Dec. 8 (Bloomberg) -- A man in a black wetsuit straps nine boxes to his body in the Russian exclave of Kaliningrad, wades into the Nemunas River and swims 200 yards to Lithuania and the European Union.
He drops his cargo as officers close in and 4,500 packs of cigarettes sink to the bottom of the river, according to photographs from the state Border Guard Service. The authorities aren’t always so successful, with the government estimating 110 million packs are smuggled into the country each year, costing it 500 million litai ($193 million) in lost taxes.
Lithuania declared war on smuggling to boost revenue in the 2011 budget under review tomorrow after the deficit swelled to 9.2 percent of economic output during the global recession. The so-called grey economy has grown to 30 percent of gross domestic product as people look for bargains and gangs flood the country with untaxed tobacco, alcohol and fuel from Russia and Belarus.
“Everyone must realize that by smoking illegal cigarettes you not only harm your health as it says on the pack but you also harm your parents and your children,” Prime Minister Andrius Kubilius said Nov. 9 in an interview with Ziniu Radijas. “You take away money from the school your children attend or you take away money from the pension your parents get.”
Baltic neighbors Lithuania, Latvia and Estonia experienced the world’s deepest recessions last year. All three border on Russia, while Latvia and Lithuania also share frontiers with Belarus, making them a gateway into the EU.
Lithuania plans to collect an additional 1.2 billion litai next year, or about 1 percent of GDP, by curbing illicit activity, according to the draft budget. The government has pledged to cut the deficit to the EU limit of 3 percent of GDP by 2012.
The government on Nov. 17 approved tougher penalties for smugglers, replacing fines with prison sentences of as much as eight years. Lithuania also plans to increase spending on customs enforcement by 15 percent next year, including 8 million litai to install X-ray scanners at border crossings.
The crackdown is fueling tensions. One smuggler was killed and two officers injured in a June shootout. Last month, a border patrolman found a rag doll hanged from a wooden cross stuck in his driveway less than two weeks after his sauna was set on fire, according to the Border Guard Service.
Targeting smuggling may be the easiest avenue left to rein in the deficit after the government implemented austerity measures equal to 14 percent of GDP in the past two years, said Vilija Tauraite, a Vilnius-based economist at SEB AB, the second-biggest bank in the Baltic countries.
“Fighting smuggling is a rather realistic and effective measure, given how widespread the illegal imports are,” Tauraite said. “The illegally imported fuel, tobacco products and alcohol are no secret to anyone living in Lithuania.”
The growth in smuggling led to faltering excise-tax income, the second-biggest source of state budget revenue after the value-added tax. Consumption of taxed cigarettes fell 53 percent from a year earlier in the first nine months of the year, according to the Finance Ministry, which missed its revenue target for the excise category by 8.3 percent in the period.
“Alcohol and tobacco consumption are falling,” said Violeta Klyviene, chief Baltic economist at Copenhagen-based Danske Bank A/S. “This doesn’t mean people resolved to healthier lifestyles, but rather shows booming smuggling.”
Tomas, from Klaipeda, Lithuania’s third-largest city, says he buys illegal cigarettes at half price, saving about 180 litai a month, “a very substantial sum” compared with his monthly income of 1,200 litai from self-employment.
“Nobody in my family buys cigarettes from a shop,” said Tomas, 26, who asked to be identified by his first name because buying smuggled goods is a crime. “I don’t remember the last time I filled up my tank at a gas station. You simply pre-order and get Russian products delivered in a day or two.”
‘No Easy Solution’
Forty-nine percent of the cigarettes smoked in Lithuania this year carried foreign-language, mostly Russian, warning labels, according to the Lithuanian Free Market Institute, a Vilnius-based researcher whose motto is “If you don’t create a free market, a black market will emerge.”
The grey economies of the three Baltic states are the biggest in the EU behind Romania and Bulgaria, according to Friedrich Schneider, a professor at Austria’s Johannes Kepler University of Linz, who studies illegal economies.
The shadow economy accounts for about 30 percent of GDP in Lithuania and Estonia and 27 percent in Latvia, Schneider estimates. The EU average is 20 percent.
The growing reliance on smuggled goods makes people more tolerant of the grey economy, raising concern the crackdown won’t work, said Jekaterina Rojaka, a Vilnius-based economist at DnB Nord Bank, the Baltic unit of DnB NOR ASA. About 64 percent of Lithuanians approve of buying smuggled goods, according to a survey of 1,009 people conducted July 28-Aug. 6 by local pollster Spinter Tyrimai.
“There’s no easy solution,” Rojaka said. “To succeed with the plan, the state will have to stitch up the borders and fight.”
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