EXCISE TAX POLICY FOR ALCOHOL AND CIGARETTES IN LATVIA,

ITS IMPACT ON STATE REVENUESAND THE LAFFER CURVE

Andrejs StrateičuksDiāna Fadejeva

Valters Kaže

11.11.2011

The Laffer curve (3; 4)

• entrepreneurial activity and motivation to work reduces

• pre-tax income declines

• tax evasion boosts shadow economy

• decline of State revenue

does the after-tax revenue justify

job efforts?

Excise tax policy for strong alcohol in Latvia, 2000-2011 (6; 7)

Aim: Increase state

revenues Reduce harmful effect

4

Sales volumes by alcohol groups, 2007-2010 (12)

5

Share of alcohol groups in total sales volumesin Latvia, 2007-2010

Changes in State revenues from excise tax (excluding beer) in thousands LVL, 2004-2010 (12)

7

Excise tax revenues from alcoholic drinksin Latvia, 2007-2010

Total decrease – 13.7 mln. LVLIn the 1st HY of 2011 – revenue stabilization

BUTnew excise tax increase for strong alcohol followed

on June 1st

8

Changes in alcohol turnover in Latvia,2008-2010

Total decrease in state revenues from VAT ~22 mln LVL

9

Number of deaths from consumption of alcohol,2004-2010 (22)

583

236 269196

139176

284

0

100

200

300

400

500

600

700

2004 2005 2006 2007 2008 2009 2010*

Absolute numbers

+27% ↗ +61% ↗

10,5 10,9

13,6

8,6

6,1 7,8

12,6

-2,0 4,0 6,0 8,0

10,0 12,0 14,0 16,0

2004 2005 2006 2007 2008 2009 2010*

Per 100 000 inhabitants

+28% ↗

+62% ↗

Changes in Excise tax rate for strong alcohol per 100l a/a, retail turnover and state

revenues from excise tax, 2006-2010 (6; 12; 13)

Latvia's State Tobacco Monitoring Programme for 2006-2010

Core aims:• excise tax harmonisation - Latvian tax rates’

increase till minimum required EU level• increase public awareness of tobacco’s

negative impact on health• reduce overall tobacco consumption and

smoking rates• reduce tobacco availability, etc

Changes in excise tax rates for cigarettes in Latvia, 2004-2010 (20)

2004 2005Jan 1, 2006

Jan 1, 2007

July 1, 2007

Jan 1, 2008

Jan 1, 2009

Jan 1, 2010

Specific tax,LVL per1000 sticks 6,3 6,9 7,6 8,4 10,0 17,8 22,5 22,5**

Ad valorem tax, % fromMRP* 6,1%

10,5%

14,8% 19,2% 25% 32,2% 34,5% 34,5%

*MRP – maximal retail price** but not less than LVL 48 per 1000 sticks

The average price of the most demanded pack of cigarettes LVL,

2004-2009 (7)

+ 411%

Cigarette sales in Latvia,2005-2010, thousand units (21)

2005 2006 2007 2008 2009 2010

Legal sales 4 692 4 754 3 324 3 870 2 294 1 772

Illicit trade 247 358 1 750 956 2 075 2 033

Actual consumption 4 939 5 112 5 074 4 825 3 469 3 804

Penetration of illicit trade,

%5.0 7.0 34.5 19.8 47.5 53.4

Cigarette consumption in Latvia,2005-2010, thousand units (21)

Share of smokers in Latvia, Eurobarometer data:

200636%

201036%

Excise tax rates for cigarettes and State budget revenues, 2005-2010 (20)

 2005 2006 2007* 2008 2009 2010**

as of 01.07.

2011***

Specific tax rate, LVL per 1000 sticks

6.9 7.6 9.2 17.8 22.5 22.5 25.0

Ad valorem tax rate, % from MRP****

10.5 14.8 22.1 32.2 34.5 34.5 34.0

Excise tax revenues from cigarettes, LVL million

43.13 56.89 73.83 143.10 113.35 89.88 n/a

*average annualized rate (till July 1, specific tax rate was 8.4%, ad valorem - 19.2%, after July 1, specific rate - 10%, ad valorem - 25%)** but not less than LVL 48 per 1000 sticks*** but not less than LVL 52 per 1000 sticks*** *Maximal Retail Price

State revenues from cigarettes grew by 7% during 1st HY of 2011BUT new tax increases followed in July 2011

Changes in specific excise tax rate for cigarettes and respective changes in

State income, 2005-2010, million LVL (20)

Changes in ad valorem excise tax rate for cigarettes and respective changes in State income, 2005-2010, million LVL (20)

The impact of various factors on illicit cigarette market share in European countries

Conclusions and suggestions (1)• The increase of tax rates does not necessary lead

to growing state revenue• Latvian alcoholic beverages’ and tobacco markets

- typical examples of the Laffer concept• 41% excise tax rate increase for strong alcohol

(2008-2010) caused Latvian state budget revenues in 2010 to decreas by 15%, comparing to 2008, which was the result of increasing illegal market

• Specific excise tax rate for cigarettes tripled since 2006 while ad valorem rate more than doubled. Respective state revenues, on the contrary, in 2010 were 37% below 2008, when tax rates reached their optimal value

• Tax increases have to be supported by stricter legislation and more effective complex of border monitoring, controlling and other activities aimed at preventing the thrive of illicit market, but in Latvian case, these were reduced

• Illicit market should be reduced in order to raise the competitiveness of legal producers

Conclusions and suggestions (2)

• For alcoholic drinks, an optimal excise tax rate for strong alcoholic drinks would be approximately 650-850 LVL per 100l a/a, that’s at least 10% below the current rate (940 LVL).

• For cigarettes, tax increases, were implemented at much quicker pace than Directives actually required. In future rapid excise tax increases should be avoided, gradually reaching the EU target by 2018.

• Set of activities in order to combat illicit sales is required.• Until situation in tobacco stabilizes, an increase of excise

tax rates for cigarettes definitely cannot be considered as a source for boosting state revenues.

Conclusions and suggestions (3)