisky was raised to 50 % in 1983, to 55 % in 1984 and to 70 % in 1985, thus increasing the tax differential between pisco and whisky from 5 to 45 percentage points in less than two years, as shown in Table 6 above. The imposition of higher taxes and import duties, allied to the new macro-economic environment, had a devastating effect: sales of Scotch whisky dropped from 5.9 million litres in 1981 113 to just under 1.3 million litres in 1985114, i.e., by nearly 80 %.
  8. According to the European Communities, Chile emerged from the recession in 1987 115 and import duties were lowered to 11 % as of 1991. 116 But the remaining tax differential, together with the market dominance gained by pisco in the meantime, have so far prevented whisky from recovering its former position. By 1996 sales of whisky still represented merely 39 % of the volume sold in 1981, 117 and this despite a considerable increase in the overall demand for spirits. As a result, as set out in Table 18 above, the market share of whisky shrank from 20 % in 1982 to just 4 % in 1996.
  9. Further, the European Communities states that meanwhile, pisco sales have consistently moved in the opposite direction. Between 1976 and 1981, pisco suffered from the spectacular increase in whisky imports. Although sales of pisco continued to grow in absolute terms, they did so at a much lower rate than the sales of whisky. 118 In 1982, when Chile was hit by recession, sales of pisco fell by 20 %. 119 In reaction to this, the pisco industry stepped up the pressure to obtain additional protection against imports of whisky. As explained above, the Chilean authorities responded to those demands with a series of successive increases in the import duties and in the ILA rates on whisky. These measures proved highly effective. While sales of whisky continued to decline until 1986 and stayed relatively flat thereafter120, sales of pisco began to increase again in 1983 and by 1984 had already exceeded their 1981 level. 121 Furthermore, the additional protection afforded by the increase in tariffs and taxes on whisky allowed the pisco industry to capture most of the growth of the spirits market that took place during the following decade as the Chilean economy resumed its rapid expansion. As a result, the market share of pisco increased from 44 % in 1982 to 74 % in 1996, as shown in Table 18 above.
  10. Referring to these tables, the European Communities further notes that liqueurs are the third largest type of spirits in terms of sales volume, with approximately 4 % of the market. Most liqueurs sold in Chile have a relatively low alcohol content. As shown in Table 5 above, all liqueurs (with the only exception of anisettes) have a legal minimum strength below 35° . Imports represent less than 10 % of total sales. Together, vodka, gin and rum hold a further 4 % of the market. Imports account for a substantial proportion of their sales: 36% of gin, 41 % of vodka and 55 % of rum. Despite the considerable overall increase in demand for spirits, sales of these three types of spirits have grown only moderately, with the consequence that they have all lost market share since the early 1980's, as shown in Table 18 above.
  11. The European Communities states that tequila entered into the Chilean market at the beginning of the 1990's. Although it has enjoyed a considerable success, especially among young consumers, it still represents under 2 % of the market. All sales of tequila are imported from Mexico, as shown in Table 19 below.
  12. Table 19 122

    Sales of domestic spirits v. imports in 1996 (000 9 litre cases)*

    Domestic

    %

    Imported

    %

    Pisco

    4,501.00

    100

    Nil

    0

    Whisky

    17.00

    6.4

    247.00

    93.6

    Vodka

    55.00

    59.1

    38.00

    40.9

    Gin

    36.00

    63.7

    20.50

    36.3

    Rum**

    45.00

    44.6

    56.00

    55.4

    Brandy

    190.00

    97.7

    4.50

    2.3

    Liqueur***

    208.50

    91.0

    20.5

    9.0

    Tequila

    Nil

    0

    72.5

    100

    Other

    585.00

    100

    Min

    0

    Total

    5,637.5

    92.5

    459.00

    7.5

    * Source: ISWR report (EC Exhibit 19)

    ** Includes cachaca

    *** Includes liqueurs, bitters, aperitifs, aniseed and fruit eaux de vie

  13. According to the European Communities, brandy accounts for approximately 3 % of the spirits market. Domestic production represent nearly 98 % of the sales. The vast majority of domestic sales are of the brand "Tres Palos", with an alcohol content of 38° .
  14. The European Communities concludes that, as already explained, the sales and market share of pisco have consistently tracked changes in factors that have a direct impact on the prices of the other spirits, but not on the prices of pisco itself. Those changes include not only the changes in internal taxation, but also changes in import duty rates and exchange rate fluctuations between the Chilean Peso and the US dollar. This evidences that the demand for pisco is responsive to changes in the prices of other spirits and, therefore, that they are directly competitive or substitutable.
  15. The European Communities adds that the correspondence between the sales/market share of pisco and the prices movements of the other spirits is particularly noticeable during the period 1982 -1986, where the changes in the prices of the other spirits were most dramatic (The European Communities claims that a large portion of that period is not covered by the regression provided by Chile).
  16. The European Communities also explains that the correspondence is more easily observable in the case of whisky than in the case of "other spirits". Several reasons may account for this. In the first place, the tax increases were larger in the case of whisky. Second, "other spirits" started from a smaller base than whisky. In relative terms, however, the loss of market share experienced by "other spirits" is far from negligible. Gin and rum, for instance, suffered an 18 % share loss between 1982 and 1986. Finally, "other spirits" include a larger share of domestic production, which was not affected by changes in import duties and exchange rates.
  17. In rebuttal, Chile contends that it should be noted that Table 18 is not based on any official statistics. Further, the European Communities with this chart attempts to prove that products are directly competitive or substitutable by assuming that they are directly competitive or substitutable, since the EC chart assumes a single market composed of the sum of the sales of each different distilled spirit. Thus, the EC's economic logic is highly faulty.
  18. Chile analyses the evolution of the consumption of whisky and pisco on the basis of the data provided by the European Communities. Chart 1 below shows for whisky the changes in per capita consumption and prices during the period 1982-1986. As can be seen, during this period the price of whisky in real terms, that is, adjusted for internal inflation, rose 67%. Per capita consumption of whisky in this same period fell by 64%. No one should be surprised that consumption of a product fell as its price rose in this fashion.
  19. According to Chile, Chart 2 shows the changes in price and per capita consumption of pisco during the same period 1982-1986. As can be seen, during this period the price of pisco in real terms fell by 35% and consumption per capita rose 69%. It is similarly not surprising that a product whose price significantly declines, increases in consumption.
  20. In Chile's view, the increase in the price of whisky during the period in question, is a result of three principal factors: the depreciation of the Chilean currency, the increase of tariffs and the increase of the tax on whisky. It analysed each factor independently:
    1. Depreciation of the Chilean currency: During the period from 1979 to 1982, the Chilean peso maintained a stable relation with the dollar (Ch$ 39 = US $1). As a result the crisis of the balance of payments and other macro-economic factors, the Chilean peso fell 88% between mid 1982 (when the first series of declines occurred) and the end of 1986.
    2. Increase of tariffs: In 1982, the import tariff on whisky was 10 percent. The tariffs increased to 20 % in 1983, 35 % in 1984 and then were reduced to 20 % in 1985. In short, between the year of 1982 and 1986, there was a net increase in tariffs that increased the final price of the imported products by 9.09 %.
    3. Increase in the taxes on liquor: In 1982 the tax that applied to whisky was at a rate of 30 %. These rates increased to 50 % in 1983, 55 % in 1984 and 70 % in 1985. In short, the effect of the increase in taxes on whisky in the period of 1982 to 1986 was to increase the price to the consumer by 30.8 percent.

  21. Chile argues that taking into account of all these elements already indicated, there was an increase in the price of whisky - ceteris paribus - of 168 percent, most of which was caused by factors having nothing to do with the increase in the tax on whisky. As it could be seen, not all of this increase was transferred to consumer prices. This suggests a diminution of margins, an increase in the local production of whisky and an increase in lower priced imported whisky, or some sort of a combinations of these factors. In addition, the price of pisco in Chile fell considerably, even though the tax on pisco did not change during the period in question.
  22. Chile adds that as to other types of distilled spirits, it is not in a position to provide a similarly detailed assessment because of the wide variety of domestic and imported spirits included in that category. However, as in the case of whisky and pisco, it would not be valid to assume that sales of this array of domestic and imported products held a relatively steady share of a hypothetical "distilled spirits" market because the tax remained steady. Within that group, Chile can imagine that there would have been a wide range of price effects, on individual types of domestic and imported spirits.
  23. Chile also contests the EC statement that the period from 1982 to 1986 was not covered in the regression study of Chile. Chile included in its regression study the period from 1983 to 1997, thereby taking into account almost all the period of time in question. By contrast, the EC's study covered a shorter period and the European Communities has presented only partial results of that study.
  24. Chile further notes that the European Communities states that "the sales and market share of pisco have consistently tracked changes in factors that have a direct impact on the prices of the other spirits, but not on the prices of pisco itself ... This evidences that the demand for pisco is responsive to changes in the prices of the other spirits ..." The European Communities erroneously implies that the changes in the sales of pisco would be exclusively explained by the changes in such factors and their effects on the prices of the other spirits, and not because of changes in the price of pisco. The reasoning followed by the European Communities underestimates a fundamental aspect: if the price of a good diminishes, the demanded quantity of that good increases (unless the demand for the good is inelastic, which means inter alia that is a good with no substitutes). The relation between the price and sales of pisco is enough in order to explain the changes in the sales of pisco. As can be observed in the results of the regression submitted by Chile, the relation between the price of the other spirits (whisky) and the sales of pisco is very low and statistically not significant; therefore, this relation can not explain by itself the changes alluded to.
  25. Chile further notes that it produces more than 70 percent of the distilled spirits that are subject to the highest tax under the New Chilean System, including whisky.
  26. The European Communities disagrees with Chile's claim that the increase in consumption of pisco between 1982 and 1986 was due to the decrease of the real price of pisco and not to the increase in the price of whisky. The reduction of pisco's real price may have contributed to the increase in pisco consumption, but was not the only cause. According to Chile's own data, between 1984 and 1986, the real price of pisco remained virtually constant. Yet, consumption per capita of pisco rose by 24 %. During the same period, the real price of whisky increased by 42 % and consumption per capita fell by 25 %.
  27. The European Communities contests Chile's argument that "[i]n short, the effect of the increase in taxes on whisky in the period of 1982 to 1986 was to increase the price to the consumer by 30.8 percent". As the tax rate increased, the tax base increased too, due to the depreciation of the peso and the increase of tariffs. As a result, the effect of the tax increase in the final price of whisky was much more substantial. Thus, in the following table example below, the tax increase has the effect of increasing the final price of whisky by 286 %:
  28. 1982

    1986

    Price in US$

    5

    5

    Price in Ch$

    195

    1,025

    Import duty

    19.5

    205

    Tax

    64.35

    861

    Retail Price

    278.85

    2,091

    Contrary to Chile's claims, the tax increase accounts for the largest portion of the price increase (44 %).

  29. Chile further responds that the math used by the European Communities to demonstrate the effect of taxation in the price of whisky is misleading. Chile disagrees not only with the mathematics, but also with the EC's conclusions drawn from that exercise. These conclusions show, at least, a lack of understanding of ad valorem taxation systems. To demonstrate its point, in Table 20 below, Chile presents an exercise, based in the EC's data in which the tax rate is maintained at a flat level of 30 % throughout the period. In this case, tax per unit of whisky will rise from cCh$64.35 to Cch$369, and the total price of whisky will rise from ch$278.85 to Cch$1,599. According to EC's argumentation, this means that taxation has an effect of raising the price by 109% (even without changing the tax rate). What really happens, is that the tax base, rose by 473%, and therefore, tax levied on an ad valorem base varies accordingly.
  30. Table 20 123

    Tax effect with a 30% ad valorem rate

    1982

    1986

    % ChH.

    Price in US$

    5

    5

    0%

    Price in Ch$

    195

    1,025

    425.6%

    Import duty

    19.5

    205

    951.3%

    Pre-Tax Price

    214.5

    1,230

    473.4%

    Tax (30%)

    64.35

    369

    473.4%

    Retail Price

    278.85

    1,599

    473.4%

To continue with The 1998 Search Marketing Survey


100 The European Communities also refers to IWSR Report, p. 77, Table A (EC Exhibit 19).

101 EC First Submission, Table 9A.

102 IWSR Report, p. 78, Table C.1 (EC Exhibit 19).

103 IWSR Report, p. 43, Tables A and A.1 (EC Exhibit 19).

104 Ibid.

105 Ibid.

106 EC Exhibit 57.

107 IWSR Report, at p. 43, Table A. (EC Exhibit 19).

108 EC Exhibit 57.

109 EC Exhibit 61.

110 The European Communities refers to EC Exhibit 58, and also to the IWSR report, p. 6 (EC Exhibit 19).

111 The European Communities refers to EC Exhibit 61.

112 EC Exhibit 57.

113 IWSR Report, page 43, table A (EC Exhibit 19).

114 Ibid.

115 EC Exhibit 60.

116 EC Exhibit 57.

117 IWSR Report, page 43, table A (EC Exhibit 19).

118 The European Communities refers to IWSR Report, p. 77, Table A (EC Exhibit 19), and for the period before 1980, to EC Exhibit 59.

119 IWSR Report, page 77, table A (EC Exhibit 19).

120 IWSR Report, page 43, table A (EC Exhibit 19).

121 IWSR Report, p. 77, table A (EC Exhibit 19).

122 EC First Submission, Table 9B.

123 Chile Oral Statement at the Second Substantive Meeting, Table II.