Growth of illegal tobacco market to force the centre to share excise taxes with regions

What is happening to taxation?

As in the situation with excise taxes on strong alcohol, it cannot be said that revenues from tobacco excise taxes account for a significant share of revenues of the consolidated budget of Russia — only 3%. The Tax Code sets rates for eight types of tobacco and nicotine-containing products — cigarettes, tobacco, electronic nicotine delivery systems and liquids for them, devices for heating tobacco, and so on.

Excise tax rates are constantly increasing — for 5 years the rate on the most popular type of tobacco products — cigarettes — has increased by 1,9 times. This year, the growth of rates on all products has already amounted to about 20%. The total tax burden on the producers is also growing — from 68% in 2016 to 74,1% in 2020.

At the same time, statistics record a drop in sales volumes — the level of 2020 is 1,4 times lower than the same level of 2016. Revenues from excise taxes, of course, have also decreased. Experts explain this by a growth of the market of illegal tobacco products. We have not begun to smoke less (or switch to electronic cigarettes).

Dark market

The share of illegal products increased from 1,1% in 2016 to 10,7% in 2021. The constant increase in cigarette prices pushes the consumer to search for alternative options, and as it should be according to economic canons — any demand gives rise to supply. A further drop in income due to the pandemic will force consumers in Russia to look for cheap options, and the population in the EAEU countries to engage in smuggling. This is a huge market for illegal products.

As it is already noted in the article about excise taxes on strong alcohol, there is also a sharp discrepancy in cigarette prices in the EAEU member states — from 39 to 50 percent in 2021. Tobacco products manufactured in the participating countries and “intended” for export to third countries are not subject to marking with excise stamps, so they quietly pass through the territory of the Russian Federation and remain in our country for subsequent sale. As with strong alcohol, Russia has the highest excise tax rates — 35,87 euros per thousand units in 2021 and they are growing much faster than their colleagues in the EAEU. For example, in 2021 in Kazakhstan the rate increased by 4%, in Armenia — by 3%, in Kyrgyzstan it remained at the level of 2020, in Belarus it decreased by 1%. In Russia, an increase of 11% has been recorded (in foreign currency).

As a result, there is a high level of illegal packs in the border areas of the country — the border of Belarus — 34,6%, Bryansk Oblast — 42%, North Caucasus — 21%, Southern Siberia — 30%. The pandemic has slightly reduced the figures due to the closure of borders, but this phenomenon is temporary.

In 2020, a new marking system was introduced to combat illegal sales. But, having marked more than 11 billion packs in 2020, 5,6 billion packs were sold in retail. A large number of turnover participants do not submit information to the state information system. The number of counterfeit tobacco products seized is also growing — 5 million units were seized in 2020, and more than 9 million units — in 2021.

The growth in the share of the illegal market and the number of counterfeit products seized clearly indicates that there is a disproportionality and excesses in the regulation of this market.

Excise policy reform

The Accounting Chamber, having studied all the factors, recommended transferring part of the revenue from tobacco excise taxes to the consolidated budgets of the regions. Having received such a financial incentive, the regions will carefully monitor the tobacco market, where they now act as an outside observer. In an era when all financial flows are significantly centralised, such solution will give an additional breath of air to local budgets.

From 2017, the work on the collection of excise taxes on strong alcohol has been organised in this way, and this policy has been recognised as successful. There are several technical issues that need to be resolved to fully understand the consequences of the redistribution of income to regional budgets. In particular, there is currently no complete information on the volume of sales of tobacco products by regions, a more advanced monitoring system for product turnover is needed. Besides, we are also talking about the unification of the technology of state marking systems in the EAEU countries (so that authorised bodies can quickly respond to the injection of counterfeit goods into the market), the introduction of uniform rules for end-to-end traceability of the movement of products in the common customs space of the EAEU, the unification of legislation of the countries in this direction.

The Russian marking system is currently the most advanced — the volume of illicit tobacco trafficking has decreased from 15,6% in 2019 to 10,7% at the beginning of 2021. The excise taxes have increased by 32%, the volume of legal production of cigarettes has increased by 5%, and the volume of shipments (taxable base) has increased by 10,4%. Marking has also proven itself well in the fight against the turnover of counterfeit products — if before the introduction of the system from 20% to 75% of all inspected packs turned out to be falsified, now this figure fluctuates at the level of 1%.

In conclusion, we would like to note that the excise policy, as in the case of strong alcohol, as no purpose of earning additional income to the country's budget. The task, rather, is to try to force the population to get rid of the bad habit — to make the price tag for products on the verge of possible and redirect consumption towards non-tobacco nicotine-containing products that are more accessible and less harmful to the consumer and others. If the state can change consumption trends through a more precise adjustment of the excise policy, it will be a tremendous success. It is important to find some balance so as not to send the consumer to an illegal seller.

The nicotine addiction of the world's population does not go away for good — statistics show that the reduction of smokers has stopped. There are 1 billion smokers who will smoke anyway, even if a pack costs like an ounce of gold. At the same time, the World Health Organisation recommends raising excise taxes to 70% of the retail price. For information, now in Russia this figure is 46,6%. It is very important to maintain a balance and not let the illegal market grab a large share.