Excise Taxes: Simplicity and Risks

Excise taxes are the simplest and simultaneously the riskiest direct taxes for authorities. The introduction of such taxes pursues several goals.

The primary goal is, obviously, the tax collection. The second goal is not plain since it is associated with reducing the consumption of so-called socially harmful goods. This typically means tobacco and alcohol, but several countries apply excise taxes to sugary carbonated drinks, for example.

If the first goal falls under the purview of the Finance Ministry or tax authorities, the second goal is the prerogative of the Ministry of Health, which justifies the tax because reducing the consumption of harmful goods decreases the state’s costs of treatment of citizens, makes labor more productive, and has a positive effect on GDP growth.

Achieving the first goal is a matter of a state’s internal policy, but the state’s accession to international treaties established by the World Health Organization influences the second goal, so it is a matter of foreign policy.

The essence of an excise is that it levies each produced or imported unit of a product, item, liter, or kilogram at a fixed rate. Direct taxation increases the retail prices of goods by the amount of the excise tax. This has unpleasant consequences.

The difference in prices for a legal product, which includes excise, and an illegal product, which is free of taxes, stands for the potential income for criminals. It creates the opportunity to sell more illegal goods by offering a lowering price. The higher the excise tax, the greater the opportunity for criminals to make money by trading in illegal goods. If the state does not prevent the sale of illegal goods on its territory, then legal producers and importers lose interest in the business, and excise tax revenues fall.

Think not about the excise tax rate, but about gross tax collections, which depend on the excise tax rate and the turnover of illegal goods. Besides excise taxes, do not forget about VAT and import duties, which also affect motivation and behavior of manufacturers and importers. The relevance of tax rates may be straightforward, but the turnover of illegal goods depends on the following variables:

• The size of the market for excise goods—the larger the market, the more it will attract criminals.
• The rate of excise and related taxes and duties affecting margins on illegal business.
• The presence of nearby countries with lower excise tax rates, which make it possible to set up flows of goods that are legal in neighboring states, but illegal domestically.
• The presence of initiatives to distinguish legal goods from illegal goods using special stamps, digital codes, and traceability technologies ( Track & Trace ).
• Border control and the ability to transport illegal goods, including export controls.
• Production control, licensing of goods, and licensing of equipment for domestic production of goods.
• Control of transit of goods within the country.
• Control of retail sales.
• Taxpayers’ and buyers’ motivation to control the legality of goods and work only with legal goods.
• Authorities’ and regulators’ motivation to prevent the circulation of illegal goods.

The excise tax administration seems simple: pick a rate and increase it to earn more money for the state budget. However, it is exceedingly difficult to optimize the collection of excise taxes and reduce the excise tax gap. These objectives require in-depth analysis, considering many variables, and consistently implementing a lot of initiatives that will really help achieve the desired goal.