A necessary condition for the quality legislative activity is the requirement to submit documents to the parliament with an assessment of the expected impact on the welfare of all economic agents, the activities/interests of which are regulated by law.
The analysis of the draft laws submitted to the Verkhovna Rada of Ukraine shows that in most cases, the subjects of legislative initiative are not very concerned about this need. However, the draft State Budget for the next year submitted to the Verkhovna Rada of Ukraine is an exception, since it is accompanied by high-quality analytical materials. The draft State Budget is already being actively discussed in the expert community, as its study allows one to get an idea of what kind of policy (budget, debt, tax, social, etc.) the government is going to implement not in words but in deeds.
In this context, of particular research interest is the case with the tobacco industry of the domestic economy, as in order to “balance budget revenues” and “eliminate logical contradictions” excise tax rates on its products are increasing and consumers and producers have to pay a larger and larger share of the tax burden.
This is due to the good intentions of caring for the health of the population and the need to implement European tax standards in Ukrainian legislation. But in this case, it will not be about the health of the population, but about the state budget revenues in terms of collecting excise tax on tobacco products. It is interesting not only because of certain reservations about filling the state treasury, but also because such decisions call into question the prospects for the development of the market for these products, fair competition in it, investment attractiveness of the economy as a whole.
The explanatory note to the draft State Budget states that the indicators of the revenue side of the state budget are developed taking into account the fact that in 2022 indexes of consumer prices, industrial producer price will not apply to tax rates of excise tax, environmental tax and rent defined in absolute terms. At the same time, the table below shows that there is still a 20% rise in rates of specific excise duty on cigarettes and heated tobacco products (HTPs). Therefore, rates are changing and the tax burden on taxpayers, at least smokers, will increase.
Notably, the excise tax today is an important fiscal instrument providing significant revenues to the state budget of Ukraine. For example, this kind of revenues is even greater than corporate profit tax revenues. This year it is planned to receive UAH 61.9 billion from the excise tax on tobacco products, which is a little more than 40% of all excise revenues. In total, in terms of all taxes and fees paid to the State Budget of Ukraine, the tobacco industry provides up to 7% of tax revenues.
However, if we consider not absolute, but relative figures and calculate the growth rate of tax revenues from year to year, we can see that the trend is more threatening than positive. To understand this, it should be recalled that tax revenues are a function of the two main factors of the size of the tax base and the tax rate.
Regarding the tax rate, we should remind that the Law of Ukraine No. 2245-VIII of December 7, 2017 “On Amendments to the Tax Code of Ukraine and Certain Legislative Acts of Ukraine to Ensure Balanced Budget Revenues in 2018” provides for an annual increase in the excise tax rate on cigarettes by 2025 (almost 30% in 2018 and at a rate of 20% in the future). Regarding the tax base, the proxy measurement of which can be the growth rate of the average wage in the economy, we have an average annual growth rate of 10% over the last three years. During the same period, i.e. 2019 – 2021, revenues from tobacco tax increased by an average of 12% annually.
This year it is especially noticeable, because according to the Law of Ukraine No. 466-IX of January 16, 2020 “On Amendments to the Tax Code of Ukraine Regarding Improvement of Tax Administration, Elimination of Technical and Logical Inconsistencies in Tax Legislation” from January 1, 2021 the rate of excise tax on heated tobacco products (HTPs) was increased by 320%. Therefore, the government is expected to attract UAH 5.1 billion revenues to the budget from the taxation of these products, which is more than twice the amount received last year.
But if we return to the draft budget, we see that next year, despite a further increase in excise tax rates, nothing like this is expected. The draft State Budget for 2022 states that the excise tax provides UAH 53.6 billion revenues from domestic tobacco products and UAH 8.9 billion from imported tobacco products.
Thus, in total, the government plans to attract UAH 62.6 billion in tax revenues from the taxation of tobacco products. The difference with this year’s revenues is only UAH 700 million. The relative increase is generally a modest one percent!
The explanation for this phenomenon was proposed almost forty years ago by Professor Laffer, who developed the relationship between the tax rate and tax revenues. It is indirect and inverse, which in simple words means the existence of a certain threshold of the tax rate, which allows one to maximize revenue, but if you exceed it, the tax base begins to decrease. In fact, we are clearly observing this phenomenon today.
Further increase in the tax rate does not provide a proportional increase in tax revenues. The growth rate of income of the majority of the population is much lower than the growth rate of the tax burden! In addition, the study shows that, despite the relatively low price of cigarettes in Ukraine against the EU, their affordability for Ukrainian consumers over the past 5 years has decreased significantly and approached 25% of average daily income. In advanced countries, this indicator does not exceed 15%, which is a certain critical threshold, exceeding which increases the desire of the population to buy illegal products in order to minimize their own costs.
In fact, this is exactly what we observe in our real life. According to Kantar TNS Study to identify an approach to measure the illicit market for tobacco products, which was published in October 2020, the weighted average level of illicit trade in tobacco products in Ukraine in 2020 was 6.9%. Last October, this market segment grew significantly to 10%, mainly due to an increase in sales of counterfeit products. According to the latest Kantar TNS Study, as of May 2021, the market share of illegal tobacco products has grown to 15.9%. According to expert estimates, state budget revenues are less by about UAH 13.2 billion because of the existence of the shadow cigarette market.
Expectations for the next year on the dynamics of tax revenues from excise tax on tobacco are negative, which, in fact, is indirectly recognized by the government through published figures in the draft State Budget.
In the conditions of insufficient institutional capacity of the regulatory bodies, the unreasonable, detached from our socio-economic realities, increase of tax rates leads only to the growth of the shadow market of products. Given this, common sense suggests the right course of action for the government, because why we need one billion, if we can get thirteen billions!
Expert Growford, Doctor of Economics. Kostiantyn Shvabii for 24.tv.