The menace of illicit cigarettes

Late last week, the Federal Board of Revenue (FBR) published an advertisement across major newspapers that warned wholesalers, retailers as well as consumers against the sale and possession of smuggled non-duty paid cigarettes.

This wasn't the first such advertisement by the revenue collection agency; its media campaign against smuggled non-duty paid cigarettes has been going on for some time. The only problem is that these warnings and campaign against smuggled non-duty paid cigarettes hide the real problem: domestic illicit cigarettes manufactured by local producers who are not in the tax net.

While illicit cigarettes are a global and regional problem, Pakistan boasts the regions highest consumption of illicit cigarettes, according to a Jan-2016 study by Oxford Economics. The number of illicit cigarettes consumed in Pakistan is estimated to be north of 20 billion sticks per year; Philippines and Vietnam follow with the illicit cigarette consumption number just shy of 20 billion per annum.

And guess what? Of the total illicit cigarette consumption (21.2 billion sticks) in Pakistan, 17.7 billion are manufactured locally, whereas only 3.5 billion sticks are smuggled non-duty paid. Yet time and again, the FBR only campaigns against the latter and leaves the former devil unchecked, when in fact one in every five cigarette consumed in Pakistan is a locally manufactured tax evaded cigarette.

A host of studies on domestic illicit cigarettes have been conducted by the likes of Oxford Economics and Nielson market research firm. Based on those studies, BR Research did some ballpark analysis to estimate the net profits that potentially flow from domestic illicit (tax evaded) cigarette businesses - that number comes out to be about $50 million for the year 2014 (see table).

This is of course a very small figure compared to drug trafficking or also (to some extent) when compared to migrant smuggling & human trafficking. According to a 2011 study by SDPI think tank, the local value of illegal drug trade in Pakistan had an estimated worth between $910 million and $1.2 billion. Funded by the United Nations Office on Drug and Crime (UNODC), the study had put the size of the proceeds of migrant smuggling and human trafficking from Pakistan at around $107 million.

However, a more relevant comparison to contextualise the $50 million estimated net profits from domestic illicit industry (or its $229 million gross proceeds) lies with illegal arms or illegal timber trade businesses, which are not inherently illegal businesses and are only illicit because of being outside the scope of formal economy.

The SDPI study called, "Examining the dimensions, scale and dynamics of illegal economy" states that economic value of the production and trade (not net profits) of AK-47 in Pakistan was estimated to be $52 million, whereas proceeds from illegal timber logging in Pakistan and the smuggling of illegally logged timber from Afghanistan into Pakistan was estimated to be around $23 million.

What other evidence does the FBR need to understand the gargantuan size of domestically manufactured illicit cigarettes? Produced by no more than 50 to 60 factories located in pockets around Khyber Pakhtunkhwa and Azad Jammu Kashmir, these cigarettes are sent to wholesale markets around Pakistan's cities through an elaborate storage and distribution network. Yet, and despite that 13 agencies are empowered in Pakistan to curb illicit cigarettes, the government has been doing precious little to arrest the growth of locally produced illicit cigarettes.

The relevant authorities would do well to understand the impact of these illicit cigarettes on Pakistan's economy and indeed the society at large. According to the 2016 study by Oxford Economics, the estimated tax loss from illicit cigarettes consumption was about Rs36 billion in 2014.

Moreover, since these cigarettes are sold cheap (@ Rs27/pack) compared to those sold by formal players in the industry whose taxes per pack alone is north of Rs30, the incidence of smoking remains virtually unchanged in Pakistan. The Nielson study, titled "The challenge of illicit trade in cigarettes: impact and solutions for Pakistan" shows that despite government regulations to have bigger health warning signs, pictures of smoking hazards on cigarette packs and successive increase in taxes on cigarettes, the incidence of smoking in Pakistan reduced by only 0.2 percentage points during 2008 and 2013.

Lastly, while there is no explicit evidence to suggest that proceeds from domestic illicit cigarettes are used to finance criminal and terrorism activities, a host of UNODC studies and that by others have shown how money flows from the illegal informal economy are used for organized crime activities, including drugs, human and arms trafficking, as well as terrorism. That risk alone should put authorities into action.