The government has imposed a 200 percent increase in the Federal Excise Duty (FED) on tobacco products, ostensibly to raise revenue. But this policy has backfired, as it has severely damaged the legitimate tobacco industry while fueling the growth of the illicit trade.
According to industry estimates, the production of the formal tobacco sector has declined by 40 percent from July to November 2023, compared to the same period in 2022. This indicates a loss of income, and tax revenue for the country as the consumption of tobacco has not decreased at all, suggesting that smokers have switched to cheaper and unregulated alternatives.
The illicit trade of tobacco, which evades taxes and regulations, has flourished in the wake of the FED hike. The formal tobacco industry estimates that the share of illicit cigarettes in the market has risen from 25 percent in 2019 to 50 percent in 2023. This means that half of the smokers in Pakistan are consuming products that deprive the government of billions of rupees in revenue.
The FED increase has also undermined the effectiveness of the Track & Trace System (TTS), which was introduced in 2020 to curb the illicit trade. The TTS requires all cigarette packs to have a unique identification code that can be verified by the authorities. However, the system has been compromised by the rampant use of fake stamps and counterfeit packs, which mimic the leading brands of the formal sector. The TTS has failed to deter the illicit trade, as it lacks proper enforcement and penalties.
The government’s tobacco tax policy is counterproductive and unsustainable. It has hurt the legitimate tobacco industry, which contributes more than Rs240 billion to the national exchequer annually, while benefiting the illicit trade, which undermines fiscal objectives. The government needs to rethink its strategy and adopt a balanced and comprehensive approach to address the issue.
The formal tobacco industry claimed that the share of illicit has exceeded and doubled in recent years while the formal sector shrank, so the economic viability of the tax-paying sector has entered into a danger zone.
From 2012 to 2016, the government switched to a 2-tier structure from a 3-tier Structure which was implemented in Pakistan in 1992. This triggered revenues to fall by more than 25 percent due to the above-inflation excise increase in 2015-16 and illicit trade hovered close to 50 percent of the market, as it is today.
To curb the menace of illicit trade, the government then decided to re-introduce a 3-Tier system which not only increased revenues by more than 40 percent but also discouraged illicit cigarette trade. But now again two tiers have been implemented and then the FED was increased to maximize revenues.
However, the volume of the tax-paying sector started shrinking, which should have caused alarm bells among the policymakers, but they were found moving at a snarling pace. If the formal sector continued to shrink, then the revenues might collapse in months ahead.
A comprehensive and balanced approach to adopting a level playing field for the legitimate tobacco sector is imperative to ensure long-term sustainability.
The government should consider the following measures to restore the viability of the formal tobacco sector and curb the illicit trade:
– Rationalize the FED in the upcoming budget for 2024-25, by reducing the tax burden on the lower-tier cigarettes and increasing it on the higher-tier ones. This would create a more equitable and progressive tax structure, which would encourage smokers to switch to tax-paying products.
– Implement and enforce the TTS effectively, by ensuring that all cigarette packs have valid and verifiable stamps, and that any violations are detected and punished. The TTS should also be extended to the point of sale, where retailers should be required to display and sell only legal products.
– Strengthen the enforcement against the illicit trade across the value chain, by cracking down on the manufacturers, distributors, and retailers of illegal cigarettes. The government should also increase the awareness and cooperation of the public, media, and civil society, to expose and report the illicit trade.
The government has a responsibility to protect the interests of the legitimate tobacco industry, which is a major source of employment, income, and revenue for the country. It also has a duty to ensure that the products consumers consume are regulated. The government can achieve both goals by adopting a rational and balanced tobacco tax policy, which would create a level playing field for the formal sector and discourage the illicit trade.
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