THE drastic increase of excise duties on tobacco, liquor and possibly fuels will not support Bulgaria’s Budget 2006 but will have a negative impact on citizens and the local economy.

This is according to a series of statements by state and company officials, over the past week or more , on the Cabinet and ruling coalition’s intention to the gaps in next year’s budget through increasing earnings from indirect taxes.

The leaders of the three parties in the coalition – the Bulgarian Socialist Party (BSP), the National Movement Simeon II and the Movement for Rights and Freedoms – on October 6 approved a major increase in excise duties on cigarettes and alcohol. It is not clear, however, if it will actually occur nor what scale will be the hike of the duty on fuels.

Excise duties on cigarettes and alcohol are to be increased earlier than planned to the levels required by the European Union. However, the Government has two other plans in hand to assuage the hike. One is to have higher inflation in 2006, thus avoiding it in 2007-2009 when the country’s macroeconomic figures will be scrutinised against the requirements for the introduction of the single European currency in Bulgaria in 2009 or 2010.

The unpopular move, according to Prime Minister Sergei Stanishev, is also needed to partly offset the expected loss of budget revenue resulting from reduced income tax and social security contributions. The Cabinet is preparing to reduce the social security contributions by five to six percentage points, which will allow employers collectively to save about 600 million leva for investments and wage-increase.

Easier said than done, as the Government has failed to calculate the risk of dropping sales resulting from the hike in excise duties, economists say. The higher rates will doom some companies, while others will be forced to shift into the grey economy in order to survive.

Shrinking cigarette consumption and production

The effect of the shocking increase in excise duties next year would have a doubtful offsetting effect on the revenue part of the budget, Georgi Kostov, executive director of Bulgartabac Holding,, told a meeting of the parliamentary committee on budgetary policy on October 13.

The Finance Ministry has estimated that the higher rates it has prepared for the excise duties on cigarettes will yield an additional 200 million leva to the revenue part of the budget. Although the new rates have not yet been officially revealed, media reports say that 15 leva for 1000 cigarettes plus 48 per cent on the sale price will be charged from January 1 2006.

Kostov, however, said the figures seemed wrong because the ministry officials failed to foresee the shrinking of cigarette consumption and production quantities.

World Health Organisation estimates show that each 10 per cent increase in cigarette price shrinks consumption by four per cent. In Bulgaria, however, the hike would be 60 per cent, which meant 24 per cent lower consumption, Kostov said.

His calculations indicate that if the excise duties are hiked only by the rate planned for 2006, the cigarette market will be 17 000 tons next year, which will bring revenues from excise and VAT to 1.016 billion leva. With the shocking mark-up however, the market will shrink to 13 500 tons, which will lower the indirect taxation revenues by about 20 million leva to 996 million.

Bulgartabac’s net income would decline by at least 100 million leva as a result of the drastic excise duty increase in 2006, Kostov  told the MPs. The output of the best-performing factories of the holding, the ones in Blagoevgrad and Sofia, will cover domestic and export consumption, but the other two factories, in Plovdiv and Stara Zagora, will not stand up to the competition and will go bankrupt in 2007, Kostov said.

To add to the negative forecast, he said the shrunken consumption and production of cigarettes would lead to fewer transfers to the State Tobacco Fund, which aids the local tobacco producers. As a result, Bulgarian tobaccos will become uncompetitive in price terms.

Alcohol excise-intoxication

However strong the negative impact will be on the tobacco sector, the axe on the alcoholic beverages’ market also seems very serious. Unofficial figures show that in 2006, spirits will have 60-per-cent higher prices resulting from the new excise duties. From the current 0.075 leva for an alcoholic grade, the duty is expected to ump to 0.11 leva.

Representatives of the Association of Producers, Importers and Traders in Alcoholic Beverages (APITAB) told a news conference on October 17 the shocking excise-duty hike would do nothing else but fuel the grey economy. It would also boost the illegal import of liquor, said Branimir Botev, board chairman of the organisation.

Even now, sector estimates show, about a third of the alcoholic beverages sold on the local market are smuggled. Other statistics point that the consumption of home-made spirits accounts for about 50 per cent of all consumption.

By boosting the illegal production and import of liquor, the Cabinet would not fill any gaps in the budget, Botev said. Instead, he believes, the state should tighten the control on the customs and the illegal producers.

On the social cost

The Government appears clueless about offsetting the negative standard-of-living impact that Bulgarians will suffer as a consequence of the shocking excise-duty hike.

This is in addition to the household-budget threat coming from the higher power tariff introduced on October 1, the higher heating price to come to force on November 1 and the cost of fuels.

The Government had only limited options for reducing the effect of the high prices of fuels and power on the economy, business and end users, Prime Minister Sergei Stanishev said during question time in Parliament on October 14.

Stanishev pointed out that the reduction of excise duty on fuels, which had been proposed as a possible measure similar to other European countries, was impossible because of the commitments undertaken to the EU – levelling of excise duties to the minimum EU levels by January 1 2007.

The reduction of VAT calculated on oil derivatives together with the excise duties might prove a risky step considering the large amount of funds, which would be spent this year to cover flood damages and the need of additional revenue to the budget, Stanishev said.

Although ruling out the chance to counter the social cost through taxation reliefs, the Cabinet demonstrated it will seek other ways to at least make the fuel burden milder.

Economy and Energy Minister Roumen Ovcharov said on October 14 that he would lead negotiations with LUKoil Bulgaria and Bulgargaz in finding ways to secure lower prices of fuels.

The talks with LUKoil would be based mostly on the fact that January-September oil prices in Bulgaria appreciated by 35 per cent while the increase in the EU countries equalled 11 to 19 per cent, said Ovcharov.

Bulgargaz, the country’s monopolistic gas supplier and distributor, might be allowed to keep the revenues from transit fees rather than contribute them to the national budget, Ovcharov said. In his view, the measure will allow Bulgargaz to get additional financial resource, which will result in bigger investments in the gas transiting network and lower prices for consumers.

The fact is, however, that both Stanishev and Ovcharov are running out of time, as the top members of their BSP do not seem to like the socially devastating situation. A meeting of the parliamentary group of the socialists on October 12 showed that the party was no longer willing to tolerate the situation.

“We have not forgotten our election promises but will carry them out in stages,” Stanishev told his party fellows.

Finance Minister Plamen Oresharski, who also attended the meeting, had to find a way of justifying the unpopular moves of the Government. He blamed his predecessor Milen Velchev of spending funds that would have been enough for years.

The summer floods affected 75 per cent of the country’s territory, with damages amounting to at least a billion leva, he said. According to Oresharski, the largely advertised budget surplus of one billion leva for 2005 has already been spent.

There is not enough money for the socialists’ main promise to business: the introduction of a zero tax on reinvested profit and accelerated depreciation. What is more, the planned reduction in employers’ social security burden by six percentage points next year was not certain yet either, Oresharski said.

The increase in government sector wages and pensions by five per cent from January 1 2006 had also been revised, Oresharski said.

With rising pressure from politicians, employer organisations and trade unions, as well as from the International Monetary Fund, it is not clear yet whether the Cabinet will be able to successfully form next year’s budget, and this is one of the key points for the survival of the ruling three-party coalition.