Since the excise duty is currently one of the most harmonized taxes in the EU, Ukraine when applying to join this integration entity should take into account the requirements of the common European legislation on the tobacco products excise taxation, as well as the approaches of the EU countries to setting the respective excise duty rates.
Principles of excise policy in the field of tobacco products in the EU
The 2021 Annual Tax Report[1] identifies four tax policy priorities to help achieve the EU’s strategic development goals, in particular:
- Promoting innovation and productivity.
- Paving the way for environmental sustainability and good public health.
- Preventing tax fraud, evasion and abuse.
- Contributing to social justice and prosperity.
The policy in the field of tobacco excise taxation, which is defined by Council Directive 2011/64/EU dated June 21, 2011 «On the structure and rates of excise duties applicable to tobacco products (codification)», is consistent with these tax policy priorities[2]. It is aimed at achieving a threefold goal (priorities): ensuring a high level of public health protection; proper functioning of the domestic market for excisable goods; filling the budgets of countries with tax revenues.
To achieve these goals, the EU member states use common approaches to tobacco excise policy. These approaches are based on the fact that tax rates should be high enough to achieve the main regulatory effect, which is aimed at reducing the consumption of tobacco products. The Directive establishes the minimum level of tax burden (liability) and its structure.
This triangle of excise duty policy goals is characterized by the fact that they are not complementary, but rather mutually exclusive. This is not a paradox, since in the broader context of the goals of state tax policy, we also observe a fundamental contradiction between social justice (equality) and economic efficiency of taxation. It was formulated in such an explicit way in 1975 by Arthur Okun[3], although in fact the range of efficient tax policy states is defined by Adam Smith’s four maxims. On this area of the «set of tax compromise states», it is important that there is no excessive bias to any side, and that all economic agents – subjects of tax relations – act in the way of achieving a mutually beneficial equilibrium. Therefore, the state tax policy, both in general and separately by its components, is an art of compromise between mutually exclusive requirements of taxation in the areas of «economic efficiency – social justice» and «efficiency of administration – convenience and simplicity of tax payment». If this balance is achieved, the relationship between taxpayers and the state is characterized by a high degree of trust, which is manifested in a sufficiently high level of voluntary tax payment, absence of opportunistic behaviour of taxpayers and, accordingly, large tax gaps[4] both for certain taxes and the tax system as a whole[5].
In the context of such mutually exclusive requirements, the EU countries are establishing their excise duty policy in the field of tobacco products, since we see a certain contradiction in the requirements of such a policy and, therefore, the need to reach a compromise between the needs of consumers, state budget revenues and the position of tobacco manufacturers.
Council Directive 2011/64/EU defines the principles of harmonization of the structure and rates of excise duty on tobacco products (processed tobacco) – cigarettes, cigars and cigarillos, smoking tobacco, but does not regulate the taxation of heated tobacco products (HTPs) and liquids for electronic cigarettes.
A gradual increase strategy for cigarette excise duty rates in the EU
The OECD’s 2020 report on taxation trends in consumption indicates that if the primary goal of excise duty policy is to generate additional tax revenues, the tax rate should take into account the elasticity of demand for products and the desired level of accumulation of budget revenues. A moderate tax rate may be sufficient to obtain the desired level of stable tax revenues without creating political and economic tension in society. It is also noted that in the case of international trade and a significant level of price differentiation for tobacco products between countries, the risks of illegal production and trade must necessarily be in the focus of attention, as the establishment of high tax rates becomes impossible without an appropriate level of interstate cooperation[6].
In order to take into account the peculiarities of the tobacco market, the EU countries have chosen a strategy of gradual moderate increase in excise duty rates.
According to the EU statistics on the importance and place of the excise duty on tobacco products, we observe the following situation and trends[7].
If we analyse the value of the excise duty on tobacco products as a percentage of GDP, meaning as a component of the overall tax burden (tax ratio), we see that the average value for EU countries as of the end of 2021 is 0.75%. The highest value of this indicator is in Bulgaria (2.088%), and the lowest in Sweden (0.215%). It is important to analyse the trends in this component of the overall tax burden over the past years. In order to do so, we compared the values of this indicator for each country in 2021 and 2010. Across the whole sample of countries, the percentage of excise duty decreased by an average of 0.075% during this period. An increase in the percentage of excise duty in the total tax burden was observed in only six countries (Austria, Bulgaria, Croatia, Estonia, Finland, and France).On average, the increase was 0.11% of GDP for these countries. In other EU countries, there was a decrease. Despite the fact that during this period the excise duty rates for both ad valorem and specific tax components increased, which was stipulated by the requirements of Council Directive 2011/64/EU.
On average, the share of excise duty on tobacco products in total tax revenues in the EU is 2.16%. In countries such as Bulgaria, Greece, Romania and Croatia, the excise duty on tobacco products plays a significant role in the structure of total tax revenues. The share of excise duty is 6.8%, 3.0%, 4.9% and 3.6% respectively. This can be partly explained by the lower level of per capita income in these countries. Less wealthy EU member states, in compliance with Council Directive 2011/64/EU, are forced to implement a rather strict fiscal policy in this area, and therefore the importance of a particular duty in the total amount of tax revenues is growing. For comparison, in Ukraine, as of 2021, the share of the excise duty on tobacco products in total consolidated budget revenues was 3.2%. Moreover, it has remained at this level for the last ten years.
The «small steps» strategy of increasing the excise duty on cigarettes in the EU can be illustrated by the following example. In 2012-2018 (for 6 years), among 11 post-socialist EU countries, the minimum excise duty on cigarettes increased the most in Lithuania (by 42.94%), Estonia (by 44.23%) and Latvia (by 48.94%). At the same time, the corresponding average amount in the EU-11 was 28.65%[8]. It should also be added that in Latvia, the increase in the minimum excise duty by 27.79% in 2012-2016 was accompanied with an increase in excise duty revenues from cigarettes by 27.67%. In Lithuania, the increase rates were 26.51 and 35.76%, respectively, and in Estonia – 21.50 and 20.23%, respectively[9]. This is evidence that the fiscal goals of the policy of increasing excise duty rates on tobacco products were achieved in these countries.
However, there were exceptions, when the excise duty in EU countries increased too rapidly (in particular, the Baltic states became balanced not immediately, but after their own unsuccessful experiments), which was accompanied by a rapid increase in the level of illegal cigarette trade.
It should be noted that EU experts point out that there is a need to improve Council Directive 2011/64/EU, which has remained unchanged for more than a decade and, in the opinion of experts, some of its provisions need to be actualized, and a more comprehensive and holistic mechanism needs to be developed to achieve a harmonized policy in this area[10].
The practice of excise duty differentiation for cigarettes and novel nicotine products in the EU
As mentioned above, HTPs and liquids for electronic cigarettes are not currently harmonized excisable goods. Therefore, EU countries can determine their taxation mechanisms at their own initiative, taking into account, among other things, the potentially reduced health risks of their consumption.
However, the European Commission, being concerned that the EU countries will implement different national excise duty systems for HTPs, which will prevent further development of a harmonized approach in this area, recommended to tax these products in accordance with the approaches (including rates) used for the harmonized excise category «other smoking tobacco»[11]. In most EU Member States, excise rates for the said category are set at a fixed amount per unit weight in kilograms.
In 2019, 13 of the 21 EU countries that had introduced HTPs to their national markets at that time applied an excise duty rate for HTPs that was identical to the rate for other smoking tobacco[12]. However, as these alternative products became more widespread and popular among consumers, many governments were inclined to create a separate excise category for them. An example is Denmark, where, prior to the introduction of a new excise category for HTPs, they were classified in the general category of «other smoking tobacco»[13]. Moreover, this did not affect the excise duty rate.
In 2023, nine EU Member States (Greece, Denmark, Estonia, Spain, Cyprus, the Netherlands, the Czech Republic and Sweden) set equal excise duty rates for HTPs and other smoking tobacco. In Bulgaria, Croatia, Finland, Latvia, Romania, Slovakia and Slovenia the excise duty for HTPs is specific, set per unit weight of tobacco, but slightly higher than the excise duty for other smoking tobacco. At the same time, the excise duty burden on HTPs is currently lower in all EU countries compared to cigarettes.
Given that cigarettes are subject to mixed excise duty rates (specific per thousand units and ad valorem as a percentage of the maximum retail selling price), and HTPs are subject to either a specific duty rate per unit weight of tobacco in kilograms or a rate per thousand units (Italy, Lithuania and Hungary), or mixed duty rates (France, Germany, Poland, and Portugal), or only an ad valorem duty rate (Spain), the calculations to determine the level of differentiation of the excise duty burden on these two products are complicated. They have never been carried out by the European Commission.
Our calculations of this level of differentiation of the excise duty burden in the EU countries as of April 1, 2023, are based on a comparison of the excise duty rate for HTPs converted from the unit of weight in kilograms to per thousand units of production and the minimum excise duty liability per thousand cigarettes (MED) published by the European Commission. The results of the calculations are presented in Table.
Thus, among the 18 EU Member States that were analysed, the ratio of excise duties on HTPs to cigarettes in 2023 ranged from 82.5% in the Netherlands to 14.9% in Hungary, with an average of 66.3%. In seven EU Member States, the excise duty on HTPs was at least 4 times lower than the MED on cigarettes, and in only one country the ratio was less than 2 times.
Moving on to review of the EU countries’ practice of applying excise duty on liquids for electronic cigarettes, we note the following. The European Commission recognized the right of countries to introduce non-harmonized excise duties for these products, but refrained from providing clear recommendations on their administration. It was decided to wait until the information gaps are better filled in regarding: the features of the distribution of these alternatives in the EU market; problems that may arise in the field of tax administration; the impact of liquids for electronic cigarettes on human health[14].
Italy (since 2013) and Portugal (since 2014) were the first countries to introduce a non-harmonized excise duty on liquids for electronic cigarettes, followed by Romania, Slovenia, Latvia, and other countries. Similarly, to conventional tobacco products, post-socialist countries had lower excise duty rates on liquids for electronic cigarettes than the EU-15. However, in all EU countries, the excise duty burden on these alternative products was several times lower than on cigarettes[15]. Germany was the latest to introduce an excise duty on liquids for electronic cigarettes (starting July 1, 2022) with a relatively low rate of EUR 0.16 per ml. However, the former is to increase annually until it reaches the level of EUR 0.32 per ml on January 1, 2026.
Today, excise duty on liquids for electronic cigarettes has been introduced in 15 EU Member States. The approaches to its administration differ, with different taxation rates for liquids with and without nicotine. In Italy, a differentiated excise duty rate is applied (depending on whether the liquid contains nicotine), which is calculated based on the weighted average retail price of traditional cigarettes. In Croatia, such liquids are classified as excisable goods, but they are subject to a zero-duty rate (Figure).
The European Commission has already emphasized that differences in approaches to the categorization and excise duty taxation of HTPs in the EU countries create obstacles to the functioning of the single market. This can lead to distortions in competition and disputes over law enforcement. In addition, there are administrative barriers to the cross-border movement of these products between countries that have chosen different approaches in this area.
The European Commission also concluded that different approaches to excise taxation of liquids for electronic cigarettes create significant obstacles to the functioning of the single market and complications for both economic operators and government authorities.More about this and other aspects of ensuring the completeness of tobacco excise duty revenues in the EU countries is described in our new research «Excise Policy in the Field of Tobacco Products and Prevention of Their Illicit Trade in the Face of New Challenges and Threats
[1] Annual Report on Taxation 2021. Review of taxation policy in the EU Member States.
[2] «On the structure and rates of excise duties applicable to tobacco products (codification)». Council Directive 2011/64/EU of the European Union dated June 21, 2011.
[3] Okun A. M. Equality and Efficiency. The Big Tradeoff. Washington, The Brookings Institution. 1975. 124 р.
[4] Loss of budget revenues due to tax evasion and other undesirable phenomena.
[5] Tax policy of the state. Another great compromise / edited by K. I. Shvabiy. K.: Alerta, 2018. 62 p.
[6] Consumption Tax Trends 2020. VAT/GST AND EXCISE RATES, TRENDS AND POLICY ISSUES. P.140.
[7] «Taxes in Europe» database.
[8] Dialectic of Reforming the Excise Taxation of Tobacco Products in Ukraine: European Integration Aspect. [edited by V.I. Korotun]. K.: Alerta, 2018. P.67.
[9] Excise Duty Tables. Part III – Manufactured Tobacco (Tax receipts – Manufactured Tobacco). European Commission 2018.
[10] Evaluation of the Council Directive 2011/64/EU of 21 June 2011 on the Structure and Rates of Excise Duty Applied to Manufactured Tobacco: Commission Staff Working Document.
[11] Report from the Commission to the Council on Directive 2011/64/EU on the structure and rates of excise duty applied to manufactured tobacco. 12.01.2018.
[12] Tax regulation of the tobacco market in the context of its transformation [Korotun V.I., Koshchuk T.V., Novytska N.V., Khlebnikova I.I.] / edited by Koshchuk T.V. Irpin-Khmelnytskyi, 2020. P.42-43.
[13] Denmark adopts new tax category for heated tobacco. July 26, 2018.
[14] Report from the Commission to the Council on Directive 2011/64/EU on the structure and rates of excise duty applied to manufactured tobacco. January 12, 2018.
[15] Study on Council Directive 2011/64/EU on the structure and rates of excise duty applied to manufactured tobacco. Final Report. May 2017.