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. Last Updated: 07/27/2016

Hazy Logic on Imported Vodka

Russia's vodka war has started and although the main antagonists are clear, the fog of battle obscures all but the most basic outlines of what is going on.

On one side, the government and the legal domestic vodka industry are fighting a gang of illegal importers and bootleggers who do not pay tax.

The government's goal is to increase its tax collection by about $4 billion a year and the local vodka industry wants to eliminate "unfair" competitors who do not pay taxes and have taken away half of the market.

On the other side, bootleggers and crooked importers want to preserve the current situation. They can sell a half-liter bottle of contraband imported vodka or of local moonshine for about 5,000 rubles (about $1), half the "tax-paid" local price.

The smoke starts to thicken and the lines become much less clear when it comes to describing exactly how the government, which now needs to raise money to honor President Boris Yeltsin's election promises and meet its own budget, is attacking the problem.

To fight tax avoidance within Russia, the government has decided to extend to locally produced vodka the system of blue labels that are currently stuck on all imported liquor. The idea of the labels is that bottles of liquor must carry an official excise stamp proving taxes have been paid. Without a stamp, the goods get confiscated.

To weed out low quality, cheap distilleries, the government will also start licensing local vodka producers.

To further restrict contraband imported vodka, the government has announced plans to impose quotas limiting sales of foreign spirits in Russia.

But the most bizarre set of measures is a perplexing series of rules setting minimum wholesale and retail prices for spirits.

The fog is getting more dense. Minimum prices are unusual weapons to employ in a battle with contraband and tax avoidance. What difference will they make to government tax collection? If importers are forced to sell at a higher price, they will just enjoy a higher profit. What guarantee is there that they will hand more money to the government?

The answer will depend on the level at which the minimum prices for imports and domestic vodkas have been set relative to a fair tax-paid price.

It appears that as far as imported liquor goes, the minimum price of 40,000 rubles has been set at a level which makes most imported liquor totally noncompetitive with domestic vodka. Cheap Ukrainian vodka will be wiped out although the more highly priced West European brands will be less affected.

The minimum price of 16,000 rubles applies to all locally produced vodka and that from Moldova, Belarus and Kazakhstan, where by agreement tax rates on liquor have been brought into line with Russia.

At this minimum price, bootleg "no-tax" vodka will be about at the same price level as "tax-paid" vodka. The argument is that once there is a level playing field in terms of price, consumers will choose legal vodka over their low quality untaxed competitors. After all, 43,000 Russians died from drinking bad vodka (or perhaps, too much bad vodka) last year alone.

According to government officials, bands of police, tax officials and trade inspectors are now descending on Russia's outdoor wholesale liquor and arresting people who sell at below the minimum price. Since the excise tax is a function of the wholesale price, the tax police can follow hot on their trail.

But history provides a warning. Remember those blue labels. They have been stuck on imported vodka for the last two years but they have not actually raised tax collection or the price of imported vodka.

In fact, Yeltsin himself basically sabotaged the idea by granting a mysterious exemption from the rule to the National Sports Fund, more a private company than a charity, headed by his friend and tennis partner Shamil Tarpishchev.

This exemption cost the government at least $1 billion last year and Tarpishchev's organization made unbelievable amounts of money.

As the costs to the budget became clearer last year, that starry-eyed financial reformer, Anatoly Chubais, rashly said that either the exemptions went or he did. Chubais was forced to resign in January. Meanwhile, Tarpishchev has become one of the richest men in Russia and deputy chairman of the "Re-elect Yeltsin" campaign.

Alas for Tarpishchev, all good things come to an end. Under pressure from the International Monetary Fund, the funny exemptions from the import taxes were at least formally canceled at the end of 1995.

In fact, a lot of cheap imported vodka is still clearly getting through. Most people say the new route for the imported vodka is now through Belarus, which has granted exemptions to National Sports Fund clones. Since Belarus is in a customs union with Russia, once the liquor has entered Belarus it can then be shipped without any hassle or tax to Russia.

The lesson is that the latest flurry of activity could face the same risk of death by intrigue that turned the tax stamps into a dead letter. With tariffs high, corruption is highly lucrative.

Besides, returning to reality, increasing tax collection on vodka will inevitably raise prices at least at the bottom end of the market and this will be politically difficult to implement before the election. President Yeltsin, the Russian drinkers' friend, said as much when he addressed workers in his home region of Sverdlovsk last month. The government could find Yeltsin its biggest opponent in its vodka war.

Geoff Winestock is a Moscow-based correspondent for the Journal of Commerce.