Following its state budget strategy discussions, the coalition government announced Monday a bill, which is already at the Riigikogu, to reduce alcohol excise duties by 25 percent, effective from July 1, should the bill pass. The move reverses several years of excise hikes, under the previous administration. However, the excise shortfall that cutting alcohol excise duties in Estonia would bring can only be made up by increased consumption, both by Estonians and Finns, writes Viktor Trasberg, lecturer in economic theory at the University of Tartu.
The goal in lowering excise duties is to bring back alcohol purchases to Estonia, which had been lost to Latvia [due to lower alcohol prices, trade at Latvian border towns such as Valka and Valmiera has been thriving in recent years-ed.].
However, that is all that it does. So far as state revenues arising from excise go, these will in fact fall, by €12 million per year.
Estonian beer producers lobbying
What, then, in terms of numbers, will a 25 percent drop in excise on beer and strong alcohol mean?
If the fall were to become reality, then revenue from beer sales would have been €16 million less, last year, and for strong alcohol, the figure would have been twice that at a €32 million fall.
To compensate for such losses, 30 million liters of strong liquor would have to be sold, at the new excise rates. Perhaps, every Estonian person aged 18-80 would have to buy over 50 half liter bottles of beer, and nine bottles of vodka, per year – which it total makes three liters of pure alcohol per person.
And despite this, we would not have added a cent more to state coffers, but merely compensated for the excise duty falls.
So to boost the state receipts, both Estonians and foreign visitors would need to drink even more.
From the lobbying of Estonian brewers and producers, one could get the impression that the excise duty hikes have as good as led to a collapse in the sector. However, the numbers show exactly the opposite. Our beer excise receipts have never decreased, and actually have never before grown as rapidly as in recent years, even by as much as 11-12 percent per year.
At the same time, while excise receipts on strong alcohol have been declining, by as much as 20 percent, they have been soaring on wines, with increases several years on the trot.
Were we to put the blame at Latvia's feet, we could say that the drop concerned vodka and not beer. Unfortunately, we don't know for sure whether the full in excise duty receipts on vodka is due to its higher prices, post-excise hikes, or simply a change in human consumption.
What is going to happen?
But what will be certain to happen after excise cuts on alcohol? There are three things which are sure to happen, and three more which are harder to predict.
First, the state budget revenue from excise duties will fall, over the short term. Meaning a fall, not just a lack of growth. If the level of excise duty on alcohol sold in Estonia decreases by a quarter, it cannot be compensate by the inflow of Latvian purchases of alcohol.
This truth will become apparent to all those who talk about Estonia's €500 million in lost tax money from Latvia. Unfortunately, there have never been hundreds of millions of tax losses to win back. Excise receipts can increase solely through increased consumption in Estonia and Finland.
Second, such a steep drop in excise has harmed the government's image. In a situation where budgets are being tightened and higher education institutions and retired people are grilling the government [the state budget discussions also announced that proposed research funding increases, to 1 percent of GDP, would not be taking place-ed.], effectively donating €50 million to alcohol producers is cynical behavior.
Third, we have already lost the excise war with Latvia and Finland. Obviously, the possible reaction of our closest neighbors and the tax competitiveness have been ignored here. Both Latvia and Finland have already announced possible countermeasures to our excise duty reduction plan.
We are bound to lose this "beer tax war", because our tax system is not simply competitive compared with those countries. Latvia has modernized its tax system and has initiated a progressive income tax rate. This has made it possible to reduce dependence on consumption taxes, and has increased the capacity for maneuver of public finances.
Latvia thus has no problem with reducing excise duty and transferring it to the personal income tax or corporate tax burden. However, Estonia still has an under-developed proportional income tax, a deformed tax system and a high dependence on consumption taxes. As we can see, the underpayment of every small consumption tax in Estonia will have negative impact on the budget.
Of the three less certain outcomes, first, we can look at the extent to which the reduction of excise duties might be passed on to retail prices. Whether merchants have a concrete desire to cut retail prices, or not, we will see in the near future.
Second, we do not know yet how the structure of alcohol consumption might change. Strong alcohol might now become relatively very cheap, especially when compared with wine. What, and how much more, people drink will also be difficult to predict. But the risk of increasing alcohol consumption is nonetheless very high!
Third, we attach too much importance to the impact of alcohol excise on the tourism sector. Alcohol consumption is shaped by many different factors besides price. The claim that "we can lower the excise duty, and then Finnish tourists will come back," does not apply that simply.
In fact, alcohol consumption is decreasing everywhere – in Finland, alcohol consumption has fallen by 20 percent in the last decade. Thus, Finns will not buy and drink as much as before, regardless of price, and so will not be attracted in droves to Tallinn as in the past.
All in all, I would like to paint the bigger picture. Alcohol taxes are a rather insignificant part of our overall taxes, and have already caused some embarrassment. It has to be admitted that the speed of the hikes over the last five years has been a clear mistake, and this result was quite predictable.
However, now as excise rates are getting too high, they are reaching their natural levels, in conjunction with neighboring states, and budget surpluses are quite common. Also, "general" nafta (crude oil-ed.) and "colonel" petrol have also played their part in diminishing Latvian travelers.
I would advise the government leave excise duties be, and deal with the crucial tax issues – reducing corporate tax burdens and gradually making changes to income tax. Without these, there can be no substantive tax reforms, and thus the state budget would have no scope for fulfilling its own commitments.
Editor: Andrew Whyte