Excise duty on tobacco products - guide

16 July 2008
by eub2 -- last modified 16 July 2008

The European Commission presented on 16 July a Report and a proposal for a Directive to amend the current EU excise duty legislation on tobacco. The draft EU Directive foresees a gradual increase in the EU minimum taxation levels on cigarettes and fine cut tobacco up to 2014. It also updates the definitions of different types of tobacco products so as to remove loopholes which allow certain cigarettes or fine cut tobacco to be presented as cigars, cigarillos or pipe tobacco and therefore benefiting from a lower tax rate. Today's proposal will narrow differences between EU Member States' tobacco taxation levels and so help tackle intra-EU tobacco smuggling. It would also make the taxation rules more transparent, thereby creating a level playing field for manufacturers and giving flexibility to Member States to set minimum taxes. It also aims to contribute to reducing tobacco consumption by 10 per cent within the next 5 years.

What are the main objectives of the proposal?

The policy objectives are the following:

• to ensure the smooth operation of the single market , narrow the differences in price levels of tobacco products and to ensure stability of budgetary resources for Member States,
• to contribute to the Community objectives of creating a high level of health protection,
• to modernise the current arrangements and create a level playing field for producers, importers and retailers,
• to give more flexibility to Member States to set minimum taxes.

Are taxes an appropriate means for tobacco control?

Smoking is still the biggest single form of avoidable death in the Community and one of the leading causes of illness and mortality in the EU. Taxation forms part of an overall strategy of prevention and dissuasion of tobacco consumption. According to the World Bank, price increases of tobacco products are the most effective single measure to prevent smoking. A price increase of 10% will decrease consumption on average by about 4% in high-income Member States. Importantly, the impact of higher prices is likely to be greatest on young people, who are more responsive to price rises than older people.

What are the current taxation rules for cigarettes?

Excise duties levied on cigarettes must fulfil the following conditions:

• They must include a proportional component, calculated on the basis of the maximum retail selling price, and a specific component, levied on each unit of the product.
• They must account for at least 57% of the retail selling price, inclusive of all taxes, and be at least €64 per 1000 cigarettes for the cigarettes belonging to the most popular price category (MPPC).
• The specific component of excise duty must not represent less than 5% or more than 55% of the amount of the total tax burden on cigarettes falling in the MPPC.
• In addition, Member States may levy a minimum excise tax but this may not be more than 100% of the total excise on the MPPC.

However there are also a number of derogations and transitional periods:

• Member States which levy an excise duty of at least €101 per 1000 cigarettes for cigarettes of the MPPC do not need to comply with the 57% rule. This "escape clause" is needed to ensure that the higher-taxing Member States do not have to constantly raise the excise duty in order to comply with the 57% rule.
• Under their Acts of Accession, a number of new Member States were granted derogations to postpone the application of the minimum excise duties for periods ranging from 31 December 2006 to 31 December 2009.

What are the retail prices for cigarettes belonging to the most popular category in the EU? What is the proportion of excise duties?

The figures on 1 July 2008 are as follows:

What does the Commission propose regarding the taxation of cigarettes?

The proposal contains two main elements:

• With a view to more transparency of the arrangements and in order to create a level playing field across the tobacco sector, the MPPC (the most popular price category) should be replaced by weighted average prices (WAP) as a reference point for EU minimum requirements. In order to underscore health objectives it should be combined with a monetary minimum applicable to all cigarettes
• From a health perspective an increase in the minimum duties over the next five years to €90 on all cigarettes and 63% on WAP would probably contribute to a 10% decrease in demand. In addition, the Commission proposes to give more flexibility to Member States to fix the structures of excises duties as they wish (see below).

How will the proposal contribute to creating a high level of health protection?

This proposal will contribute to creating a high level of health protection in several ways:

• it will increase taxes on cigarettes and reduce cigarette consumption; the proposal aims to contribute to a 10% reduction in cigarette consumption over the coming 5 years;
• it will make it easier for Member States to ensure a minimum price level for cigarettes and to tackle in particular the very cheap cigarettes on the markets.
• it will also increase taxes on other tobacco products which are substitutes for cigarettes; in this way it avoids substitution of cigarettes by other products which are equally harmful for health.
• in this context, it will increase taxes on fine-cut tobacco, with a view to reducing its consumption.

Will the new proposal contribute to ensuring convergence between Member States on cigarette prices?

Yes. The increase in the minimum duties to €90 on all cigarettes and 63% on WAP will decrease the gap between the cheapest and most expensive cigarettes in the EU and simultaneously reduce the gap at regional level taking into account the geographical spread of the enlarged EU.

Does this proposal only affect new Member States?

No.

The proposed introduction of a minimum specific excise duty of €90 per 1000 cigarettes would lead to an increase in excise duty on cigarettes in the new Member States (except Malta) as well as in Spain and Greece.

However, the 63% rule would mostly affect the EU-15 Member States leading to an increase of excise duties in those Member States.

What will be the impact of the proposal on prices and demand of cigarettes in the 27 Member States?

According to the impact assessment which is based on figures of 2006, the direct impact of the proposal on price and demand would be as follows (assuming that all Member States have reached the current minimum levels including those which were granted transitional periods till 2009):

* Some Member States might have modified excise duties since 2006. Therefore figures only represent a general trend.

A combination of a €90 on all cigarettes and a 63% on WAP would mean on average a probable 10% reduction in demand in the 22 affected Member States RO is not included due to the lack of data; DE, FR, UK and IE would not be affected since the national rates are above the monetary and proportional EU minimum requirements).

It has to be stressed however that the proposal could have an indirect impact in those high taxing Member States as they may be inclined to increase their tax levels in response to tax increases in neighbouring countries.

How the Commission proposal will bring more flexibility in the structures of excise duties on cigarettes?

At present, Member States have to apply both a specific (a fixed amount per 1000 cigarettes) and a proportional (or ‘ad valorem’) excise duty on cigarettes. The specific component of the excise duty may not be less than 5% or more than 55% of the amount of the total tax burden resulting from the aggregation of the proportional excise duty, the specific excise duty and the VAT levied on these cigarettes.

The Commission proposes to widen the band from 5-55% to 10- 75% of the total tax burden. This system would provide the Member States with more flexibility to determine freely the relative weight of both excise elements, taking into account the characteristics of their national market for cigarettes.

Moreover, the Commission proposes to abolish the existing rule which forbid Member States to levy a minimum excise tax higher than 100% of the total excise on the MPPC. This would allow Member States to fix minimum tax levels without any cap.

Why does the Commission propose to increase the "escape clause"?

In order to avoid that the highest taxing Member States will be obliged to increase their rates further, there is currently an "escape clause" for Member States with excise duties above a fixed amount. This cap is increased from €101 to €122 in the proposal. As a result the highest taxing Member States (e.g. Ireland, the United Kingdom, France, Germany and Sweden) will not have to comply with the 63% minimum requirement.

Why not fix minimum retail prices in order to reduce tobacco consumption?

A minimum price level can be ensured by minimum taxes. Minimum taxes make the smoker and the industry pay for the social of costs of smoking, as the costs are paid to the Treasury. Minimum prices, on the other hand. Allow the revenue to go to the companies, thereby hampering price-competition and protecting the profit-margins of the industry.

Recently, some Member States have fixed minimum retail prices in order to reduce tobacco consumption. The EU case law of the Court of Justice of the European Communities has clearly settled that minimum prices infringe Community law.

What amendments are proposed to the excise duty rules for fine-cut tobacco?

Sales of fine-cut tobacco accounts for around 8% of the total EU market for tobacco products. Although cigarettes and fine-cut tobacco intended for the rolling of cigarettes have different characteristics, they are competing products. The gap between the current level of taxation for cigarettes and that for fine-cut tobacco gives rise to product substitution (there are situations today where the tax level on hand-rolled cigarettes is less than 30% of the tax level for cigarettes). In the period 2002 to 2006 the quantities of fine-cut tobacco sold in the EU-25 increased by around 10%.

Rolled cigarettes and cigarettes are equally harmful for health. There is little justification for a wide variation in the minimum rates applicable to these products at Community level (currently they are fixed at 36% of the selling retail price, OR €32 per kilogram).

Therefore, the Commission proposes a partial (up to two thirds) alignment of the minimum rate for fine-cut tobacco to the minimum excise for cigarettes. In addition, it introduces a compulsory monetary minimum, just as for cigarettes. The minimum rates would therefore increase by 2014 to €60 and the proportional element would be fixed at 38%, in line with the proposed increases for cigarettes.

What are the current rates applied in the Member States on fine cut tobacco?

The situation on 1 July 2008 is as follows:

Does the Commission propose amendments concerning the taxation of cigars and cigarillos?

Cigars and cigarillos' consumption has been declining over the last 30 years, representing less than 1% of the total EU consumption of tobacco products. The current excise regime on these products takes into consideration the nature of the production (labour-intensive, with small business units and a low speed of production). A lower excise duty rate is therefore applied on cigars and cigarillos compared to cigarettes: the minimum rate is set at 5% of the retail selling price, all taxes inclusive, or €11 per 1000 items or per kilogram, which is less than 20% of the minimum rate for cigarettes.

The problem is that some new tobacco products are presenting themselves as cigars or cigarillos in order to benefit from the reduced tax rate, despite being similar in function, taste, filter and presentation to a cigarette.

The Commission proposal therefore amends the definition of cigars and cigarillos in order to restrict the application of the lower minimum rate to "traditional cigars and cigarillos". In addition it is proposed to adjust the specific minimum amount for inflation, with the effect that the specific minimum for cigars and cigarillos would be fixed at €12 by 2014.

Are any other changes proposed regarding pipe tobacco?

Pipe tobacco consumption in the EU-15 declined by around 50% over the last 10 years and represents only a very minor part of the total EU tobacco consumption. The excise regime offers the possibility for lower taxation than for fine-cut tobacco: the minimum rate is set at 20% of the retail selling price, all taxes inclusive, or €20 per kilogram.

Again a number of Member States face an increasing problem of pipe tobacco being used for hand rolling or tubing of cigarettes. Therefore, the definition of smoking tobacco should be adapted in order to better differentiate between pipe and fine-cut tobacco and to avoid inappropriate taxation. In addition to the proposal foresees fixing the specific minimum amount for pipe tobacco at €22 per kilogram by 2014, in order to take into account inflation since 2003.

Will this proposal not contribute to an increase of illicit trade?

There are two main causes that fuel non-domestic taxed consumption: the fact that cigarettes are less affordable due to sharp tax increases and the fact that certain Member States share porous land borders with low-tax third countries.

Further approximation of excise duties within the EU and better coordination of price increases on cigarettes for tobacco control will certainly contribute to tackling the problem of illegal trade within the EU. However a number of new Member States have land borders with neighbouring third countries where the level of taxation and the retail selling prices of tobacco products are low compared to the EU level. This encourages third country smuggling. Therefore increases in excise duties on cigarettes should be combined with a reinforcement of the fight against illicit trade from third countries.

How significant is illicit trade?

It is not possible to quantify exactly the level of illicit trade in tobacco products. In 2005 a study carried out for the Commission estimated that total non-domestically-taxed consumption represented approximately 13% of the total EU tobacco market. The markets share of legitimate circumvention represented 4% to 5% and of illegitimate circumvention 8% to 9% of the EU tobacco market. However, in some major markets in the EU this rose to more than 20%.

What measures are foreseen to tackle illicit smuggling from third countries?

The fight against illicit trade is mainly the responsibility for Member States. However, the Commission is playing a key role in the on-going negotiations in the World Health Organisation (WHO) to elaborate a Protocol on the Illicit Trade in Tobacco Products. The aim of the Protocol is to develop an internationally binding legal instrument to curb the illicit trade in tobacco products. The neighbouring third countries from which most of the problems arise with regard to illicit trade are involved in these negotiations.

Furthermore, the Commission and 26 Members States (all except the United Kingdom) have signed up an Anti-Contraband and Anti-Counterfeit Agreement with Philip Morris International and with Japan Tobacco. Under these agreements, the companies enhance the tracing and tracking of their products so as to assist law enforcement authorities in combating illegal trade. The companies have to pay compensation for loss of duties in case of seizures of cigarettes bearing their trademark. The terms of cooperation with other tobacco companies are under negotiation.

In addition, the European Anti-Fraud Office (OLAF) is in the process of placing overseas liaison officers in “tobacco hotspots” to facilitate its work with the authorities in countries from which contraband and counterfeit is smuggled into the EU.

Has taxation already proved to be efficient in reducing tobacco consumption?

Taxation forms part of an overall strategy of prevention and dissuasion which also includes other reduction demand measures such as non-price measures, protection from exposure to tobacco smoke, regulation of the contents, etc. However, according to the World Bank price increases in tobacco products are the single most effective intervention to prevent smoking. A price increase of 10 % decreases consumption on average by about 4% in high income countries . Importantly, the impact of higher prices is likely to be greatest on young people, who are more responsive to price rises than older people.

The consumption of cigarettes in the EU decreased by slightly more than 10% between 2005-2006, mainly due to tax increases.

What are the trends in tobacco consumption within the EU?

Official releases for consumption of cigarettes in the EU decreased during the period 2002-2006 by ca. 13%. This percentage takes into account intra EU cross-border flows, but needs to be adjusted for the illicit trade from third countries. Consequently the real decline in cigarette consumption in the EU can be estimated at slightly more than 10%.

This trend is mainly due to the EU-15 where releases for consumption of cigarettes went down by 16%. Over the same period the excise duties on cigarettes increased on average by 33%.

On the other hand, in the EU-12 (Excl. RO) releases for consumption decreased on average by only 1%. From the accession until the end of 2006, there has been on average an increase of 34% in tobacco excise duties in these countries. The small decrease can probably be explained by the low level of taxation before accession.

On the other hand, the quantities of fine-cut tobacco sold in the EU increased in the same period by around 10%.

What transitional periods are proposed for Member States which still have derogations from the current legislation?

As a rule, Member States shall gradually increase excise duties in order to reach the new minimum requirements by 1 January 2014.

Poland, Hungary and Slovakia are proposed to be authorised to reach the new minimum requirements by 1 January 2015 at the latest.

Romania, Bulgaria, Lithuania, Estonia and Latvia are proposed to be authorised to reach the new minimum requirements by 1 January 2016 at the latest.

Source: European Commission