The paper examines the excise policy in the area of tobacco products and its impact on the illicit cigarette trade in EU countries, the tobacco market transformation and the tobacco excise duty problems in Ukraine during the war, as well domestic realities of combating the illegal turnover of cigarettes. Specifics of the functioning of track&trace systems of tobacco products and security features in EU countries and the initiative of the electronic excise stamp in Ukraine have been analyzed. Conclusions and recommendations for the excise policy of Ukraine on the way to integration into the EU have been argued. Possibilities of our state’s implementing effective European practices in combating the illicit tobacco market have been identified.
1. The principles of excise policy in the area of tobacco products are in line with the EU strategic development goals and the basic principles of the European Economic Community, but take into account the economic nature of the tax and the goals defined by Council Directive 2011/64/EU. The effectiveness of the policy implementation lies in the need to reach a compromise between the consumers’ needs, filling the state budget with tax revenues and the position of tobacco product manufacturers.
The strategy of a moderate and gradual increase in excise duty rates on cigarettes allows considering, on the one hand, the regulatory requirements of EU legislation regarding the harmonization of this tax, and on the other hand, taking into account the differences in the levels of social and economic development of EU countries. At the same time, this mechanism of tax elements “fine tuning” makes it possible to achieve such goals of excise policy as the need to influence consumer behavior and provide budgets with additional tax revenues, which means the need for a more comprehensive and integral approach in this area.
Council Directive 2011/64/EU defines the principles of harmonization of the structure and rates of excise duty on tobacco products (manufactured tobacco), namely cigarettes, cigars and cigarillos, smoking tobacco, but does not regulate the taxation of Heated Tobacco Products (HTP) and liquids for electronic cigarettes. The excise duty on the latter products in EU countries is also gradually increasing, but the level of its differentiation with the excise duty on cigarettes remains quite high (in the vast majority of countries by more than two times). This is, in particular, due to the potentially lower risk of consumption of such alternatives for human health.
In the EU, there has been a discussion on updating the Council Directive 2011/64/EU that covers the issue of raising the minimum excise duty on cigarettes and establishing the rules for excise taxation of HTP and liquids for electronic cigarettes. However, there is a consensus on the lower excise tax rate of the new nicotine consumption products compared to cigarettes.
2. The analysis of the foreign scholars’ papers and European experience has proved that even the most developed countries did not manage to avoid spikes in the illegal trade when there was a significant increase in the excise tax on cigarettes. This caused losses in budget revenues and prevented the achievement of healthcare goals. Bulgaria, Lithuania, Latvia and Hungary, in compliance with the requirements of Council Directive 2011/64/EU, applied the mechanism of slowing down (suspending) the increase in excise duty rates on cigarettes, which allowed them to effectively combat illegal trade in these products and increase tax revenues. 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.
3. The degree of achievement of the tobacco products excise policy goals in Ukraine should be assessed in accordance with policy priorities and considering all possible options of behavioral effects. Taking this into account, we state that the degree of implementation of the excise policy on tobacco products is characterized by an insufficient level of progress on this way.
The war has had a significant impact on the tobacco industry. The halt in production in frontline zones, logistics problems, massive migration flows and a drop in the purchasing power of the population are systemic challenges for the tobacco market. The growth of the shadow cigarette market to a record almost 20% and the loss of budget revenues in the amount of UAH 19.1 billion are extremely undesirable. It is not possible to counteract these phenomena only by strengthening control. The collapse of the HTP market, a surge in sales of significantly cheaper liquids for electronic cigarettes (mainly of illegal origin) and roll-your-own tobacco (RYO) are not the consequences that were expected after raising the excise duty either.
In addition, the dangerous trends of the war were the increased trade in counterfeit cigarettes and “duty free” cigarettes or for export, and the fact that most illegal tobacco products are sold in kiosks and shops.
4. 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.
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. However, in spite of these successes, the share of illegal cigarettes in the total volume of their consumption remains high, some tobacco criminals are being replaced by others.
Over the past five years, budget losses from the illicit turnover of tobacco products grew annually, and the total amount of such losses is estimated at UAH 46.1 billion. The main problems in the fight against illegal cigarette trade remain: the shadow market is equated with the shortcomings of excise duty administration, while the factor of tax burden growth is ignored; a comprehensive system of state control over the production and turnover of tobacco products has not been formed; insufficient effectiveness of the fight against producers and “big” suppliers of illegal products; an effective interaction of state institutions in combating the illegal cigarette market is not provided; lack of measures aimed at eliminating the reasons for the illegal cigarette trade existence.
5. The analysis of the experience of implementing track&trace systems and security features in the EU allowed one to find out that the member states coped with this difficult task and fully fulfilled the requirements of the FCTS Protocol regarding tracking and tracing tobacco products based on international standards to ensure the possibility of global information exchange in the future. The countries are able to track all products on the domestic market and for export, which reduces the likelihood of new tax evasion schemes.
The obstacles to the track&trace system implementation include: insufficient time to implement certain steps; system complexity; its high cost; problems with the quality of traceability data regarding information about production equipment. Instead, the factors of successful implementation of the system are: a long period of establishing its functioning; a careful approach to the selection of suppliers of technological solutions; consultations with the public and tobacco market operators. Despite certain problems, the track&trace system in the EU is fully functional and well established. The European Commission will continue to monitor the effectiveness of its application to determine whether its long-term effectiveness can be improved.
The experience in the transformation of security systems on the EU market to fulfill the norms of Art. 16 of the TPD Directive shows that most EU countries have changed the set of protection elements on excise duty stamps, and those countries that previously refused the tax verification system have introduced non-fiscal labels to mark them with visible, partially or totally hidden protection elements provided by the TPD Directive.
Ukraine now has an open window of opportunities to implement the track&trace system, and it is necessary to take into account the relevant experience of the EU, so that in the future the national system of tracking and tracing of tobacco products can be integrated with the European one. In addition, in view of the requirements of Art. 16 of the TPD Directive, it is not reasonable for Ukraine to abandon paper excise duty stamps. The experience of implementation and practical application of cigarette track&trace systems with separate functionality, which are developed on the basis of open international standards, taking into account the relevant requirements of the FCTC Protocol and harmonized EU approaches, is valuable for our country.
6. The electronic excise stamp system initiated in Ukraine today takes into account the requirements of European legislation only partially, and does not comply with a significant number of the provisions of Art. 15 and 16 of the TPD Directive. The latter makes it incompatible with the tobacco product track&trace system used in the EU. In addition, this initiative has significant legal, technical and institutional shortcomings. It should also be supplemented by appropriate digital solutions, which are currently not ready and worked out by the regulatory bodies.
We should evaluate not only the advantages of new technological solutions, but also their risks. It is necessary to answer a number of important questions. Will the use of an electronic excise stamp in Ukraine be effective? Will it not cause significant obstacles to the activity of operators of the legal tobacco products market? Given the latter risk, it is necessary, among other things, to provide for the use of a test mode before the full implementation of the system. Will the electronic excise stamp provoke the emergence of new tax evasion schemes? All risks must be considered.
Moreover, when introducing the electronic excise stamp as provided by the initiative, we should understand that these are only interim changes that must be significantly adjusted upon Ukraine’s accession to the EU.
7. The European integration aspect of the reform of the excise duty on tobacco products should consider the socio-economic situation in Ukraine, including specific 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 rate for cigarettes at the level of 20% per year is too high, it must be slowed down.
It is also necessary in Ukraine: 1) to restore the differentiation of the level of excise duty on HTP and cigarettes by temporarily refusing to increase the excise duty for HTP; 2) to improve measures to combat illegal trade in liquids for electronic cigarettes; 3) to increase the excise duty on other tobacco products, which will make it possible to slow down the transition of consumers from cigarettes to cheaper roll-your-own tobacco (RYO), with increasingly large losses of tax revenues.
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.
Ukraine has not determined the effectiveness of the measures of the Strategy in combating the illegal production and turnover of tobacco products for the period until 2021 and its modernization, taking into account the new challenges of illegal cigarette trade. It is necessary to update the Strategy, define a clear Plan of measures for its implementation for a five-year period.
An urgent state priority is to form a comprehensive system of state control over the production and turnover of tobacco products. This covers the following issues: modeling of the impact of excise policy measures on the volume of the illegal cigarette market; improvement of information and analytical support in the field of control over the production and turnover of these products; improvement of licensing of production and turnover of tobacco products; settlement of the issue of their online sales.
It is important to institutionally improve the work of the State Customs Service and the State Border Service, to ensure their coordinated activities and to strengthen the coordination of their actions with similar bodies of EU countries and Moldova. It is necessary to introduce criminal liability for smuggling excise goods.