Following previous tax hikes, cigarette contraband has already reached an all-time high. To many familiar with developments in the former communist countries of Europe, the incidence of cigarette smuggling in the region belongs to the wild days of the early to mid 1990s, when these new market economies were struggling with a period of massive social and economic change.
Since 2004, many of these nations have been members of the European Union and transparency and the rule of law have ostensibly become the watchwords of the present. This has been the case with the Baltic States of Estonia, Latvia and Lithuania, as with others that once existed behind the Iron Curtain.
If only things were that simple. In order to follow the European Union’s intensifying campaign to discourage smoking among its member countries, the Baltic States have been committed to increasing excise duties on cigarettes and this has actually led to a boom in the illicit trading of tobacco products.
The situation does not appear to have much chance of improving, either. In early November 2009, the EU’s member nations agreed that taxes should be lifted to EUR 90 per 1,000 cigarettes from 2014, though the more recently acceded countries, such as the Baltic States, would be given another four years to implement the decision (see also article on page 78).
The irony is that one of the motives behind the Brussels-based initiative is precisely to tackle cigarette smuggling but, as far as the Baltic States are concerned, such moves look likely to backfire.
BAT closes factory
In mid June 2009, British American Tobacco (BAT) Latvia announced that it would be closing its factory in the capital Riga. In its statement to mark the development, the company spelt out its reasons for doing so in unequivocal terms. It said: “Drastic excise tax increases during recent years have resulted in significant cigarette price rises which have consequently allowed illicit trade to grow rapidly. Within the past two years, the legal cigarette market has shrunk by 40 per cent and this has especially affected the low-price segment.”
The worldwide recession had exacerbated the situation for BAT in Latvia, it added. The statement went on: “The overall economic situation in the country has intensified the negative effects [of the excise hikes]. In this situation, many consumers, especially on low incomes, tend to look for cheaper alternatives and choose duty-unpaid cigarettes instead of legal products.”
BAT later pointed out to TJI that illegal cigarettes currently represented around 30 per cent of the total market in Latvia and that this was increasing, given that in spring 2009 the share of the duty-unpaid market was 26 per cent and in September it had gone up to 36 per cent, according to research carried out by TNS Latvia.
The whole phenomenon of smuggling had had a withering impact on BAT’s operations in Latvia, the company said. “Comparing the first six months this year with the same period last year, we can see that production volumes have decreased 64 per cent. Today, the factory uses less than 20 per cent of its capacity.”
The only possible solution to such a dire situation was to close the factory, BAT insisted. Peter Halacz, BAT Latvia’s chairman of the management board, said that all the excise tax increases were leading to the “further development of organised crime”, exactly the opposite of what they were apparently setting out to do.
At the end of September 2009, BAT’s factory in Riga finished manufacturing cigarettes. The company will continue sales and distribution of its brands in the Baltic countries. However, the products which were produced in Riga now will be produced in other BAT Group factories.
The upshot is that Latvia has ended up losing revenue that it had actually sought to boost by upping excise charges, given that BAT had contributed LVL 40 million (EUR 57 million) a year to the country since it began operating there. The company claims that it was one of the biggest contributors in tax to the exchequer. It also employed 296 people, including 156 in manufacturing, in Riga. That may not seem like a lot but then the population of Latvia does only total around 2.3 million people, according to recent estimates.
Close to cheap markets
The situation genuinely does appear to be an odd one, as far as the tobacco industry in the Baltic States is concerned, and much of it can be explained by its former status as a part of the Soviet Union. Despite being countries that have striven as hard as any to shed themselves of the old communist legacy, they are also trapped by the simple fact of their geographical proximity to Russia, Ukraine and Belarus, where tobacco products are a lot cheaper.
The incidents of cigarette smuggling are legion in the three small countries. In just one week, from late October to early November 2009, Estonian customs officials found 16,640 packets of illicit cigarettes being transported from across the border in Lithuania, in consignments that were reportedly bound for the United Kingdom. To highlight the extent of the problem, a Lithuanian train conductor on the route from St Petersburg to Vilnius, in June 2009, was caught in the Russian border town of Pskov with 550 packets of cigarettes that he was trying to smuggle into his native country.
The same customs officials also apprehended the driver of a car bound from the Russian town of Vologda to Latvia in November 2009. Hidden in the upholstery of the vehicle were 251,815 packets of Marlboro and Prima cigarettes, as well as 20 kilograms of loose tobacco.
Such reckless attempts at illegally transporting cigarettes are clearly the result of the Baltic States’ recently-found relationship with the European Union. They are key transit routes to countries with larger populations and much higher markups when it comes to the most appealing brands.
But according to some observers, the region has always had difficulty with the selling of legitimate products. Alf Vanags, director of the Baltic International Centre for Economic Policy Studies (BICEPS) in Riga, told TJI: ”The big problem here is that there is a history of smuggling cigarettes. In the 1990s, the Danish company House of Prince pulled out of Latvia. This is clearly not a place where the production of cigarettes flourishes.”
Acceleration of contraband
The same story is recounted by experts in Latvia’s neighbouring countries. Violeta Klyviene, senior Baltic analyst at Danske Bankas in Vilnius, Lithuania, said: “The situation here in Lithuania is pretty similar to Latvia. We can clearly see an acceleration of the contraband process, mainly from Russia and Belarus, which is largely due to the significant rise in excise duties – and not only for tobacco products.”
And while the government in Vilnius – as with its counterparts in Riga and Tallinn – is keen to muscle in on the tobacco industry in the form of higher excise taxes, it appears less eager to do so as far as the smuggling scene is concerned, in Klyviene’s opinion. She said: “In reality, the government is doing nothing and what is worse still is that it is planning to introduce a no-visa regime for the border countries of Russia (the Kaliningrad region) and Belarus. This means the contraband situation will not get any better.”
As with other former communist countries, another source of the booming trade in illegal cigarettes is the plentiful supply of open-air markets in Lithuania. More monitoring of these would help stamp out the smuggling, Klyviene insisted. She said: “More order in the various types of bazaar we have here would significantly help efforts to manage this kind of illegal activity but, again, nothing is being done in this respect.”
Yet the governments in the Baltic States have continued their relentless drive to push up excise taxes on cigarettes as a supposed answer to the contraband problem, as well as promoting better health. On 26 November 2009, Estonia’s parliament decided that the duty on cigarettes would increase by up to 20 per cent as from January 2011.
Estonian prime minister Andrus Ansip said after the vote that the increase in excise taxes for 2010 to 2011 was “minor in nature” and would not affect consumers too greatly. He also justified the increase in charges on tobacco and alcohol by saying that they would inhibit the use of harmful substances and beverages, which in his opinion would bear “good results”.
Adverse effect anticipated
However, Baltic State governments might be advised to pay heed to other “results” that have been obtained by raising excise duties on tobacco. According to a report by the local business news portal www.dv.ee in November 2009, revenue from the taxes in Latvia fell by 18 per cent in the first nine months of 2009 compared to the same period of the previous year. From January to September 2009, the government collected LVL 89.6 million (EUR 127.5 million) from the duty, which was LVL 19.6 million (EUR 27.9 million) less than in the first three quarters of 2008.
Also during this period, 584.6 million cigarettes were produced in Latvia, which was again significantly lower than in the corresponding nine months of 2008. The shortfall amounted to 60 per cent.
The report in www.dv.ee concluded: “It would appear that increasing excise taxes on tobacco products can have a marked impact on their turnover, reducing sales and the amount of tax that can be collected. So far this year, legal sales of cigarettes have fallen by 39 per cent compared to the same period of last year.”
Latvia’s inland revenue said some 46 per cent of tobacco products were being brought into the country from neighbouring countries every year, which were declared as being for personal use but were actually sold on the black market. This meant that the budget was deprived of excise tax funds to the tune of LVL 4.1 million (EUR 5.83 million).
One solution to the problem has been for the Latvian parliament to pass new legislation that will limit the number of cigarettes and similar products that individuals from Russia and Belarus can bring into Latvia. They will also be restricted to bringing tobacco products across the border only once a day.
Currently, citizens from nations outside the European Union are allowed to take 200 cigarettes, 100 cigarillos or 250 grams of loose tobacco with them into Latvia. The new law will cut this to 40 grams in the first instance, 20 grams in the second and 50 grams in the third.
The finance ministry reportedly believes that this new measure will aid the sales of legal tobacco products and lead to the state’s coffers being boosted by almost LVL 3.30 million (EUR 4.6 million).
Finance minister Einars Repse argued in November 2009 that moves against the army of “legal” smugglers should have been introduced well before this year, particularly as some individuals had been making several journeys a day to sell cigarettes illicitly. He also suggested the tax authorities had fallen short in their efforts to collect excise duties.
But whether these initiatives and others will help legal entities such as BAT sell their products effectively is another matter. Clearly, the company does not think they will, otherwise the Riga factory would continue working.
In the view of some commentators, the smuggling trade in Latvia and its neighbours will continue to thrive precisely because of the tobacco industry-related laws that have been implemented.
Alf Vanags said: “The excise tax changes in recent years mean that they are now more than twice those in Ukraine, for instance, which makes it difficult for tobacco companies to operate.” He went on: “There haven’t been any serious attempts to clamp down on the illegal sale of cigarettes, from what I can see, because there are too many interested parties involved. It is a hugely lucrative business when we talk about smuggling to France and the UK, so the incentives [for smuggling] remain high.”
Colin Graham
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