Igor Mazepa
Founder and CEO

Cigarettes, Smuggling and Europe

After the tragic events in Mukachevo, the cigarette smuggling topic has been re-actualized.

Of course, many people knew about it before. Just did not want to focus on another social disease.

After all, the whole discussion of the tobacco business results in the initiative to radically raise the excise tax, for people smoke less and pay more to the budget.

But now it turns out that the smoking problem has no straightforward solution. Rising tariffs for «heavy smokers," we just translate it into a different form.

In short, a topic is interesting. That’s why we with our colleagues from the Business Council "Price of the State" decided to explore the issue to understand what should be the weighted excise policy in this segment.

The first thing that caught my eye: "to raise or not to raise excise taxes" is no longer in question. Yes, Ukraine by signing the EU Association Agreement, has undertaken to raise the cigarettes excise rates up to the European level.

Let me remind, our excise taxes on cigarettes account for about 13 EUR per 1,000 pcs, while the EU makes its members charge at least EUR 90 per 1,000.

In such a situation, it would seem everything is clear: let do. Moreover, this is the notorious "European practice". However, as the experience of new EU member states shows, the rate of excise increase is of key importance. Here are two illustrative examples.

In 2007, Bulgaria joined the EU, in 12 years after signing of the Association Agreement. About a year before joining, the country initiated a sharp increase in excise duties - from 19 to 37 EUR and, as a consequence, "enjoyed" incredible growth of smuggling - about 30% of the market share.

As a result, the government "rolled back" the excise rate to rectify the situation.

The second example is Lithuania. The country joined the EU in 2004, in six years after signing of the Association Agreement.

Somewhere in two years before it, Lithuania raised the excise tax on cigarettes more than twice in order to meet the EU requirements. As a result, instead of negligible 3% smugglers got about 40%.

Because of these and other bad examples, the European Commission had to direct that the increase in excise rates should be "gradual" and as far as possible - "taking into account the regional context."

We have the following regional context.

On the one hand, to the west of us are the European markets, where excise taxes and cigarette prices are several times higher. It is logical that the Ukrainian smugglers are interested in the illegal export of cigarettes. It is in order to solve this problem, the European Commission asked to raise the excise rates.

On the other hand, Ukraine itself is a sweet spot for smugglers from Russia, Belarus and Moldova. Low personal incomes and transparent border in the east contribute to it.

It turns out that Ukraine is caught between the devil and the deep sea, and we should increase the excise duty in such a way no to repeat the experience of Lithuania and Bulgaria.

Our situation has worsened with emergence of the "gray zone" in the territory of the Eastern Donbas in 2014. Thus, cigarette smuggling is a good source of income for criminals from the so-called LNR and DNR. And it is not just smuggling, but the matter of the terrorism financing.

As they say, another reason why the tobacco excises should be treated very carefully.

What solution do we see for our situation? What should be the excise policy to reduce the smoking level and not to create conditions for the illegal market growth? The same international experience gives an answer: increase in excise tax rates should be based on income levels.

Photo by unian.net

After all, as it turns out: prices for cigarettes increased, but the urge to smoke was not beaten. So, a man buys contraband or counterfeit goods.

Our answer is the proactive growth of excise taking into account the revenue growth. According to our estimates, this increase in excise taxes by an average of 16% per year will enable us to gradually increase the excise tax rate to the EU level in 18 years.

For your understanding: it is less time than it took to harmonize excise duties of the new EU member states.

In lieu of an afterword. Excise theme pops up every time when the Government has to "patch the hole" in the budget. Every stage of excise rising miraculously coincides with the crisis and the obvious need to quickly get money for the treasury.

These initiatives refer to smoking control for the sake of appearance. In this context, the signing of the Association Agreement and the requirement to set a clear deadline for raising excise taxes is a great opportunity to make this aspect predictable.

After all, predictability and understanding of the future is the basis for any commercial taxpayer, even for cigarette producers.