A rapid increase in illicit tobacco products production and turnover due to a sharp increase in the excise tax indicates the systemic nature of the problem and is an important counterargument to the still widespread view that the shadow cigarette market in Ukraine is insignificant. In view of the above, it is important to make a balanced adjustment of the state fiscal policy, taking into account the indicators of the illicit cigarette market and the risks of its further expansion. Insufficient state policy and failure to fulfill the Strategy for Combating the Illicit Production and Turnover of Tobacco Products till 2021 (hereinafter – the Strategy) draw increasing attention to cigarettes excise taxation and indicate the need to take into account the basic provisions of documents of international organizations and foreign experience while updating this Strategy.
- The state should identify forms of illicit tobacco products turnover in order to develop effective measures to combat them. Cigarettes have the largest share in the structure of illicit trade. The main forms of illicit tobacco products turnover are:
– production and sale of cigarettes with counterfeit tax stamps, use of duplicate stamps;
– sale of tobacco products declared for export, i. e. exempt from tax, on the domestic market (including the trade in cigarettes for Duty Free);
– sale of undeclared products (in particular due to the existence of an illicit “third shift” at the production facilities of legal producers);
– falsification of products of well-known legal brands;
– production of cheap “іllicit whites” or “cheap whites” cigarettes intended for іllicit trade;
– cross-border smuggling;
– use of certain districts of Donetsk and Luhansk regions for illicit supply of tobacco products to the domestic market;
– sale of tobacco products via Internet web-sites, telecommunications, various applications and e-mail, etc. without paying taxes in the proper scope.
Depending on the prevalence of forms of illicit tobacco products turnover, appropriate measures to combat tax evasion should be selected and implemented.
- It is important to clearly identify the causes and factors that contribute to the spread of illicit tobacco products turnover. These include the high profitability of illicit business practices compared to legal ones, institutional insolvency and general weakness of the legal framework, corruption risks, low effectiveness of law enforcement and judicial systems, the existence of hidden distribution networks and organized crime groups, conducting hostilities in the east of the country, the existence of borders with states characterized by similar problems and recognized by the world community as smuggled hubs. The issue of rational increase of excise tax rates is a key economic mechanism to combat the illicit production and turnover of cigarettes. Tax administration, in particular in the field of application of the automated system of control over the turnover of tobacco products is an auxiliary factor in reducing the share of their illicit market.
- The implementation of the Strategy should be carried out in accordance with the peculiarities of the functioning of the national economy, based on the analysis, planning and use of the most efficient practices of tax administration. It is important to systematize reliable information on the prevalence of smoking, consumer preferences and the level of consumption of relevant products by geographical area, the share of the illicit market of tobacco products. It is expedient to: model the supply and demand for tobacco products, taking into account the growth rate of cigarettes prices, household incomes and the consumer price index; systematization of information on its illicit turnover; description of the mechanisms of activity of the main participants in the shadow cigarette market; assessment of institutional capacity, transparency and accountability of fiscal and other authorized bodies for combating illicit cigarette production and turnover. The lack of accounting of statistical information by fiscal authorities on key positions of the Strategy is a significant shortcoming of the relevant state policy.
4. The state economic policy of combating illicit tobacco products turnover should be characterized by systematic and consistent involvement in the development processes of all stakeholders, verification and implementation of regulatory measures. The latter should include public administration bodies, civil society institutions (including non-governmental organizations), legal market producers, mass media, think tanks, representatives of the scientific community, etc.
5. Active cooperation between central authorities and local self-government institutions is the key to successful and effective fight against illicit tobacco products turnover. Improper communication between fiscal and law enforcement agencies, on the one hand, and local authorities, on the other, reduces the effectiveness of measures to combat the illicit tobacco market.
6. The set of issues on combating illicit trade should be the basis of state policy in the field of forming a comprehensive system of control over the production and turnover of tobacco products. In a number of developed and transforming economies, including the United Kingdom, Ireland, the Philippines, etc., measures to combat illicit tobacco market and the transformation of excise taxation have been complementary. The World Bank report “Tobacco Tax Reform: Health and Development” summarizes the key elements of successful transformation strategies, including:
- ensuring the fiscal effect for the state budget and reducing smoking prevalence indices;
- modeling the optimal configuration of fiscal policy, in which an increase in excise tax on tobacco products will actually reduce the availability and consumption of the latter, in particular, cigarettes;
- constant interaction with the public, informing the public about the inevitable growth in retail prices for tobacco products and the real reasons for such growth;
- use of digital products in the administration of excise tax on tobacco products;
- effective cross-border cooperation to minimize smuggling;
- achieving synergies in the interaction of stakeholders at the national and local levels.
7. Elimination of international disparities in excise tax rates on tobacco products with a gradual and balanced increase in the tax burden should be accompanied by a simultaneous strengthening combating illicit production, counterfeiting of tax stamps and cross-border smuggling, as a result, the volume of the smuggled and counterfeit products market will not grow. This is possible, in particular, through the implementation of an international protocol to combat illicit tobacco products turnover, strengthening the control over the latter.
8. The study proposes areas for further improvement of cigarettes excise taxation, taking into account its fiscal and regulatory aspects. It is necessary to take into account the positive experience of Central and Eastern European countries, which more smoothly and prudently increased excise tax rates in accordance with EU Directives, which allowed them to effectively combat the illicit market of tobacco products and increase budget revenues. On average, this way of approximation of excise tax rates with the minimum level in the EU lasted about 14 years. The draft Plan on increasing the excise tax rates on cigarettes in Ukraine in 2022–2028 is presented, which will increase tax revenues, reduce the size of the domestic illicit cigarette market, and reduce the spread of smoking in Ukraine.
9. The modern features of the development of the cigarette market in Ukraine are determined. In 2021, the size of the shadow market of tobacco products shows the maximum value for the last decade (15.9%) and continues to increase, posing significant social and economic challenges for the state. Insufficient level of validity of state decisions on excise policy leads to erosion of the legal market. The lack of comprehensive and systemic measures in this area will lead to budget losses from the shadow cigarette market in 2021 at 0.24% of GDP, and in 2022–2024 – an average of 0.37% of GDP per year. The expediency and measures for the formation of a holistic and comprehensive system of state control over the production and turnover of tobacco products are substantiated. Combating illicit turnover of these products must become an important element of the national and economic security strategies.