Ukraine’s state budget faces serious challenges, especially in the context of the war and economic recovery. However, even under such conditions, there are areas where the state deliberately limits its revenues, which raises questions about the real purpose of such decisions. One of these areas is the preferential taxation of EHTs (electronically heated tobacco products), which at first glance seems unnoticeable, but in fact has a significant impact on the budget. How many millions of hryvnias will Ukraine’s budget lose due to these privileges? Who is the main lobbyist behind this ‘caring’ decision? The answers to these questions reveal a complex picture where the interests of the state and business do not always coincide.
Preservation of tax privileges for tobacco manufacturers
The tobacco industry in Ukraine has long operated in an unstable business environment, with excise rates changing almost every six months. The state found itself in a situation where every hryvnia in the budget could be crucial for economic stability during the war. But instead of filling the state treasury as much as possible, lawmakers decided to play in the interests of large tobacco corporations. In June 2024, the Verkhovna Rada passed a bill in the first reading that would increase excise taxes on traditional cigarettes.
In addition, in 2025, Ukrainians will face another blow to their wallets – a significant rise in cigarette prices. This is not just a consequence of economic fluctuations, but a deliberate decision by the government to increase excise taxes on tobacco products. This step is part of the overall strategy to harmonise tax policy with EU standards, but it has other important implications. Starting from 1 October 2024, excise rates will be calculated in euros, which is supposed to protect revenues from inflation. However, this also means that any devaluation of the hryvnia will increase the burden on consumers, with higher cigarette prices becoming inevitable.
One of the biggest changes will be an increase in the specific excise tax rate on cigarettes with and without filters – by as much as 23.4%. This will lead to a rise in the price of one thousand cigarettes from 47 to 58 euros, and the minimum tax liability will increase to 78 euros. Such changes will not go unnoticed by consumers: experts estimate that cigarette prices will increase by 20-25%, which means that the cost of each pack will rise by several tens of hryvnias.
This increase in excise taxes is part of Ukraine’s commitment to harmonise its tax policy with the EU. At the same time, the government expects that these changes will bring additional revenues to the budget, which, according to preliminary estimates, will amount to about UAH 27.1 billion. Although this step is necessary to fulfil European obligations and support the budget, consumers will have to feel a significant hit on their pockets. However, something else caught the public’s attention: the draft law provides for the preservation of tax benefits for HTPs, including IQOS and glo. This is no longer just a matter of excise taxes, but a real smokescreen that hides multibillion-dollar budget losses and benefits for tobacco giants.
Why did HTPs, which were equated to regular cigarettes a few years ago, suddenly become ‘less harmful’ to health and the state budget? This decision looks particularly suspicious given that in 2021, when excise taxes on HTPs were equal to traditional tobacco products, the budget received a shocking six-fold increase in revenue in one year. After that, the World Health Organisation recognised the Ukrainian solution as the best international practice, and now we are witnessing a strange liberalisation.
However, if we analyse the dynamics of this market, it becomes clear who is behind the lobbying for such changes. ‘Philip Morris Ukraine, the largest player in the Ukrainian HTP market, is actively promoting the idea that these devices are ‘less harmful’, supporting its claims with references to European practice and scientific research that is questionable due to its links to the tobacco industry. At the same time, the World Health Organization and numerous independent studies indicate that HTPs can cause similar health risks as regular cigarettes. Moreover, the long-term effects of these products are still not well understood, making any claims of their ‘safety’ premature.
In addition, arguments about the social impact of HTPs in Ukraine also sound rather controversial. According to statistics, 18.3% of smokers in Ukraine choose HTPs, which is much higher than in the EU, where the figure is about 5%. The question arises: who will benefit from lower excise taxes on HTPs? Obviously, not the state, which is losing huge tax revenues, but tobacco corporations, which are getting unique conditions to increase their profits amid the war.
The return of tax privileges for HTPs in 2024 looks like a step backwards not only in the healthcare sector, but also in budget revenues. The same lawmakers who justify their decision with ‘European practice’ forget about WHO recommendations for equal taxation of all tobacco products. As a result, the state not only loses money, but also stimulates further growth in the number of HTP smokers, instead of reducing the number of tobacco addicts. Is this the European way that Ukraine is striving for?
Impact on the state budget of tax privileges for HTPs
In August 2024, the debate on tax exemptions for HTPs in Ukraine took on a new dimension after a study by the Vienna Institute for International Economic Research (wiiw). This issue has become a key one for both politicians and society, as it is not only about tax revenues, but also about the health of the nation and the influence of large corporations on government decisions. The Institute’s modelling has shown an interesting, albeit worrying, trend: maintaining tax privileges for HTPs may slow down the growth of budget revenues and not lead to a reduction in the prevalence of smoking among the population.
Why is this so important? The government planned to increase excise taxes on tobacco products to boost budget revenues while reducing the number of smokers. However, analysts predict that these plans may fail, especially due to uneven taxation of different tobacco products. Tobacco products for electronic heating devices (EHDs) have significantly lower tax rates than regular cigarettes. If the excise tax on HTPs remains 20% lower, it could cost the Ukrainian budget approximately UAH 7 billion annually after 2025.
According to the estimates of NGOs, such as the NGO ‘Life’, this gap will result in the state losing about UAH 18.6 billion in 2025-2028 alone. At the same time, there is no reason to expect a significant reduction in smoking either: consumption of HTPs will start to grow as early as 2026, which will undermine public health and potentially increase medical costs.
The situation is further complicated by the influence of the main player in the HTP market, Philip Morris, which controls 80% of the Ukrainian HTP market. Despite the fact that it is one of the largest taxpayers in Ukraine (UAH 30.3 billion in 2023), there are serious doubts about its true intentions. At the same time, Philip Morris paid $220 million in taxes to the Russian budget, supporting a state that is waging war against Ukraine. This double game puts Ukrainian politicians in a moral dilemma: should they promote the development of a business that, although paying taxes in Ukraine, continues to invest in Russia? This question becomes especially relevant as other tobacco companies try to avoid cooperation with the aggressor state.
In addition to budgetary losses, it is worth paying attention to social and health aspects. According to the World Health Organization (WHO), in countries where HTPs are sold at lower prices due to tax incentives, the prevalence of smoking among young people is growing twice as fast. For example, in Japan, where HTPs have been on the market for several years, there is a trend towards an increase in the number of young people who start smoking through these devices. Ukraine may repeat this negative experience, which will lead to increased medical costs and higher mortality from smoking-related diseases.
The WHO study also shows that in countries with high taxes on tobacco products, smoking prevalence decreases faster.
For example, in France, where tobacco excise taxes are very high, the smoking rate among the population has decreased by 17% over the past five years. Ukraine can learn from this experience by increasing the tax burden on all tobacco products, including HTPs.
It should be noted that the taxation structure of tobacco products in Ukraine is complex and includes several components, including specific and ad valorem excise taxes. The specific rate of UAH 907.2 per thousand cigarettes and the ad valorem rate of 12% of the retail price are the main elements of the excise tax. The ad valorem tax is calculated as a percentage of the price of the product, which is why it is difficult to predict for the budget, as its revenues depend on price fluctuations in the market.
To stabilise budget revenues, the government has set a minimum tax rate. In cases where the price of cigarettes exceeds UAH 51.07, manufacturers pay both a specific excise tax and an ad valorem tax. Despite its name, the minimum excise tax does not reduce tax revenues, but rather protects the budget from losses by ensuring sustainable taxation. The excise tax increase plan envisages that the specific and minimum rates will increase by 20% annually until 2025. However, the ad valorem rate remains at 12%, as its increase is not advisable for several reasons:
- The ad valorem tax is unpredictable due to its dependence on the price of premium cigarettes, which account for only 16% of the market. The pandemic, economic crises, and the growth of shadow trade are exacerbating the situation, making it impossible to predict the growth of this segment.
- The ad valorem excise tax creates an uneven playing field in the market. Most cigarettes are not subject to this tax, which gives a competitive advantage to manufacturers specialising in cheaper brands. It also encourages companies to produce cheaper cigarettes, which negatively affects budget revenues.
- The increase in the ad valorem rate widens the price gap between cheap and expensive cigarettes, which leads to a decrease in demand for premium brands and an increase in demand for cheap ones. Consequently, revenues from this excise tax are declining.
In view of this, many EU governments have already reduced the ad valorem tax on cigarettes to reduce price imbalances and stabilise the market. The Ukrainian government has also decided not to raise this tax until 2025, trying to maintain stability in budget revenues, but sometimes legislative initiatives do not meet the real needs of the economy.
Is there a way out?
At present, the solution to the problem of preferential taxation of HTPs largely depends on the decisions of the Verkhovna Rada of Ukraine. MPs have the opportunity to make important amendments to the draft law before the second reading, which could dramatically change the situation. One of the key options is to raise the excise tax on HTPs to the level of regular cigarettes. This will avoid significant financial losses for the state budget, as HTPs are gradually gaining a larger market share, and their current preferential taxation leads to a significant shortfall in revenue. Moreover, such changes could reduce the harm to public health, as higher prices for tobacco products could reduce consumption.
However, it is not that simple. Powerful tobacco lobbyists are standing in the way of such decisions, exerting serious pressure on the government and MPs. Their main argument is that the giant companies have already invested heavily in production during the war, creating jobs and generating tax revenues. They argue that an increase in excise taxes could lead to a reduction in investment and affect the economy at a time when the country is already in a difficult situation.
Thus, the government faces a difficult question: what is more important – short-term tax revenues from a few tobacco companies or the long-term health of the nation and a stable budget? The answer to this question may have significant implications not only for the country’s economic policy, but also for the future health of Ukrainians.
Oksana Ishchenko
