Going after excise duties akin to Russian roulette

Alko1000 shop in Valka. Photo: Mihkel Maripuu

While Estonia’s alcohol excise duties hike paved the way for border trade with Latvia, lowering the rates back to their original levels might not reverse the damage. Moreover: it might lead to something worse.

Many outspoken politicians and brewers, who admittedly have personal stakes in the matter, find there is a magic wand with which to obliterate border trade and increase tax revenue: to lower excise duties back to the level they were on before the vodka rally broke out.

Incoming finance minister Martin Helme (EKRE) has promised to lower the duties on several occasions. If only because the matter is of considerable symbolic importance. He said in an interview to Ärileht that taxes could be lowered enough so the price difference of alcohol with Latvia would fall inside a few euros – that would take away people’s motivation to drive all the way to Latvia for their booze.

Helme has said he does not trust finance ministry officials who have missed the mark considerably when forecasting excise duty receipt (the forecast was off by more than €100 million last year – ed.).

Helme has a point insofar as no other tax receipt forecast has been off by that much. More so as the ministry is usually conservative in its forecasts – revenue usually outperforms expectations – while excise duty receipt forecasts were extremely optimistic for years.

Vodka rally to disappear

CEO of Estonia’s leading brewery A. Le Coq Tarmo Noop agrees with Helme. He said that the price difference of a case of beer in Estonia and Latvia needs to fall below €2 and that of a half-liter bottle of vodka below €1. According to Noop’s calculations, Estonia would have to lower the duty on beer by 30-35 percent and that on vodka by about 10 percent for that to happen.

Noop said how this would do away with 90 percent of border trade in just three-four months and restore border trade with Finland.

“The state will gain €100 million in tax revenue on both,” the brewer said, convinced that border trade is down only to the difference in excise duties. Noop dismissed an established network of shops and new consumer habits as relevant.

“It would be sad if Estonia failed to seize this opportunity. Talk that it is impossible to reverse border trade is nonsense! Nor does it contribute anything to our budget,” Noop said.

A recent study on border trade ordered by the finance ministry and carried out by consultants PwC and Statistics Estonia that cost nearly €100,000 does not share the optimism of A. Le Coq’s CEO. One of the principal conclusions of the study is that border trade with Latvia is here to stay.

Authors of the study rely primarily on the example of Denmark and Germany where border trade has persisted for over 45 years despite various policy changes. The countries have realized that it is impossible to abolish the phenomenon, while it can be kept in check to an extent.

The study gives another theoretical example: when Sweden wanted to lower excise duties by 40 percent, Denmark decided to go along. A decision to lower the duties by Denmark will prompt Germany to do the same. That is to say that a major slash of duties by one country would cause a chain reaction wherein other countries would try to maintain their position.

The study admits that Estonia has no experience in terms the effect an abrupt excise duty slash would have on domestic consumption.

Experience of other countries also suggests border trade only slows down when the target country (in this case Latvia) hikes its taxes, not when the source country (Estonia) lowers them on its end.

The study’s other main conclusion was that major and abrupt excise duty changes make all manner of prognosis virtually impossible. What is more: because revenue per bottle sold would fall, it is possible tax revenue would take an even bigger hit on the whole.

Question of targets

The finance ministry more or less agrees. The ministry’s press representative Ott Heinapuu said the new government’s most important task is to phrase what it hopes to achieve by altering the duties: whether it is to boost tax revenue, improve public health or develop business environment.

Is it possible to do away with border trade? “Of course, it is possible to curb border trade if prices go down,” Heinapuu said.

He added, however, that the question of whether prices would actually change remains – the price also depends on merchants’ markup. Also, the reactions of Latvia in the south and Finns in the north remain unknown.

“Just as we don’t know how long it would take for border trade to slow down and for Finnish buyers to return to Estonia. Consumption has shifted in favor of light alcoholic beverages in Finland, which means that potential tax revenue would not be what it was,” the press representative said.

These are the reasons the finance ministry remains cautious. Past miscalculations give plenty of reason for this modest approach. Heinapuu summed up the ministry’s position: we cannot say with certainty that lowering the duties would either lower or boost receipt of tax. He added that more accurate assessments are in the works.

Cryptic answers of a merchant

Owner of the Superalko chain of three alcohol shops in Latvia Riho Maurer remained cryptic in his answers. Asked whether it would be possible to shake border trade, he said that no phenomenon exists of itself and there are underlying reasons for everything. “If you remove these reasons, the phenomenon will disappear much as it appeared.”

When we asked whether draconian excise duty rates were one such reason, Maurer replied that he has not said anything of the sort. Maurer is convinced that Estonian officials, politicians and the public know very little about border trade and proceed mainly based on superficial information and hearsay that is not true.

The businessman said that one such myth is that it is much cheaper to construct shops in Latvia.

“A border shop looks cheap because it is part of the concept of cheap prices,” Maurer said. “Officials also believe that border trade is fueled, in addition to the difference in duties, by lower markup of border shops, the greed of Estonian traders, infrastructure and a conspiracy between producers.”

Maurer said that none of these reasons are strictly accurate but did not reveal the true driving force behind border trade.

“Border trade is big business and sees daily tax fraud that stretches into millions that has for years had political protection. Some major Estonian producers have hidden stakes in the business, and we also need to consider people who work in the sector,” Maurer added.