EDITORIAL: The fundamentally flawed nature of the tax regime operational in Pakistan is both well-documented and subject to much criticism, yet tax authorities remain unwilling or unable to reform a system riddled with inefficiencies and inequities.
As a result, the greatest burden continues to fall on documented earners, while undocumented, illicit, cash-based sectors readily evade taxes, scrutiny and accountability.
A new report authored by distinguished economist Sakib Sherani presents a very stark picture of this reality by using the state of the tobacco sector to highlight how a very high incidence of tax, regulatory loopholes and weak enforcement have allowed the illicit tobacco sector to thrive at the expense of legitimate businesses, which shoulder an unfair share of the tax burden.
The report, titled “Towards an Optimal Tax Regime for Pakistan’s Tobacco Sector” estimates that a massive Rs300 billion in revenue is lost yearly due to an unsustainable and inequitable tax regime in the tobacco sector alone.
Excessive levels of taxation, which includes the federal excise duty, sales tax, income tax and various other levies, have not only placed a heavy burden on tobacco manufacturers operating in the formal sector, severely impacting their profitability, this has also increased the size of the illicit segment, which now makes up 56 percent of the total market.
According to the report, the high level of taxation has crossed the “optimal tax point”, which means that instead of adding to the government kitty, increasing tax rates now reduces revenue generation as consumers increasingly switch to cheaper, counterfeit, tax-evading alternatives that are often smuggled over our western borders while the formal sector continues to shrink despite contributing 98 percent of the tax revenue collected from the tobacco industry.
It is clear, then, that the government’s tax policy is actively contributing to a flourishing illicit tobacco market and to the overburdening of the regulated tobacco segment: only two foreign firms and a few local manufacturers contribute to tax revenues, while a significant portion of the tobacco supply chain – from cultivation to the point it reaches the manufacturers – also remains largely untaxed.
Besides distorting market competition and failing to augment government coffers, the high tax rates and the uneven enforcement of taxation measures have also had an adverse impact on the business environment as companies assess the viability of operating in such a punitive regulatory environment.
A case in point here is British American Tobacco’s warning last year that it might reconsider its presence in Pakistan if taxes on cigarettes were raised further. It goes without saying that if long-standing players started exiting the market, it would deal a severe blow to both domestic and foreign direct investment, eroding investor confidence and reinforcing the perception that Pakistan’s business environment is becoming increasingly untenable for legitimate enterprises.
Beyond the deep-rooted weaknesses of the tax regime, the utter failure of the government apparatus to curb the widespread smuggling of illicit tobacco also remains a major concern, as does the ineffectiveness of the track-and-trace system to tackle the counterfeit tobacco trade.
Here, it is important to note that the easy availability of illicit tobacco also raises serious public health risks, as these unregulated products bypass quality control measures, and their lower cost makes them more readily accessible to vulnerable groups, particularly minors.
A well-rounded solution, therefore, is the need of the hour – one that eliminates excessively high tax rates on compliant businesses, expands the tax base, and enforces stricter measures against tobacco smuggling and the counterfeit tobacco trade.
Most importantly, a more strategic and considered approach to macroeconomic policymaking – something that has sorely been missing so far – has become essential to accurately assess potential long-term impacts and ensure sustainable economic outcomes.
Copyright Business Recorder, 2025
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