Summary

In recent years, the annual consumption of cigarettes in Ukraine has been about 65-70 billion pieces or 1600-1700 cigarettes per person (15 years of age and over). The area of tobacco production declined from 21,700 hectares in 1980 to 2,680 in 2001. Raw tobacco production in Ukraine declined from 28,190 tons in 1987 to 2,180 tons in 2001. Cigarette production in the 1980s was more or less stable - about 80 billion cigarettes annually. Ever since 1990, the whole economy has been in crisis, including the tobacco industry. Up until 1993, tobacco production had decreased almost twice and then started to increase. In 2001, the production was 69 billion cigarettes.

In the early 1990s, transnational tobacco companies (TTC) established joint ventures with six of the eleven cigarette factories operating in Ukraine. In 1994, joint ventures produced 79% of total production in Ukraine. In 2000 and 2001, the share of joint ventures production increased to 95%.

Total employment in tobacco factories in Ukraine in 1996-2000 decreased by 27%, while total cigarette production increased by 31%.

The excise tax rates in 1996-1999 increased annually. Governmental revenue from excise tobacco taxation increased from 54 million hryvna (US$ 30 million) in 1996 to 522 million hryvna (about US$ 126 million) in 1999. After a decrease if excise taxes rates in late 1999, the revenue in 2000 decreased to 446 million hryvna (US$ 82 million) despite the increase of cigarette production. In 2001, excise tobacco tax revenue was 583 million hryvna (US$ 108 million). In dollar value, it is less than in 1998 and 1999.

Since 1996, the general tobacco trade balance (raw tobacco and cigarettes) for Ukraine is negative. In 1996-2000, combined import spending exceeds export earnings by 525 million US$, which is 100 million more than the tobacco excise tax revenue for the same period.

The policy of lowering excise taxes in 1993-1995 resulted in: 
1) a significant decrease in state budget revenues, since the small increase of production didn’t compensate for losses caused by lowered excise rates; 
2) an increase of the share of non-filter cigarettes in general production; 
3) an increase of contraband sales.

The results of the four-year period of tax increases were the following: 
1) the state budget income grew ten times in UAH, or four times in dollars; 
2) the share of non-filter cigarettes in general production decreased from 85% to 39%; 
3) contraband sales decreased.

On November 19th, 1999, the Verkhovna Rada finished the period of annual growth for the cigarettes excise rate and in December 2000 it decreased the non-filter cigarette excise tax.

Tax rate cuts were made in order to fight against contraband, but there has been little signs of success. In 2001, the production of non-filter cigarettes was 15.2 billion pieces, which is 17% more than in 2000, but the revenue from the excise tax for non-filter cigarettes was 39% less.

In 1999, Russia (which had much lower tax rates than Ukraine) collected only 2.4 billion rubles of tobacco excises, while production equaled 294 billion cigarettes. Russia produced 6 times more cigarettes than Ukraine, but collected only 96 million dollars of excises, which was 30 million dollars less than Ukraine’s revenue.

According to the experience gained from the Ukrainian tax policy in 1993-2001, the most promising policy from the point of view of state budget revenues is to increase cigarette taxes annually.

The two main types of excise tax, specific and ad valorem, have different effects on prices, profits, tax revenues, and administration. The relative merits of each tax depends in part on whose perspective is being used to evaluate their effect.

Tobacco producers care about profit and market share. Therefore, the producers that produce cheap cigarettes prefer ad valorem taxes. The producers that produce expensive cigarettes prefer specific taxes. The government cares about tax revenues, ease of administration, effective tax collection, and the welfare of consumers. From the public health perspective, the primary purpose of the tax is to discourage the consumption of cigarettes. Specific tax keeps the price of the cheapest cigarettes rather high and discourages low-income people from smoking. However, due to inflation, the tax influence on price is decreasing over time. For example, the tax for filter cigarettes in Ukraine has been stable for the last 2 years and their inflation-adjusted price has decreased by more than 25% over this period. The decrease in real prices could cause an increase of cigarette consumption.

The hybrid tax is often referred to as the “administered-price ad valorem rate” excise tax, which uses positive features of both ad valorem and specific taxation. The excise rate is defined in ad valorem terms as a fixed percentage of the taxable price per unit.

At present, the combination of specific and hybrid tax could be the best option for Ukraine. Since the current specific tax rate is rather low from the government revenue perspective, it is recommended not to decrease specific tax, but to add hybrid tax to the specific tax.

Econometric estimations of the three major equations for Ukraine’s tobacco industry (the demand function, the price equation, and the Laffer curve) provide us with the following results:

Smoking prevalence and tobacco consumption was studied in two nation-wide in November 2000 (1797 respondents over 15 years old) and in June 2001 (2721 respondents, 14 years old and older).

According to both surveys, 34% of respondents (57% of males and 14% of females) are smokers.

65% of those who smoke wish to quit and 60% already have tried to do so. 9% of the respondents successfully quit smoking. Only 2% of the smokers applied for professional smoking cessation help, and only 5% of them used medicine for quitting.

The total amount of cigarettes smoked in Ukraine in the year 2001 is estimated at 67 billion pieces, 88% of which is smoked by men and 12% by women. Teenagers from 14 to 17 years old smoke 3.3%.

The total expenses of Ukrainian smokers are estimated on the level of 4.1 billion UAH. The proportion of expenses born by young people from 14-17 years old is estimated to be 4.76% of the total amount.

If the price of cigarettes substantially increases, 31% of smokers will smoke the same number of the same cigarettes as before, 18% of them will smoke cheaper cigarettes, 18% of them will smoke fewer cigarettes, and 17% will try to quit smoking. Among those who have a low income, aged over 50, smoke cheap cigarettes, and live in cities and towns, 70% of them expect to reduce or quit smoking.

All teenagers expect to reduce smoking with a higher probability than adults. Teenagers from poor families tend to reduce or quit smoking in comparison to teenagers from rich families.

52% of the respondents support the introduction of tax on tobacco products, which is used for Pension insurance fund, 33% are of the opinion that this tax should be increased, and only 15% said that this tax should be reduced or cancelled.

The analysis of cigarette brands smoked in Ukraine revealed that several groups can be characterized by different types of tobacco consumption. From the point of view of prognosis of their behavior, if cigarette prices increase, they can be united into larger groups. The first group includes the 36% of smokers that are characterized by comparative well-being, higher educational level, living in larger cities, the majority of them women, consumption of more expensive cigarettes, less intensive smoking and probably a lower level of tobacco dependence, and in case of a price increase they tend to decrease the quantity of cigarettes smoked. The second group includes the 20% of smokers that are characterized by a lower level of income and education, living in villages and small towns, the majority of them men, higher intensity of smoking, and probably higher tobacco dependence. They consume cheaper cigarettes, mostly non- filter. In case of a price increase, they tend to shift to even cheaper cigarettes.

The individual price elasticity of cigarette demand was estimated with control for many factors that may potentially affect the amount of cigarettes smoked. For the base group, the price elasticity of demand equals –0.24, meaning that a ten-percent increase in cigarette prices leads to approximately a 2.4-percent decrease in cigarette consumption. As smokers become older, they are less sensitive to price changes. For high-income individuals belonging to a particular age group, price elasticity is the lowest (i.e. they are least price sensitive). At the same time, low-income individuals have a little bit smaller elasticity than compared to middle-income individuals.

The overall income elasticity was estimated to be 0.06. This means that a ten-percent increase in the household income causes the cigarette demand to rise by approximately 0.6 percent.

While cigarette smuggling in Ukraine is a serious problem and tax increases can lead to an increase in smuggling, the scale of the problem has been significantly overstated, particularly when it comes to the impact of smuggling on changes in cigarette smoking and tax revenues.

The estimates of the amount of annual budget loss caused by smuggling vary from 100 million UAH to up to 200 million US dollars. Our analysis reveals that the budget loss as a consequence of tobacco smuggling did not exceed 200 million UAH in 2000 and 100 million UAH in 2001. In the same years, the annual budget incomes from Ukrainian cigarettes smuggled to other countries could be up to 125 million UAH.

The smuggling of cigarettes produced in Ukraine to the Western and Central European countries, while giving some benefits to the Ukrainian budget, creates political problems and spoils the international image of Ukraine.

Ukraine is used for the transit of smuggled cigarettes both legally to high-risk smuggling countries, and illegally, such as smuggling cigarettes back to the country of their production.

The international and Ukrainian experiences clearly indicate that increases in tobacco taxes will lead to a reduction of smoking and growth in tax revenues, even when they are accompanied by increases in cigarette smuggling, while reductions in taxes that are aimed at reducing the smuggling problem will lead to reduction in tax revenues and greater smoking.

The tobacco companies play a critical role in tobacco smuggling.

The most appropriate response to the threat of smuggling is not a reduction (or even stabilization) of taxes, but the adoption and implementation of strong measures to counteract smuggling itself.

Raw tobacco production in Ukraine was very high in the 1980s. It declined in the early 1990s and especially in the late 1990s – the average annual production in 1996-2000 was less then 3,000 tons. To protect domestic tobacco growers, it is reasonable to establish a high specific tax to discourage the import of cheap tobacco from other countries. The present law provision on the obligatory content of domestic tobacco in cigarettes produced in Ukraine is unjustified from the point of view of international law, national economics, and public health. A substantial increase in raw tobacco import duties is the best solution for the national economy and public health, while it is definitely against the vested interests of tobacco industry.

Since 1989, the deteriorating condition of state tobacco factories has decreased production and diminished profits, which has encouraged their privatization. The six biggest tobacco factories of the 11 existing at that time became joint ventures with transnational tobacco corporations (TTC).

If tobacco factories with foreign investments produce cigarettes more efficiently, the result may be lower cigarette prices. Moreover, foreign investors use aggressive marketing techniques and distribution systems to increase their market share and sales, and lead to higher overall cigarette consumption. In other industries, lower prices, more appealing products, easy accessibility, aggressive marketing, and higher sales may be entirely positive. But cigarettes are a unique product — when used as intended, they kill. Consequently, if foreign investments increase cigarette consumption, this will lead to higher health care costs and a higher burden of ill health and premature deaths for smokers, families, society, and the economy.

The experience of tobacco investments in Ukraine reveals that these investments serve the interests of the investors much more than the interests of the country:

Developed countries economies have made much more profit from tobacco investments in Ukraine than the Ukrainian economy. In fact, tobacco investments in Ukraine are investments of Ukrainian smokers’ money into the economy of developed countries.

Tobacco products kill half of all long-term users, and cause a high incidence of serious diseases, resulting in a severe burden on families, society and the state. In order to minimize this harm, all governments should implement comprehensive tobacco control measures tailored to the situation and needs of the country, regardless of the ownership of cigarette enterprises. As the multi-national cigarette producers spend millions each year in aggressive and highly effective marketing and promotion, a comprehensive ban on all tobacco product marketing and promotion should be a key part of the regulatory framework for tobacco. Most importantly, governments should not allow private cigarette investors to influence tobacco tax policy. Tobacco taxes are the most effective policy instrument that governments have to affect the level of tobacco products consumption in the country. Furthermore, tobacco excise taxes can raise very large amounts of tax revenue. The level and structure of tobacco taxes that will best serve the public interest and the country’s fiscal interests are likely to be considerably higher than the level of taxes that cigarette manufacturers will want to see.