1. EXCISE TAX POLICY FOR ALCOHOL AND CIGARETTES IN LATVIA, ITS IMPACT ON STATE REVENUES AND THE LAFFER CURVE Andrejs Strateičuks Diāna Fadejeva Valters Kaže 11.11.2011

2. 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?

3. Excise tax policy for strong alcohol in Latvia, 2000-2011 (6; 7) Aim:  Increase state revenues  Reduce harmful effect

4. 4 Sales volumes by alcohol groups, 2007-2010 (12)

5. 5 Share of alcohol groups in total sales volumes in Latvia, 2007-2010

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

7. 7 Excise tax revenues from alcoholic drinks in Latvia, 2007-2010  Total decrease – 13.7 mln. LVL In the 1st HY of 2011 – revenue stabilization BUT new excise tax increase for strong alcohol followed on June 1st

8. 8 Changes in alcohol turnover in Latvia, 2008-2010  Total decrease in state revenues from VAT ~22 mln LVL

9. 9 Number of deaths from consumption of alcohol, 2004-2010 (22)

10. 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)

11. 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

12. Changes in excise tax rates for cigarettes in Latvia, 2004-2010 (20) 20042005 Jan 1, 2006 Jan 1, 2007 July 1, 2007 Jan 1, 2008 Jan 1, 2009 Jan 1, 2010 Specific tax, LVL per 1000 sticks 6,36,97,68,410,017,822,522,5** Ad valorem tax, % from MRP* 6,1% 10,5 % 14,8%19,2%25%32,2%34,5% *MRP – maximal retail price ** but not less than LVL 48 per 1000 sticks

13. The average price of the most demanded pack of cigarettes LVL, 2004-2009 (7) + 411%

14. Cigarette sales in Latvia, 2005-2010, thousand units (21) 20052006200720082009 2010 Legal sales 4 6924 7543 3243 8702 2941 772 Illicit trade 2473581 7509562 0752 033 Actual consumption 4 9395 1125 0744 8253 4693 804 Penetration of illicit trade, % 5.07.034.519.847.553.4

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

17. Share of smokers in Latvia, Eurobarometer data: 2006 36% 2010 36%

18. Excise tax rates for cigarettes and State budget revenues, 2005-2010 (20) 200520062007*200820092010** as of 01.07. 2011*** Specific tax rate, LVL per 1000 sticks 6.97.69.217.822.5 25.0 Ad valorem tax rate, % from MRP**** 10.514.822.132.234.5 34.0 Excise tax revenues from cigarettes, LVL million 43.1356.8973.83143.10113.3589.88n/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 2011 BUT new tax increases followed in July 2011

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

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

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

22. 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

23. 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)

24. 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)

25. References (1) 1.Ballard, Charles L. Fullerton, Don Shoven, John B. General Equilibrium Model for Tax Policy Evaluation. University of Chicago Press, 05/2009, pp 180-190. 2.Krause Alan. A general equilibrium analysis of the Laffer argument. Social Choice & Welfare; Nov2009, Vol. 33 Issue 4, pp 601-615 3.Schwesernotes 2011 CFA Level 1 Book 2: Economics. Kaplan, Inc, 2010., pp 180.-181. 4.Д.Г. Черник. Налоги. Москва, «Финансы и статистика», 2002, стр. 55. 5.Strateicuks A. Kaže V. Skapars R. Influence of the increase in strong alcohol excise tax on the state revenues in Latvia, Conference proceedings: Current issues in management of business and society development -2011, Riga, Latvia, May 2011. 6.State revenue services of the Republic of Latvia, electronic resource www.vid.gov.lv. 7.The Cabinet of Ministers of the Republic of Latvia, electronic resource www.mk.gov.lv. 8.Peattie. L. An Idea in Good Currency and How It Grew – The Informal Sector, World Development, Vol. 15, No 7, 1987, pp. 851-860. 9.Feige. E. Defining and Estimating Underground and Informal Economies: The New Institutional Economics Approach, World Development, Vol. 18, No 7, 1990, pp. 989- 1002. 10.Brēķis E. Ēnu ekonomika: izskaust vai integrēt?, Darba tirgus sociālie un ekonomiskie izaicinājumi: Conference proceedings, Riga, Latvia, Turība, May 30. 2008.

26. References (2) 11.Maloney W. Informality Revisited, World Development, Vol. 32, No 7, 2003, pp. 1159– 1178. 12.State revenue services of the Republic of Latvia, National Customs board, Alcohol consumption report for 2007; 2008; 2009; 2010. 13.Central Statistical Bureau of the Republic of Latvia, www.csb.gov.lv, 2011. 14. LADRIA / Alcohol market in Latvia (2011), Association of Latvian alcohol producers and distributors. 15. World health organization, Report on alcohol consumption, 2009. 16. Alcohol consumption report for Latvia (2010), Association of alcohol producers and distributors (ARTA), 2011. 17. Council Directive 95/59/EC of 27 November 1995 on taxes other than turnover taxes which affect the consumption of manufactured Tobacco http://europa.eu/ 18. Latvia's State Tobacco Monitoring Programme for 2006-2010 http://phoebe.vm.gov.lv/ 19. Council Directive 92/79/EEC of 19 October 1992 on the approximation of taxes on cigaretes http://europa.eu/ 20. State revenue services of the Republic of Latvia, National Customs board, Tobacco consumption report for 2007; 2008; 2009; 2010. 21. Tobacco in Latvia. Country Reports. Euromonitor International Passport GMID, 2011.