4.5. A response to the smuggling problem in Ukraine

While cigarette smuggling and the crime that accompanies it can cause significant problems, the government does not need forego cigarette tax increase because of fears over them. Instead, the appropriate response to smuggling is to adopt policies that make it less profitable, more difficult, and more costly to engage in smuggling.

Since 1996, the Ukrainian government has undert strong measures to control the tobacco market. For one, they established stricter rules on the border. For example, if cigarettes are declared transit goods, they should be under control of the customs service up until the moment they leave Ukraine or to pay a security deposit, which is returned if the cigarettes have left Ukraine. These and other measures apparently reduced tobacco smuggling into Ukraine at that time, but since 1999, Ukraine has been experiencing large-scale smuggling of non-filter cigarettes from Russia due to high excise tax difference.

In the year 2000, the International Centre For Policy Studies conducted research on tobacco smuggling in Ukraine. While the study is paid for by the PBN Company and the Coalition for Intellectual Property Rights, the research team was aware that these organizations are just affiliates of Philip Morris. As it were, role of tobacco industry in smuggling was not discussed at all. Despite the limits, the researchers were professional enough to give the following main conclusion:
"In our opinion, reducing the excise rates for non-filter cigarettes, aimed at eliminating the incentive for illegal imports, will result in a significant decrease in budget revenues and will have a negative effect on society as a whole. Hence, we propose to concentrate efforts on the following measures: (1) increase the effectiveness of law-enforcement agencies, (2) simplify conditions regulating the legal retail trade of tobacco products, (3) improve mechanisms for punishing illegal distributors of tobacco products, and (4) increase protection of state borders."

The ICPS report also states: Excise reduction would contradict the objective of harmonization of Ukrainian and European legislation. For example, Eastern European countries aiming at entering the EU are forced to increase excise rates significantly in order to match them to those in the EU. Moving in the opposite direction will have negative consequences for Ukraine in the future. Such changes in taxation will reduce the stability of Ukrainian taxation policy, because they contradict the strategic directions of its development and make the policy dependent upon decisions made by Russian authorities.

On July 10, 2000, the Law of Ukraine that amended some legislative acts regarding the intensification of fighting the illegal production and circulation of ethanol, cognac, fruit alcohol, alcoholic beverages, and tobacco products came into force. Implementation of the Law will promote a more effective counteraction against the illegal circulation of tobacco products. The Law envisages the following measures:

- the establishment of a department for combating illegal circulation of alcoholic beverages and tobacco products within the structure of the tax police. According to Ukrainian law, the State Tax Administration of Ukraine is made responsible for combating the illegal circulation of alcoholic beverages and tobacco products. It is specified that the State Tax Administration will maintain registers of importers, exporters, wholesale and retail traders, and places where alcoholic beverages and tobacco products are stored;

- obligatory destruction of seized tobacco products;

- regulation of administrative liability for retail and wholesale trade in tobacco products without a license or excise stamps (the fine is set at 20-100 non-taxable minimum [monthly] wages);

- setting the fine for illegal vendor trade at the level of 1-7 non-taxable minimum wages;

- specification of liability for storage or transportation of tobacco products without excise stamps (the fine equals 20-100 non-taxable minimum [monthly] wages, and 100-300 non-taxable minimum [monthly] wages for committing the crime repeatedly or in large amounts).

Since February 2001, the “Tobacco” operation has been conducted in Ukraine. Its aim is to coordinate the efforts of the State Customs Service, the State Tax administration, the State Standardization Committee, the Frontier Guard Service, and the Ministry of Internal Affairs in combating smuggling and illegal trafficking of tobacco items. The main way of combating is strict control of all firms that could have some involvement in transport, storage, or sale of smuggled cigarettes. Already at the first stage of the operation when 1073 firms were checked, in 253 cases evidence of storage or sale of smuggled cigarettes was revealed. In January-September 2001, the State Customs Service disclosed 2847 attempts to bring cigarettes illegally into Ukraine. More than 4 million cigarette packs with total cost of more than 6.4 million UAH were seized. The reduction of the quantity of smuggled cigarettes in 2001 is partly caused by the joint efforts of these agencies.

The following measures could be also useful in combating smuggling:

1. The introduction of big health warnings in Ukrainian on cigarette packs (at least 25% of the largest surface). They will clearly show that a pack was produced for the Ukrainian market and make the legality of cigarette packs more immediately visible for consumers and law enforcers.

2. Cooperation with custom authorities at least with neighboring countries and comparing the quantities of exported and imported cigarettes between the two countries as well as informing each other about suspicious transit of cigarettes.

3. Penalties for smuggling could be made sufficiently enforced to deter those who currently perceive the risks of prosecution to be low. At present, street vendors are generally ignored by police because they are looked upon as poor old women for whom illegal cigarette sale is an additional source of income. However, several media reports clearly reveal that street vendors are strictly controlled by organized criminal structures that take more than a half of the income of these old women. At any rate, since most street vendors are involved in illegal activities for years, they a have much higher income than the average citizen of Ukraine. Corruption of the police is main reason of street vendors being ignored. For example, according to a newspaper report in Berdyansk, there is a special order: every day one of street vendors in next line with their “voluntary” list goes to the police with her/his cigarettes. The cigarettes are seized and she/he is fined. The police reports show that they work hard, and the street vendors consider these seizures as a kind of payment to criminal structures. To effectively fight street vendors, all that is needed is political willpower, since all police officers know all of the street vendors in their district quite well. With proper enforcement of existing laws and regulations, the network of street vendors (which, according to the estimates of one expert, consists of about 35,000 persons) could be destroyed within one month. However, the tobacco industry (for example, the chief executive of Philip Morris Ukraine, Mirek Zelinski (see Business newspaper, N9, 2001) proposes to legalize street vendors. The reason is that street vendors sell annually about 10 billion cigarettes legally produced by multi-national tobacco companies in Ukraine in addition to smuggled ones (mainly produced by the same companies in other countries). Without this network, the total sale of cigarettes could decrease. The legalization could give street vendors more protection but would not remove incentives to sell smuggled cigarettes, so this measure could hardly decrease smuggling into Ukraine.

4. To decrease the smuggling of cigarettes produced in Ukraine, manufacturers could be required to stamp each pack of cigarettes with a serial number to enable tracking. With increasingly sophisticated technology, pack marking could provide information about the distributor, wholesaler, and exporter as well. Manufacturers could also be required to take responsibility for better record-keeping to ensure that the final destination of their products is as officially intended. Computerized control systems would enable governments to track individual consignments and inspect their progress at any time.

Conclusions