Introduction

Tobacco smuggling is certainly a serious economic and public order issue, and it has important health consequences. These consequences arise because the consumption of tobacco is related to its price and therefore to taxation. Smuggling undermines tobacco tax policies and hence causes harm to health in two clear ways. Firstly, by reducing the average market price as cheap illegally sold cigarettes take a share of the market. Secondly, by helping the tobacco companies exert pressure on governments to reverse the policy of having high taxation in the legal market. In both ways, demand is increased – and in both ways the tobacco industry benefits.

Smuggling reduces the maximum revenue that can be raised by cigarette taxes since, as tax rates increase, the quantity of smuggled cigarettes is also likely to increase. Attempts to control smuggling could absorb law enforcement resources. Smuggling may present opportunities for corruption. Estimates of the magnitude and determinants of cigarette smuggling are, therefore, important inputs to the design of tobacco tax policy.

There is a wide variety of activities that fall into the broad categories of smuggling. Ukraine experience the following kinds of smuggling:

1. Bootlegging is the purchase of tobacco products in a low-tax country in amounts that exceed the limits set by custom regulations for resale in high-tax country without paying applicable taxes or duties. Cigarettes are bootlegged to Ukraine (mainly non-filter cigarettes from Russia and Moldova). This kind of smuggling is often considered to be the main problem in the past few years. However, bootlegging of cigarettes from Ukraine (mainly filter cigarettes to Germany, Poland and other countries) also takes place.

2. Wholesale smuggling is the sale of cigarettes without payingtaxes or duties, even in the country of their origin. This kind of smuggling also has two types: a) pseudo export, when cigarettes produced in Ukraine are declared as exported, but leave Ukraine only by documents and in reality are sold at black markets in Ukraine; b) the illegal import of mainly international brands produced in USA or EU countriesthat are exported to some country but “disappear” in transit. This was the main kind of smuggling in 1994-1997 in Ukraine. Currently, the frequency of this type of smuggling is often underestimated.

3. Transit for smuggling: when cigarettes pass through Ukraine for illegal sale in some other country. It does not cause any problem for tobacco consumption and budget revenues in Ukraine but spoils image of Ukraine in international community. It has two types: a) the illegal transit of cigarettes covered with other goods (for example, British made cigarettes to Germany); b) the legal transit of cigarettes through Ukraine to countries well-known as “high-risk” smuggling countries.

The bootlegging of non-filter cigarettes from Russia and Moldova in 1999-2001 is perceived as the main smuggling problem. To combat it, the Ukrainian parliament decreased the excise tax rate for non-filter cigarettes twice (in November 1999 and in December 2000), the last time from UAH 10 per 1,000 cigarettes to UAH 5 per 1,000 cigarettes. These tax decreases were justified by alleged high loss of budget revenues caused by smuggling and by promises to increase domestic production to a level where additional tax payments exceed budget revenues loss with a lower tax rate.

4.1. The level of cigarette smuggling into country and its impact on government revenues