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KYUSTENDIL, Bulgaria (Reuters) - Cash-strapped Bulgaria and Romania hoped taxing cigarettes would be an easy way to raise money but the hikes are driving smokers to a growing black market instead.
Criminal gangs and impoverished Roma communities near borders with countries where prices are lower -- Serbia, Macedonia, Moldova and Ukraine -- have taken to smuggling which has wiped out gains from higher excise duties.
Bulgaria increased taxes by nearly half this year and stepped up customs controls and police checks at shops and markets. Customs office data, however, shows tax revenues from cigarette sales so far in 2010 have fallen by nearly a third.
"The government created something unique. We actually now have a whole industry that provides for a big group of people," said Tihomir Bezlov of anti-corruption think-tank Center for the Study of Democracy.
Bulgaria and Romania, the two poorest countries in the European Union, are struggling to recover from deep recessions and their deficit-stricken governments have a powerful incentive to let their populations keep puffing for the immediate future.
Bulgaria reversed a national ban on smoking in all cafes and restaurants in June, which analysts said was due to pressure from cigarette producers, importers and distributors and the need for tobacco sales as public revenue falls.
Only Kyustendil, a town of 70,000, retained the ban from July 1 and the discontent is palpable, with bartenders and club owners concerned about making ends meet and partygoers frustrated. Few believe the ban will survive the winter.
"This is a complete nonsense, given that 90 percent of the people smoke," said Kyril Mirchev, 22, grumpy because he cannot smoke while playing billiards. Dancing too just isn't the same without a cigarette, so discos are deserted.
Excise duties on cigarettes are an important source of income and accounted for some 10 percent of all Bulgaria's revenues last year, or 1.77 billion levs ($1.15 billion).
It is the most addicted European Union member along with Greece, with some 40 percent of the population smokers, a recent Eurobarometer survey showed. Nearly a third of neighbor Romania's 22 million population smoke.
"The steep excise hike shocked consumers and increased the demand for cheap cigarettes. We see brands we have never seen before," said Ivan Bilarev, managing director of state-controlled Bulgartabak, with a 38 percent market share.
Cigarette prices in Bulgaria and Romania, at 2.00-2.50 euros ($2.50-$3.20) a pack, are significantly lower than in many other EU nations but still painful for consumers given lower incomes.
A pack on the black market, however, is 1.00-1.75 euros.
Bilarev says smuggling has hit sales at Bulgartabak and some analysts said a total smoking ban would have further lowered the company's price at a pending privatization.
Overall losses from smuggling will probably outweigh tax gains as Bulgaria struggle to fight the growing black market, which has risen to over 30 percent of all cigarette sales and could cost 500 million levs in lost revenues this year, said Bezlov at the Center for the Study of Democracy.
While the government expected higher income from taxes in 2010 it has already revised that to the same level as last year. "However, this (too) looks unlikely at present," Bezlov added.
Romania, desperately trying to keep a 20 billion-euro International Monetary Fund-led bailout deal on track, has a similar problem after nearly doubling cigarette prices in 2009 then hiking value added tax.
Romania's top three cigarette makers -- units of British American Tobacco, Japan Tobacco International and Philip Morris -- contributed roughly 2 billion euros to the budget in taxes in 2009, or just under 2 percent of GDP.
They estimate about a third of cigarettes in Romania are smuggled and say this could cost the state over 1 billion euros.
Additional reporting by Irina Ivanova in Sofia, Luiza Ilie in Bucharest, Ece Toksabay in Istanbul and Renee Maltezou in Athens; Editing by Sam Cage, Sonya Hepinstall and Nina Chestney