Since 2019, President Zelenskyi’s government has been working to combat the illegal trade in tobacco products. In recent years, important steps have been taken to combat this practice. We observe the closure of illegal tobacco factories and the confiscation of their equipment and products, the arrest of corrupt officials.
For a long time, Ukraine was the main transit country for illegal cigarettes to Europe. But in recent years, the illegal production of cigarettes for the domestic market has increased dramatically. Illegal trade in tobacco products has reached an unprecedented maximum.
In 2018, Ukraine introduced a seven-year plan to increase excise duties on tobacco products by 20% per year until 2025 in order to reach the minimum excise duty rate in force in the EU. This became the main reason for the increase in the level of illegal cigarette trade in Ukraine from 1% in 2016 to almost 20% in 2022. In particular, during the last two years, we have observed the greatest growth of this indicator.
In the conditions of the war in Ukraine, the deterioration of the economic situation, the disruption of logistics channels, the decrease in the purchasing power of the population and the simultaneous increase in excise duties on tobacco products prompted more and more consumers to look for cheaper alternatives offered by manufacturers of illegal products.
In the conditions of increased level of illegal trade in tobacco products in Ukraine, negative effects of the spread of such criminal activity are even more noticeable: the rise in the volume of tax revenue losses; increase in corruption in state bodies and a general increase in the level of crime; growth of income received from illegal trade in tobacco products, which become the object of the money laundering process; loss of the market share and shortfall in profits for legal cigarette manufacturers and tobacco market operators; deterioration of the situation in healthcare, limited state influence on reducing the prevalence of smoking.
The impact on the Ukrainian budget was obvious. In 2021, Kyiv lost more than 375 million euros in tax revenue due to the illegal trade in cigarettes. In 2022, the loss of income is estimated to reach almost half a billion euros. This is the income that the country needs to finance the war against Russia.
Despite the rapid increase in the level of illegal trade in tobacco products with the beginning of the Russian aggression against Ukraine and the related temporary imbalance in the activities of the control bodies, the situation remains under control and at the end of 2022 there was some reduction of the illegal cigarette market. The breaking of the negative trend of increasing the volume of illegal trade in tobacco products became possible due to the measures taken, including at the highest political level. The Zelenskyi administration forced law enforcement agencies to reveal up to 10 places where cigarettes intended for domestic and international markets were illegally produced. These were well-equipped enterprises with fairly modern equipment.
However, despite these successes, the share of illegal cigarettes in the total volume of their consumption remains high, some tobacco criminals are being replaced by others.
We would not like to see Ukraine fall into the situation that similar excise policy measures have caused, for example, in France, where after a sharp increase in the excise duty on cigarettes, the illegal share of the tobacco market has almost tripled.
Another negative example is the Netherlands, where in 2021 the level of illegal cigarette trade increased immediately from 6 to 18%. This happened also in the conditions of a radical increase in the excise duty.
It is necessary to pay attention to the fact that France and the Netherlands are not countries with high corruption risks and have a much more effective law enforcement system compared to Ukraine. But, having received a serious problem, these countries in 2022 and 2023 did not increase the excise duty on cigarettes at all.
But in Poland, the excise duty on cigarettes increased by only 5% in 2020, and remained unchanged in 2021. Despite the fact that the Polish budget needed additional resources to fight the pandemic. And the budget received this money. But not due to an increase in excise duty, but thanks to the reduction of the illegal cigarette market from 9 to 5%.
When making a decision to increase the excise duty on tobacco products, Ukraine can take into account negative precedents in the EU and the experience of more successful neighbors.
Moderate excise policy is an effective tool to combat illegal production and turnover of tobacco products. Also, increased institutional capacity of control bodies can be effective only if it complements (and does not replace) a reasonable rise in the excise duty on tobacco products.
The European integration aspect of the reform of the excise duty on tobacco products should consider the socio-economic situation in Ukraine, including factors that affect the proper functioning of the tobacco market. The European experience teaches us the most important thing – the increase in excise duty on tobacco products should be gradual. The rate of increase in the excise duty for cigarettes at the level of 20% per year is too high.
Combating the illegal production and turnover of tobacco products is a complex problem, the solution of which requires a systemic approach, a coordinated response of the state, business and civil society. It is necessary to consider the best experience of the EU countries in this area, take into account the measures that allowed these countries to significantly reduce the share of the illegal cigarette market and increase budget revenues.
These are centralized coordination of actions at the highest administrative level, intensification of cooperation with EU Member States, strengthening of regional and international cooperation, inspection of the civil service, control of customs and border inspectors, strengthening of the police and improvement of legislation, information campaigns, etc.