Have signed the Association Agreement with the EU, Ukraine’s excise rates on tobacco products have converged with the EU’s to combat fraud with excisable goods. As a result, the minimum rate of excise duties per 1,000 cigarettes is to increase almost sixfold during 2015-2022, and the share of consumer taxes in the retail price of cigarettes in 2022 is to exceed 70%.
In 2020, the State Budget of Ukraine collected UAH 138.3 billion of excise tax, which is 3.3% of GDP and 12.9% of budget revenues. The most important group of excisable goods are tobacco and tobacco products, excise taxation of which provides about 40% of total excise tax revenues. In 2021, according to the budget plan, the excise tax on tobacco products is to generate UAH 61.9 billion of budget revenues, including UAH 57 billion on the excise tax on domestic tobacco products.
The dynamics of the minimum rate of excise duties on cigarettes is as follows (specific rate – UAH per 1000 pieces):
• 2015 – 304.11
• 2016 – 425.75
• 2017 – 596.05
• 2018 – 773.2
• the first half of 2019 – 927.84
• the second half of 2019 – 1011.35
• 2020 – 1213.61
• 2021 – 1456.33
• 2022 – 1747.60.
How did this increase in rates affect the budget revenues from excise tax? Revenues from excise taxation of tobacco products amounted to UAH 22.2 billion in 2015 and are to grow to UAH 62.4 billion in 2022. That is, with a 6-fold increase in tax rates, the absolute amount of budget revenues grew by less than 3 times.
To make correct comparisons, let us also calculate the real rates of excise tax on tobacco products and real revenues to the budget from this tax after the impact of inflationary factors. We deflated the specific rate of excise tax on tobacco products and budget revenues from it on the cumulative value of the consumer price index (CPI).
As a result, it was found that the specific rate of excise duty in real terms from 2015 to 2021 increased by 118%, while real budget revenues from this tax increased by only 23%.
Source: the author’s calculations according to the Ministry of Finance, the State Treasury and the State Statistics Service of Ukraine.
The obtained real indicators show that budget revenues underreact to the increase in excise tax rates. The most important reason for this situation is the significant shadowing of the tobacco market, which is caused by the low purchasing power of the population of Ukraine and the weak administrative possibilities of the state to control the production and circulation of tobacco products.
According to rather conservative estimates of KANTAR-Ukraine, the average annual level of illegal trade in tobacco products in Ukraine in 2021 is 14.4%, which is the highest level for the last 10 years. More than 7 billion cigarettes are distributed on the black market every year. And the losses of the state budget from unpaid taxes in 2021 are estimated by the company’s experts at UAH 13.2 billion.
Obviously, the significant shadowing of the production and circulation of tobacco products violates competitive market conditions and the same rules of the game for all market participants, since the lack of tax liabilities for shadow market operators gives them an unjustified competitive advantage over legal manufacturers and sellers of tobacco products.
The dramatic increase in excise tax rates with the weakness of national regulatory authorities was the result of Ukraine’s forced implementation of Article 352 of Section 5 of the Association Agreement between Ukraine and the EU. This article provides that the Parties shall develop cooperation and harmonise the policies in counteracting and fighting fraud and smuggling of excisable goods; this cooperation includes, in particular, the gradual convergence of excise duty rates on tobacco products, taking into account the constraints of the regional context.
In addition, Article 353 of the Agreement provides that the gradual convergence to the taxation structure as laid down in the EU acquis shall be carried out in accordance with Annex XXVIII to this Agreement. This Annex specified the list of EU Council Directives and their articles to be implemented in the tax legislation of Ukraine.
In terms of excise taxation, these Directives include Council Directive 2008/118 / EU of 16 December 2008 concerning the general arrangements for excise duty and Directive 2011/64 / EU of 21 June 2011 on the structure and rates of excise duty applied to manufactured tobacco. Given the provisions of these Directives, Ukraine is obliged to implement taxation of all harmonized excisable goods at least at minimum rates within 2 years.
However, as we have shown above, Ukraine’s accelerated implementation of the provisions of the common EU legislation on excise taxation has resulted in a significant growth of the shadow segment of the tobacco market in Ukraine and inadequate increase in budget revenues to tax rate growth. In fact, in a broader context, the situation with the regulation of excise taxes in Ukraine has confirmed the warnings of well-known international experts about the inevitable problems with the implementation of common EU legislation in poor signatory countries of the Association Agreements with the EU.
For example, Austrian researchers Peter Havlik and Amat Adarov wrote that the common EU legislation did not solve the problem of accelerating the economic development of poor emerging market countries that were not members of the EU and did not receive large-scale financial support. Indeed, the EU acquis was developed for the needs of the mature economies of the EU and was the result of a consensus between competing interests of their state institutions and business groups.
In the case of the EU-Georgia Association, Patrick Messerlin wrote that the implementation of European legislation for Georgia was a very costly process, which imposed an additional tax on Georgian business. He called the signatories of the Association Agreements “EU Members States clones” who do not influence future EU decisions and without significant EU financial support, despite the fact that the new EU members received annual transfers from the EU up to 3-5% of their respective GDP per year.
Returning to Ukraine’s problems, it should be noted that our European partners themselves do not consider the Association Agreement with Ukraine to be an agreement that must be fulfilled 100%. The design and construction of the Nord Stream-2 gas pipeline are indicative in this respect. Although Article 274 of the Association Agreement with Ukraine outlined the goal of “further integration of energy markets” and obliged each party to take into account the energy networks and capacities of the other Party, in particular when developing infrastructure development plans.
It is also important that all Association Agreements with the EU do not have a standard single dispute settlement mechanism and their implementation is based largely on the good will of the parties.
Thus, the dominant nature of the Association Agreement with the EU in solving Ukraine’s internal economic issues and subordinating economic policy to the wishes of our international partners does not always give optimal results. And in matters of harmonization of excise taxation with the EU, our country needs more balanced approaches – a moderate and longer process of raising excise tax rates. To strengthen the institutional possibilities of state bodies responsible for fighting the illegal production and circulation of tobacco products is also an extremely important task for our country.
Doctor of Economics, Scientific Director of the Growford Institute Tetiana Bogdan for Channel 24.