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Tetiana Koshchuk, Growford Institute expert in tax issues

The State Statistics Service of Ukraine has published the information that the price of a pack of medium-class cigarettes during 2022 increased from UAH 59 in pre-war January to UAH 67.5 (EUR 1.9) in September. However, counterfeit (fake) cigarettes or ‘duty free’ cigarettes can be easily boughtfor UAH 30-40 (EUR 0.8-1.1) on the illegal market, and even cheaper offers are available on the Internet.

This price differentiation is worrying. According to Kantar data, in 2020-2021 the illegal trade oftobacco products in Ukraine rose from 5.8% in February 2020 to 20.4% in December 2021. And this happened, which is especially dangerous, due to a surge of consumption of counterfeit cigarettes and ‘duty free’ cigarettes, and the share of smuggled products reached 2.9% of the tobacco market. 

Recently, we have seen in the media that one factory in Ukraine, which illegally produced cigarettes, was closed. But has this solved the counterfeit problem? Can this temporarily free niche in the tobacco market be filled again, as it has been observed many times before? If so, how does this threatenUkraine and its neighbors?

To answer these questions, one may not delve into a complicated theory, but only analyze the trends of illegal trade in tobacco products in the EU and the main factors that caused them. EU countries are constantly responding to the risks of increased consumption of illegal cigarettes. Some do it effectively, others not so much. Let us consider the most interesting.

EU – counterfeit cigarette market growth

According to KPMG study on the illegal cigarette market, the following trends were observed in the EU in 2019-2021:

 1. Total consumption of these products (legal and illegal) decreased from 460.5 to 436.2 billion pcs., or by 5.3%.

2. Illegal cigarette market grew from 33.4 to 35.5 billion pcs., which resulted in increased share in total consumption from 7.3 to 8.1%.

3. Share of counterfeit cigarettes in the structure of the illegal tobacco market doubled, reaching a record 34.6%.

In this regard, a question arises: didn’t the policy of excise tax rise cause such a dominance of counterfeit products, which began preventing the reduction of smoking? Yes, first of all, it. Or to be more precise, it was an unsuccessful excise decision of one big country. Plus “transparent” borders for illegal tobacco products.

But let us consider everything step by step. Here are two illustrative examples.

France: how the highest excise duty in continental Europe caused a boom in the EU’s illegal tobacco market

In 2021, France was the “leader” in the EU in terms of illegal cigarette trade having an indicator of 29%. Although it is hard to believe, but almost a third of French smokers switched to illegal cigarettes. The level of illegal trade was growing in leaps and bounds: by 9.4 percentage points in 2020 and by another 6.3 percentage points in 2021. But why did this happen? Does France have a low level of income or an inefficient corrupted system of tax control?

Even French consumers turned out not to be often ready to buy some of the most expensive in Europe legal cigarettes, if they can save money. The growth of prices of these products due to the increase in excise duty by 12.5% ​​in 2020 and by another 7% in 2021 was critical. There came a time when the excise duty in the price of a pack of cigarettes in France became the highest in continental Europe and in 2022 it reached EUR 6.88. The higher level (EUR 8.85) is only in Ireland, an island country that has a land border only with Great Britain (also with a high excise duty on cigarettes), which is a barrier to the flow of illegal cigarettes, but not a “blank wall”, because the share of the Irish illegal cigarette market is 17%. And if Ireland, like France, had many land neighbors in an integrated Western Europe, we would see an even worse situation on the tobacco market compared to France today.

If in 2021 the average price of a pack of cigarettes in France was EUR 9.7, then in the neighboring Netherlands it was EUR 7.6, in Luxembourg – EUR 4.76, in Spain – EUR 4.53. It is clear that this price differentiation fueled the smuggling of cigarettes to France (especially from large Spain). However, it wasn’t even it that “made the biggest difference” in the French illegal tobacco market. The high excise tax increased the profitability of the counterfeit business so much that it allowed finding“weak links” in the country’s law enforcement system. In 2021, 8 billion pieces of counterfeit cigarettes were consumed in France, which amounted to 64.7% (!) of the total volume of counterfeit cigarettes in the EU. Moreover, French illegally produced cigarettes began to penetrate the markets of Germany, the Netherlands and Switzerland…

As you can see, mistakes in excise policy are very expensive. It is better to learn from the mistakes ofothers than to make your own!

Illegal cigarette trade in the Baltic States and a dangerous neighborhood

There are also EU countries that are forced to implement a particularly balanced excise policy because they are not lucky with their neighbors. According to KPMG estimates, in 2021 the top ten EU countries with the highest level of illegal cigarette trade include Lithuania (19%), Latvia (16%) and Estonia (10%). They also have high excise taxes on tobacco products, as for post-socialist countries with relatively low incomes of the population. In 2022 the cigarette pack price includes EUR 3.40 in Estonia, EUR 2.53 in Latvia, and EUR 2.43 in Lithuania of excise duty. For reference: EUR 1.80 per pack is the minimum level of excise duty for EU countries, which is equal to EUR 90 per 1.000cigarettes. In addition, in Lithuania in 2020, this excise duty rose by 13%, which was accompanied by an increase in the share of the illegal cigarette market by 2.5 percentage points (perhaps this rate of increase was a little too high). But obviously for the Baltic countries, the greatest risks were created by smuggling from belarus (for Estonia, also from the russian federation), where excise taxes on cigarettes are many times lower. Only the war in Ukraine significantly reduced the “transparency” of the borders with these aggressive neighbors.

But in general, when most of the country’s territory is not washed by seas or there are no ‘tightly closed’ borders with unfriendly neighbors, a significantly higher price (excise duty) on cigarettes compared to the states of the region increases the risk of smuggling. And if in some country thetobacco counterfeiting develops very rapidly, it may “become cramped” within the national market and it will try to cross its borders.

Conclusions for Ukraine

The experience of the EU once again confirms that Ukraine should right now take effective steps to combat the illegal tobacco market and, especially, its counterfeit component. When we delay these steps, we not only lose huge budget revenues when they are so necessary to fight the aggressor, not only move away from achieving the goal of reducing smoking, we also create problems for ourselves on the way to EU integration, since the EU requires Ukraine to effectively combat the illegal tobacco market and it is not interested in a new member state whose counterfeiting problems may spread further across its territory. The KPMG research showed an increase in the consumption of Ukrainian illegal Compliment cigarettes in the EU in 2020-2021 from 0.5 to 0.6 billion pcs. Then the situation may get worse…

Risks for our EU neighbors and Moldova 

The closest neighbors monitor the situation in Ukraine, not only on the battlefield. Since it is important for them to take into account all the risks that may be associated with our common borders. And if we look at the five countries of the European Union with the lowest excise tax in a cigarette pack price in 2022, we can see among them Hungary (EUR 2.36), Slovakia (EUR 2.29), Romania (EUR 2.28), Poland (EUR 2.06) and Bulgaria (EUR 1.81). All the mentioned countries have lower per capita incomes compared to most other EU states and (except for Bulgaria) common borders with Ukraine. In particular, the highest level of illegal cigarettes consumption among these five countries in 2021 was in Romania (8%), and in 2022, the illegal trade in tobacco products there decreased to 6% (according to the Novel Research study). Thus, before the war in Ukraine, all these countries chose an effective strategy of a moderate increase in excise duty to collect this tax, although not at a high rate, but in their own budget. We’ll see what’s next. Much will depend on the transformations of the illegal tobacco market in Ukraine…

I wrote about Moldova’s excise policy on cigarettes earlier. But in the context of the above, a remark about possible scenarios of future developments can be added. Today, the price of medium-class cigarettes in Moldova is EUR 1.8, which is comparable to the prices of legal cigarettes in Ukraine. The price of a pack of cigarettes in Moldova includes EUR 1 of excise duty. Therefore, when this tax rises by 15% in 2023, the risks of entry of illegal cigarettes which are sold in Ukraine at the price of EUR 0.8 into the Moldovan market will be low. But if the excise tax on cigarettes in Moldova went up at a higher rate, it would significantly increase the probability of their illegal supplies from Ukraine or other countries. At least in another neighbor of Moldova, Romania, in 2021 consumption of more than 1.5 billion pcs. of illegal ‘duty free’ cigarettes or without the indication of the country of origin on the pack was already recorded. The level of illegal trade in tobacco products in Moldova in 2021 was 4.1%.

Therefore, let us make conclusions. Making decisions on excise policy, both negative precedents in the EU and the experience of more successful neighbors should be taken into account.