The publication examines current excise policy issues in the area of tobacco products and its impact on the illicit trade in cigarettes in the EU countries. It also covers domestic trends in the development of legal and illicit tobacco markets and changes in the volume of excise revenues, analyzes the legislative initiative of the Ministry of Finance of Ukraine on reforming the excise tax to increase state treasury revenues and fulfill European integration tasks, and substantiates proposals to more effectively combating the illegal trade in cigarettes in Ukraine.
CONCLUSIONS
1. An analysis of the KPMG report on the illicit trade in cigarettes in Europe in 2022 confirms the conclusions about the link between the excise policy and the consumption of illicit tobacco products. In particular, the following can be stated: 1) a sharp increase in excise taxes on tobacco products poses a high risk of an increase in the level of illicit trade in tobacco products, and it is important to take into account the relevant rates in the region when formulating the excise policy; 2) the counterfeit component of the cigarette market is difficult to combat even for developed EU countries with an effective law enforcement system; 3) to achieve a sustainable result in reducing the level of illicit trade in tobacco products, it is important to combine a balanced excise policy with effective measures to counteract such criminal activity.
2. Ensuring the proper functioning of the domestic market for excisable goods in the EU requires coordination of excise policies of the countries, which is the focus of the European Commission’s efforts. The latter recommended that HTPs be taxed in accordance with the approaches used for the harmonized excisable category of “other smoking tobacco”, which provides for the setting of relatively low excise rates.
In all EU countries, the United Kingdom, Norway and Switzerland, the excise tax on HTPs is lower than on cigarettes. Among the 18 EU countries analyzed, the ratio of the excise burden on HTPs to cigarettes in 2023 ranged from 82.5% in the Netherlands to 14.9% in Hungary, with an average value of 66.3%. In seven member states, the excise tax on HTPs was at least four times lower than on cigarettes, and in only one country was the ratio less than two times.
3. Today, the discussion on the revision of Council Directive 2011/64/EU is continuing in behind the scenes, and its urgency becomes clear from leaks in the media about certain novel aspects. In particular, unofficial information was circulated that amendments to the legislation proposed to increase the minimum excise tax liability on cigarettes in the EU from EUR 1.80 to EUR 3.60 per pack of 20 cigarettes. Such an increase in the level is associated with the risk of an increase in the level of illicit trade in countries with relatively low incomes. There was also information that the European Commission proposed to set the minimal excise tax on HTPs at half of the excise tax on cigarettes.
The discussion about raising the excise tax on tobacco products without violating the “fine line between achieving public health goals and preventing the illicit market growth” is gaining a new focus. With regard to HTPs, this question cannot be posed unequivocally in an “either/or” format. On the one hand, research continues to prove the reduced health risks of their consumption. On the other hand, there are currently no prerequisites for the development of the illicit HTP market, and this will remain unchanged as long as the countries choose a coordinated and balanced approach to raising excise rates.
4. Taking into account, among other things, the impact of the full-scale invasion, Ukraine has recorded a sharp decline in the consumption and production of the main categories of tobacco products. In 2023, compared to 2021, 36.50% fewer excise stamps for cigarettes were purchased, 4.3% fewer stamps for HTPs, and 79.81% fewer stamps for e-liquids. The latter trend most likely indicates a significant increase in the illegal component of the market for these liquids. At the same time, the structure of tobacco consumption has changed in favor of the use of tobacco used to make roll-your-own tobacco (in 2022) and cigarillos (due to the ban on flavoring additives). Smokers’ switching from one type of tobacco product to another hinders the achievement of the regulatory goals of excise taxation to reduce smoking prevalence.
The excise tax accounted for 11% of tax revenues of the State Budget of Ukraine in 2022 and 13.9% in 2023. The share of the excise tax on tobacco products in the total structure of excise revenues in 2022 was 56%, and in 2023, – 48%. excise tax revenues from tobacco products amounted to UAH 80.29 billion. At the same time, budget revenues could have been even higher if not for the high share of the illicit cigarette market.
5. In 2023, Ukraine saw another increase in the level of illicit trade in tobacco products from 19.9% in 2022 to 21.8%, accompanied by an increase in tax revenue losses (excise tax + VAT + retail excise) from UAH 19.1 billion to UAH 23.5 billion. The main reason for this negative trend was the increase in sales of counterfeit products, the share of which part of the total volume of all cigarettes consumed in Ukraine increased from 6.6 to 8.7%. A new anti-trend is the distribution of counterfeits of well-known brands.
The level of illicit trade in products labeled “Duty Free” or intended for export remained high.
In 2023, 69% of illicit cigarettes were sold in kiosks and stores, where they were placed next to legal products. A year earlier, this figure was 63%. A regional analysis confirms the systemic nature of the problem and shows that the proximity to the front line increases the risks of illicit trade in tobacco products.
The following circumstances should be taken into account when developing measures to counteract the relevant illegal activities: 1) the counterfeit tobacco market is the most difficult to combat; 2) countries with low incomes have high risks of illicit cigarette trade; 3) aggravation of social problems encourages higher tobacco consumption.
6. The transition of consumers to HTPs, the market for which, unlike the markets for traditional and electronic cigarettes in Ukraine, is developing only in the legal segment, ensures the stability of tax revenues. This is important to take into account when taxing them along with a potentially reduced risk of their consumption to human health and the corresponding approaches to the formation of the excise policy in the EU countries.
7. The Ministry of Finance published the Draft Law of Ukraine “On Amending the Tax Code of Ukraine to Revise Excise Tax Rates on Tobacco Products”, which provides an updated schedule of an increase in excise tax rates and the transition to rates in euros. According to the proposed amendments, Ukraine in 2028 is guaranteeing its compliance with the European standard of a minimum excise tax liability on cigarettes of EUR 90 per thousand units. In addition, the level of differentiation of the excise tax burden on cigarettes and HTPs will gradually increase to 20% (the excise tax on HTPs will be 20% lower than on cigarettes). Both innovations are in line with current European practice; in EU countries, the ratio of the excise tax burden on HTPs to cigarettes is even higher.
The adoption of the draft law will favor higher revenues for state and local budgets. On the one hand, there will be no currency risks for the state. On the other hand, switching to HTPs that are sold only legally does not result in the loss of tax revenues (which are associated with illicit trade; they equal the sum of unpaid excise tax, VAT, and retail excise). There is no illicit market for HTPs in Ukraine, and it is important not to create preconditions for its emergence in the future.
At the same time, the draft law provides for a different approach to calculating the excise tax rate for tobacco products produced in Ukraine and their imported analogs. This, in addition to legal inconsistencies, creates conditions for unfair competition and budget losses. It is advisable to ensure a unified approach to the calculation of the excise tax rate on both tobacco products produced in Ukraine and imported ones.
8. Priority measures to combat the illicit trade in cigarettes in the current situation are: 1) to increase the functional efficiency of supervisory bodies (Bureau of Economic Security, tax and customs authorities, police, border guards); 2) to strengthen cooperation with European institutions and the customs authorities of neighboring EU member states in the field of combating illicit circulation of tobacco products; 3) to increase the effectiveness of the fight against smuggling; 4) to avoid tax shocks when increasing excise rates; 5) to introduce a system for monitoring and controlling the tobacco supply chain, because under martial law, when all borders are closed, it is crucial to identify “oases” of the counterfeit production of billions of cigarettes.