Lithuania - an example of common problems: taxation and smuggling

Giedrius Kadziauskas, Lithuanian Free Market Institute

20 September, 2006

Excise duties are uncomfortable issue. For governments and for analysts:

• Means of important social engineering project. • significant source of revenue for MS. • Policy objectives accompanied with – environmental and

health policy claims.• Shadow of corporate “villains”.• In these circumstances it is extremely difficult for

governments to argue for the excise policy changes. • Excise duties remain a „neglected“ issue of taxation in

public policy debates from an economic point of view. Public healthcare and environmental arguments are not always counterweighted by economic arguments.

Excise tax and Lithuanian particularities• Smuggling of books into Lithuania during the Russian

Tsar prohibition of written Lithuanian during 1854-1904 is a heroic adventurous part of Lithuanian history hailed and studied enviously in school curricula.

• From 2003 affordability decreased and smuggled cigarettes became attractive for local population

• Smuggling rate has grown with the increase of excise. Cigarettes intercepted on the border doubling every year from 2002-2004. Currently around 3,5 mln. packs per year.

• Public perceptions of smugglers remain generally positive – smugglers make goods accessible.

• Every second smoker occasionally buys smuggled cigarettes. Availability of smuggled substitutes significantly undermines public health goals.

Excise tax and Lithuanian particularities (cont.)

• Corruption. Border guards. This extends to courts and even parliament, which alleviated the criminal punishment for smugglers allegedly, lobbied by the smugglers themselves.

• EU funds allocated to the external border security doomed to be spent inefficiently.

• Lithuania has not reached minimum excise levels yet – due in 2009.

Effects on consumers:

Affordability crisis due to steep rise in excise and disproportionate burden on the consumers – minimum rates adjusted to EU-15 incomes.

• - Lithuania’s GDP is half of the EU average.• Basic foods stuffs consume third of family

income. • Affordability crisis minimised by alternative

sources -

How often respondents

personally bought smuggled

cigarettes, alcohol products, fuel and

sugar

• More than a half of cigarette consumers buy smuggled cigarettes at least once in a while. About a third of all cigarette consumers buy illicit cigarette supplies regularly or frequently.

• Almost every fifth respondent (18.4 percent) and almost every third alcohol consumer at least sometimes buy smuggled alcohol products.

5.4

15.4

7.9

7.0

22.7

50.6

44.7

68.0 3.7

42.4

26.6

40.9

14.6

3.4

3.4

1.4

0.8

0.9

11.5

2.1

2.0

1.2

14.3

1.0

1.5

1.8

2.8

1.9

0% 20% 40% 60% 80% 100%

Cigarettes

Alcohol productsi

Fuel

Sugar

Regularly

Frequently

Sometimes

Never (I buy only legal goods)I take no interest in the origin of goods

I don’t consume such goods at all

N/A

For consumers (II)

For smugglers

• Opportunities for black markets – border guarding culture, long geographical border with poorer neighbours, shadow/black distribution nets.

• Smuggling of excised goods creates entrepreneurs and systems ready to use for smuggling of other items.

• Funding for other criminal/legal activities.

For smugglers: high taxes alone reduces incentives to create, but differences in taxes boost creativity

Best method is not here …

New MS are responsible for 45 % of external EU border – with less developed neighbours

26 % is border with Norway.

For state border guards:

New MS have the burden of external borders

From transit state Lithuania has become the recipient of smuggled goods.

• Until 2003 large quantities of cigarettes destined for EU 15, for local market small portions.

• From 2003 affordability decreased and smuggled cigarettes became attractive for local population, this resulted in large scale smuggling for local market.

• Flows of counterfeited China origin cigarettes directed to the harbours of the EU, also go through the Klaipėda sea port. Lithuanian citizens are involved in transportation of Russian origin cigarettes into EU countries (organization, warehousing, logistics, etc.).

For national government and border security

• Substantial change in smuggling into the EU – before the accession row – Eastern/Western European border has been fortified by the cold war.

• Consumers in Lithuania have overpassed the threshold of illegality in 2003.

• However no adequate - border security - trained and reliable personnel

Average salary of border guard 300 Eur; average single consignment (of small scale) carried through the border is worth 3000 eur.

- wide income gap with neighbouring countries.- cultural, commercial ties with neighbours.

EU funds the external border at the same time raising incentives for smugglers to attack it.

Effects of high/low excises in New for Old member states

• Significant part of smuggling comes not only form NMS, but shipped from non-European countries etc.

• Externalities of excises themselves hit NMS hardest – border guarding, smuggling, consumer turn to cheaper substitutes.

• Differences in taxation - even if the NMS reach minimum rates – differences remain exorbitant and attractive for interstate commerce .

• Directive of 2004 on transitional periods – no distortion to internal market. • Smuggling into the EU-15 from non-European countries, has nothing to do

with minimum rates, it is due to high excised duties set by individual member states, for various policy objectives.

• One should bear the consequences of one’s actions. • Old member states have the possibility to increase excise taxes and

consequently widen tax and price differentials between markets of old and New member states.

Conclusions and recommendations:

• Excise duties are uncomfortable issue - social engineering and significant source of revenue.

• Excise is a disproportionately heavy burden for Lithuanian consumers and law enforcement system.

• Countries should be allowed to reduce excise taxes so that allowance is made for the economic situation in the new member states – minimum excise rate should be abolished or significantly lowered.

• Lithuanian consumers, smugglers and even the Government is “ready” for the increase of excise.

• On the eve of excise reform fostered by Commission report NMS are shooting at the moving target. And it is receding. We would prefer it approach.