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Social Report 2006/2007
Case Studies - Illicit Cigarettes in Hungary
Illicit cigarette trade has become a major problem for many European economies. A 2005 study commissioned by the European Commission estimated that in 2004 the illicit cigarette trade in the EU 25 represented approximately 8% to 9% of the tobacco market with estimated tax loss between € 8.1 billion and € 9.15 billion1. The case of Hungary is illustrative of the scope of this problem.
From 2003 to 2005, there was a considerable drop in legal sales on the Hungarian cigarette market. The major reason was the Hungarian government's excise policy involving increases in tobacco excise duty as a tool to improve budget resources. Between 2002 and 2004, the total increase in excise duty on cigarettes reached 94,5%. Such a dramatic rise affected not only consumer prices, but also broadened the gap in price differences between Hungary and its neighbouring countries (especially Serbia, Romania and Ukraine). The excise increases took place in three rounds in August 2002, April 2003 and January 2004. Moreover, this happened without the usual consultation with the industry. These measures took the price of cigarettes well above the rate of inflation2 and beyond the purchasing power of the Hungarian consumers. In turn, this led to a significant expansion of illicit trade both in terms of volume and organised crime infrastructure. Studies commissioned by the Hungarian Tobacco Industry Association at the time showed a significant threat of legal market collapse and an estimated decline of legal volumes by 20%.
Huge increase in illegal tobacco products
However, the result proved to be even worse than the industry had imagined. By 2005, 27% of total cigarette consumption was estimated to come from illegal products. Government revenue losses in 2004 and 2005 were estimated at around 600 million Euro in excise and VAT3. Many of the illicit imports came from countries with widespread illegal cigarette production, such as: Moldova and Transnistria, Ukraine, Kosovo and Albania. The import of Chinese counterfeit products through Ilichevsk (Ukraine) caused problems as well.
Joint responsibilities and joint solutions
This situation prompted the tobacco industry to alert Hungarian national authorities and to provide the relevant market research data. This data was used to analyse the scale and financial consequences of the illicit trade in cigarettes and the government and the tobacco industry undertook a series of jointly agreed legal, administrative and communications activities.
The Hungarian government introduced new customs control measures and thanks to the reinforcement of border controls, especially with south-east neighbours, the volume of illicit product flow into the country was significantly reduced. 250 new customs staff were recruited to deal primarily with illicit trade and the implementation of the new technical measures. X-ray scanners for trains at the Ukrainian border were installed and financial incentives were introduced to increase the use of Mobile Control Units (MCUs).
In October 2005, the Hungarian customs authorities launched a new project called "Twister" involving the introduction of strict customs controls, supported by more effective law enforcement. The second wave of this programme was carried out in summer 2006, leading to the confiscation of more than 2000 vehicles with counterfeit goods.
Also the Hungarian government passed legislation limiting the maximum legal amount of cigarettes which could be brought into the country to 200 cigarettes per person per entry.
The authorities and industry took steps to inform the public regularly about law enforcement efforts including the growing number of seizures of illicit cigarettes. In conjunction with communication activities conducted by the authorities, British American Tobacco Hungary launched a successful communications campaign, informing consumers, decision makers and the media about the substantial loss in budget revenues and the criminal nature of the illicit cigarette trade. As a result, illicit trade in cigarettes became the most frequently discussed tobacco issue in the Hungarian media sensitising consumers to the huge negative impact on both the economy and levels of crime.
A moderate tax policy
In 2004, Hungary became a member of the European Union. However, full and immediate implementation of the EU's cigarette excise duty requirements would have resulted in a doubling of the retail sale price of the most popular price category of cigarettes with the prospect of a huge increase in illicit trade. Therefore, the Hungarian government negotiated successfully a derogation which allowed for the gradual increase of excise duties on cigarettes, reaching the minimum EU rate level on 31 December 2008 at the latest. The members of the Hungarian Tobacco Industry Association were involved in the structuring of the increases and it is expected that cigarette excise duty will probably reach the required EU level before the deadline of end 2008.
Less illicit trade, more tax revenues
Hungary experienced a healthy recovery of the legal duty paid market with sales increasing by 1.5 billion cigarettes between November 2005 and July 2006 (see the Duty Paid cigarette market chart*) at the expense of the illicit sector.
Several further steps are required to encourage continued recovery of the Hungarian duty paid market including improvement of excise management, proactive communication by the industry and broader information-sharing with the customs authorities. As experience has demonstrated these measures should prove beneficial for the national budget revenue, for the legitimate tobacco industry and for the fight against crime.
Duty Paid cigarette market
* The DP cigarette market chart shows the positive effect of government and industry working in co-operation.
1 KPMG, "Study on the collection and interpretation of data concerning the release for consumption of cigarettes and fine-cut tobacco for rolling of cigarettes" (December 2005, unpublished report
commissioned by the European Commission).
2 Sziléágyi, Tibor, 2004. "Tobacco Control in Hungary: Past, Present, Future" http://www.policy.hu/tszilagyi/Angol5.pdf.
3 Calculation based on actual vs. potential minus duty non paid product based on 2003 market volume.