In recent years, there has been an expansion in the line of nicotine-containing products (NCPs) with the primary goal to offer smokers potentially less risky nicotine consumption options compared to cigarettes.

According to recent studies, the segment of nicotine pouches prohibited for sale in Russia in early 2020 is potentially less dangerous in terms of health risk profile among the types of compared products (cigarettes, heated tobacco products, liquid e-cigarettes, Swedish snus and NCPs), During this period, there have been notable changes in the Russian market for oral NCPs, which need to be taken into account when designing legislative initiatives and forecasting their effectiveness.

During the period under review, the market of pouches completely switched to the illegal mode and the largest part belongs to products of dubious quality, as well as fakes of famous brands. However, the market did not shrink as much as previously predicted, which indicates the rather high popularity of the product (330 mn packs at the end of 2020). Products’ legalization should be aimed at regulating the technical characteristics of pouches, forcing unsafe products and illegal sellers out of the market, including by natural means, due to the resumption of trade in quality products by legal sellers, as well as the integration of this segment in the excise taxation. The Gaidar Institute estimates showed that under all scenarios of tax rate dynamics there is a significant positive economic effect of controlled legalization of oral NCPs: thus, the market of quality products significantly contributes to reducing tobacco smoking, increasing the overall benefit of the economy, including by saving budget spending on health care. The expected budget revenues in all scenarios exceed Rb 3 bn per year, and the net economic effect should be over Rb 6 bn per year.

Since 2019, the market for disposable nicotine delivery devices began to show high growth rates (almost 4 times growth by the end of 2020 and expected growth of more than 3 times by 2021 in value terms and up to 90 million pieces in quantitative terms), which exacerbates the challenges of excise tax collection.

The Gaidar Institute generated estimates of collection rates for the main types of innovative products taking into account the dynamics of market volumes based on Euromonitor, The Federal Treasury and the IEP price monitoring data. Among the three types of studied products (nicotine-containing liquids, heated tobacco and e-cigarettes), the heated tobacco segment is the most transparent and is marked by almost 100% excise duty collection rate. By contrast, the excise tax collection rate in the segment of liquid e-cigarettes is extremely low from year to year, which may be the result of the "semi-legality" of most transactions and the use of unfair tax optimization. At the end of 2020, it reached only 10% for liquids and 16% for devices. The liquid e-cigarette market is not only highly differentiated by the level of product, but is also marked by a low degree of concentration by manufacturer. In addition, the vast majority of liquids and e-cigarettes today are imported. Liquid e-cigarettes are not labeled, i.e. today even an elementary way to demarcate legal and illegal products is lacking.

In terms of unfair tax optimization, it is important to note that individual components for liquids’ self- preparing for e-cigarettes are sold in the market, and the nicotine concentrate (the so-called "sotka") is paramount as far as taxation is concerned.

The practice of taxation of disposable devices under the current wording of the Tax Code of the Russian Federation shows a violation of the principle of fair taxation: both devices and liquids are taxed for reusable NCPs, while only devices are taxed for disposable NCPs. This creates even more favorable tax conditions along with high price affordability. The lack of excise tax on liquids in disposable devices implicitly forms a harmful tax optimization for devices with large volumes of liquids. According to the IEP, it makes sense to include the liquid volume of disposable devices in the taxable base. Thus, on the one hand, the imbalance will be eliminated, and on the other hand, there will be no additional obstacles for smokers to switch from cigarettes to safer products, which corresponds to the long-term goals of public health. At the same time, this measure allows to increase budget revenues. Thus, the counterfactual analysis shows that if in 2020 the excise duty were applied to a unit volume of liquid in disposable NCPs, the budget revenues would increase by Rb 2.8 bn, and by the end of 2021 the additional budget revenues could reach Rb 8 bn. Assuming that the market will grow in 2022 by 50% as a basic scenario compared to 2021, the additional budget revenues would amount to Rb 7.5 - 12 bn.

In summary, one can distinguish the following areas of legislative changes in terms of innovative nicotine-containing products which will allow to increase collection rate, budget revenues and alleviate the existing imbalances:

1. Legalization of nicotine pouches along with introduction of excise taxation, technical regulations and trade rules identical to those used for tobacco and other nicotine-containing products.

2. Introduction of excise stamps or their electronic counterparts for nicotine-containing liquids and devices aimed to demarcate the legal and illegal segments.

3. Introduction of separate excise taxation for nicotine concentrate aimed to prevent unfair tax optimization.

4. Introduction of excise taxation for liquids in disposable NCPs along with devices aimed to eliminate the contravention of the principle of justice, creating equal tax conditions in the market of innovative nicotine-containing products and increasing budget revenues.

Elisey Leonov, Researcher, Tax System Development Department of the Gaidar Institute