Excise duty on tobacco products: frequently asked questions
European Commission - MEMO/01/87 15/03/2001
Brussels, 15th March 2001
Excise duty on tobacco products: frequently asked questions
(See also IP/01/368)
Why has the Commission presented these fundamental proposals for change to the system of excise duty on tobacco?
A large number of Member States requested this at the time of conclusion of the previous review of tobacco taxation (see IP/98/485) which focussed only on technical adjustments to correct problems in implementing the Community rules for the taxation of tobacco products which exist since 1993.
The Commission agreed with Member States that a more in-depth review of the structure and rates of excise duty on tobacco products was necessary. Despite the current Community rules, tobacco prices and excise rates still vary widely between the Member States and this distorts the functioning of the Internal Market. Furthermore, the Commission feels that enhanced tax convergence is necessary in order to improve the excise system before the forthcoming enlargement of the European Union.
The present proposal and report are the result of a broad consultation process with national administrations and business and interest groups.
What amendments does the Commission propose concerning the taxation of cigarettes and why has it introduced these amendments?
The Commission has proposed the introduction of a fixed minimum amount of taxation of cigarettes expressed in euros in addition to the current 57% minimum excise incidence rule in order to guarantee a minimum level of excise duties on cigarettes in all Member States.
At present, the rule is that excise duties levied on cigarettes by the Member States must include a proportional (ad valorem) component, expressed as a percentage of the maximum retail selling price and a specific component (a fixed amount per unit of the product). The level of these two components must be such that, in the case of cigarettes belonging to the most popular price category, their combination amounts to at least 57% of the retail selling price inclusive of all taxes including VAT.
The 57% rule alone alone has not prevented the perpetuation of wide differences in rates and retail price levels. As a consequence the Commission believes that a minimum fixed amount in euros should be introduced in addition to the 57% test.
Under the Commission proposal, Member States' excise duties would have to meet two requirements: the 57% minimum excise incidence and an amount of €70 per 1000 cigarettes of the price category most in demand. The Commission believes that a minimum fixed amount of this kind would ensure more convergence of levels of excise taxes on tobacco within the EU and would also significantly reduce the incentive for smuggling between Member States.
It should be noted, however, that the introduction of a fixed amount of €70 per 1000 cigarettes does not mean that all cigarettes on the market will have to be subject to an excise amount of at least this amount. It only means that Member States have to fix their excise duty rates in such a way that they reach this minimum amount of €70 only for cigarettes in the most popular price category. Thus, in Member States which have to increase their rates to reach the amount of €70, the amount of excise duty on cigarettes which are cheaper than the most popular price category will remain lower than €70. The amount of excise duty on cigarettes which are more expensive than the most popular price category will be higher than this amount. The same rule applies for the other minimum requirement of 57%.
The present system sometimes obliges Member States which already have high tax levels to increase their excise rates further merely to comply with the 57 % minimum excise incidence rule. Is there a provision in the proposal to solve this problem?
Yes. A clause has been included in the Commission proposal to ensure that the Member States where price levels are high would not have to keep raising excise duty to comply with the 57% rule. It is not logical that a Member State like Sweden with a very significant excise charge should have difficulty in meeting the 57% excise rule, because cigarette prices there are also high, whilst Member States where price levels are relatively low may meet the 57% requirement but still have a very low incidence of overall excise duty. Therefore, the Commission proposes that Member States applying an effective excise charge of at least €100 per 1000 cigarettes for the price category most in demand should not have to apply the 57% rule, so as to ensure that those high-price Member States are not obliged to increase continuously their excise rates to meet the 57 % rule.
What are the consequences for Member States of the introduction of the fixed minimum amount of €70 per 1000 cigarettes in the most popular price category?
The proposed introduction of a minimum specific excise duty of €70 per 1000 cigarettes would lead to an increase in excise duty on cigarettes in the five Member States currently applying the lowest specific excise duty (Spain, Greece, Italy, Portugal and Luxembourg). For Member States where the immediate introduction of this minimum euro amount would be problematic for economic reasons, the Commission report suggests that a phased introduction spread over a limited period of time could be considered. Such a phased introduction may also have to be considered for candidate countries upon accession to the EU given that price levels for cigarettes including taxes are much lower in most candidate countries than in the EU.
Would the Commission proposal amend the structure of excise duties on cigarettes?
No. 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 turnover tax levied on these cigarettes. This system provides the Member States sufficient flexibility to determine freely the relative weight of both excise elements, having regard to the characteristics of their national market for cigarettes. No amendment is proposed to this system. Member States must always, of course, comply with the rule of applying a minimum taxation of 57 % and €70 for cigarettes in the most popular price category. The proposed additional requirement of applying a minimum taxation equivalent to €70 for the cigarettes of the most popular price category does not affect this flexibility.
Are other amendments proposed regarding the taxation of cigarettes?
The only additional amendment proposed concerning cigarette taxation would be to allow Member States more flexibility in the imposition of a minimum level of taxation on cigarettes.
On a number of occasions Member States have been confronted with the appearance of cheap cigarettes on their domestic market, often with disruptive effects.
To combat this situation, the tobacco legislation allows Member States to apply a minimum level of taxation on cigarettes irrespective of the sales price provided that this does not have the effect of raising the total tax to more than 90% of the total tax on the most popular price category of cigarettes. This rule has proven to be inadequate to deal with price wars and/or increases in supply at the lower end of the market. The Commission proposal would therefore dispense with the 90% rule and would allow Member States to levy a minimum excise duty on cigarettes provided only that the amount did not exceed the excise duty levied on cigarettes belonging to the most popular price category.
What are the amendments proposed concerning fine-cut tobacco intended for the rolling of cigarettes and why they are being proposed?
The Commission proposal suggests amending the existing provisions relating to the taxation of fine-cut rolling tobacco in two ways. It proposes gradually aligning the minimum percentage rates for rolling tobacco with the minimum for cigarettes and adjusting the minimum euro amounts for this tobacco (and other non-cigarette tobacco) in line with inflation. That would raise the minimum incidence for rolling tobacco from 30% to 39% and the minimum specific duty to €34 over a period of three years.
The substantial differences between Member States in tax levels on rolling tobacco, combined with major differences in pre-tax prices, encourage smuggling between neighbouring countries and give rise to distortions in the Internal Market. There is also a big difference at Community level between the minimum excise incidence for cigarettes of the price category most in demand and the minimum rates for rolling tobacco which are either 30% of the retail selling price or €25 per kilogram.
The Commission is well aware of the fact that the two products have different characteristics: cigarettes are factory-made, while rolling tobacco is a semi-finished product used by consumers who roll their own cigarettes and have to buy additional materials for that purpose. On the other hand the two products compete, since an increase in the price of cigarettes often results in smokers switching to hand-rolling tobacco. From a health point of view, both products are harmful and in that sense there is little justification for a wide variation in the rates at Community level. Many Member States already maintain a certain ratio between the taxation of rolling tobacco and cigarettes although there is no obligation at present to do so.
The Commission therefore believes that the minimum rate for rolling tobacco should be brought more closely into alignment with the 57% rule applying to cigarettes. Given the different characteristics of the two products, an adjustment of the minimum rate for fine-cut rolling tobacco up to two/third of the minimum excise incidence for cigarettes seems reasonable.
Member States which do not currently maintain such a ratio between their rates for cigarettes and rolling tobacco or which set their rates at a very low level will be given the necessary time to adjust to the new minimum rates.
The following gradual changes are proposed to the rates and amounts:
Does the Commission propose amendments concerning the taxation of other smoking tobacco?
The Commission only proposes adjusting the specific minimum amount expressed in euros in line with inflation, starting from 1 January 2003. The specific minimum rate for other smoking tobacco would therefore be set at €20 at 1 January 2003. There would be no change to the ad valorem rate.
Why does the Commission propose an amendment to the definition of cigars and cigarillos?
An amendment of the definition of cigars and cigarillos is proposed to take into account the changes in products offered on the tobacco market. In particular, a relatively new product has recently become popular in a number of Member States. In terms of function, taste, filter and presentation this product can be regarded as a cigarette or cigarette substitute, except that it has the colour of a cigar instead of the white colour of a cigarette.
The wrapper is filled with cut tobacco instead of a threshed blend and the manufacturing process is similar to that for cigarettes. Application of the current definition obliges Member States to tax the product at the rate of excise duties for cigars (minimum of only 5%) instead of the excise duties for cigarettes (minimum of 57 %). Due to the lower tax rate, the product is cheaper and quite attractive, especially for young smokers.
Because this product is similar to cigarettes, as well as for health protection, the Commission is proposing that the lower minimum rate for cigars should be restricted to the products to which it originally was meant to apply (cigars and cigarillos), the production of which has a more labour intensive character. Therefore, the proposal for a Directive would amendthe definition of cigars and cigarillos .
Are any other changes proposed regarding cigars and cigarillos ?
The Commission also proposes adjusting the specific minimum amount expressed in euros in line with inflation, starting from 1 January 2003.The specific minimum rate for cigars and cigarillos would therefore be set at €11 at 1 January 2003. There would be no change to the ad valorem rate applicable to these products, as the lower level compared to that for other tobacco products can be justified by their more labour intensive production process.
How are health concerns taken into consideration in this proposal?
Excise duty is primarily an instrument for generating revenue at national level, but policy-making in this area has to take the wider objectives of the Treaty into account and try to reconcile these with improvements in the operation of the Internal Market. Given the characteristics of manufactured tobacco products, particular attention has therefore to be paid to health considerations and to the relationship between consumer protection and the price of the products.
The level of taxation of tobacco products, through its impact on their final price, obviously has a significant effect on consumption. Taxation has to be seen as an important element of a policy aimed at reducing the consumption of tobacco.
Health considerations are reflected in the proposal by the following measures:
Why does the Commission propose lengthening the review period from 3 to 4 years ?
The Commission takes the view that a three-year period is too short a period in which to assess changes in Member States' legislation. A four-year period would be more appropriate for assessing the operation of the Internal Market and the influence of any changes in legislation.
Taking into account the time required for discussions in the Council, the European Parliament and the Economic and Social Committee, it would be logical to provide that the four-year period for the next review should run from the time discussions on the previous review in the Council are finalised.
This does not prevent the Commission from making proposals on its own initiative at any time before the end of the four-year period where it considers this necessary or where account needs to be taken of changes on the tobacco market.
Will the new proposal contribute to ensuring convergence between Member States of rates of excise duties on tobacco ?
Yes. Rate convergence has to be considered from two different perspectives:
The proposal will oblige the Member States with the lowest real rates to increase their excises on cigarettes. On the other hand, the Member States where cigarette prices are high and therefore tax is already high will not be obliged to increase their rates further merely so as to comply with the minimum of 57 %. This is bound to lead to greater excise convergence.
Should not excise rates reflect local economic and social conditions ? At present, income and purchasing power per capita differ widely between Member States.
Differences in excise rates and cigarettes prices are well in excess of differences between Member States' per capita gross domestic product, expressed in purchasing power standards.
As the proposal does not propose any amendments to the structure of the tax on tobacco (i.e. to the relative proportions of the ad valorem rate and specific excise duty) Member States will continue to have sufficient flexibility to fix their tax levels on the basis of local and regional policies such as in those in the area of employment and health.
Won't the proposal worsen the situation of candidate countries for accession to the EU ?
Both the position of Member States and that of candidate countries must be considered.
At present there is a high level of fraud and smuggling of tobacco products from the candidate countries to the Member States. Therefore, it is necessary that a minimum amount of excise duty is ensured in the present and enlarged Internal Market. A number of Member States have already expressed their concerns about the consequences on their own national cigarette markets of the accession of the candidate countries if there are no modifications to the existing excise system, in which a mere minimum percentage is applied to prices which differ enormously.
As far as the position of candidate countries is concerned, the report proposes that transitional measures could be taken in order to help them to achieve the minimum excise amount on a gradual basis.
Won't inflation rise in Member States which have to increase their tobacco excise rates ?
The overall impact will in general be quite limited.
Only 5 Member States will be obliged to increase their rates. The Commission report proposes that a transitional period could be considered for these Member States so as to allow them some additional time to reach the minimum amount.
Cigarette prices have already in the past increased in excess of inflation. These increases do not appear to have caused significant problems, given that in general the inflation level in the EU is on the low side (between 2 and 3 %).
Furthermore, the relative weight of expenditure on cigarettes in the global price index should not be overestimated. In some Member States, these products are even excluded from the price index.
Should there not be an approach based on a minimum fiscal incidence (i.e. a combination of excise duty and VAT) instead of a minimum excise incidence ?
The introduction of such a system would not guarantee greater excise convergence between Member States.
Such a system would not put an end to the present need for high cigarette price Member States to introduce excise increases merely so as to comply with the minimum incidence rule.
It would also not guarantee greater rate convergence. The gap between the Member States would even become bigger since the new percentages would still have to be applied to very different prices.