The three-tier tobacco FED regime introduced in May 2017 has led to multiple controversies. (Read: ‘A case against multi-tier tobacco tax regime,’ published December 16, 2018). One of those is the billions in tax revenues that are suspected to have been lost in the past one and a half years.
As per a report released by PIDE – ‘Economics of Tobacco Taxation and Consumption in Pakistan’ – at the PIDE annual conference last week, the national exchequer suffered a loss of Rs36 billion in FY18 on account of moving from a two-tier FED regime to a three-tier regime. This is despite production rising by three-fourth the same year whereas tax increased in low single digits.
The report maintained that this happened as the two top tobacco players transferred their bestselling brands to the lowest tier, where FED had reduced by 50 percent. In Pakistan, most of the cigarette brands are sold in the lowest tier. And the three-tier system effectively eroded the FED base in the lowest tier – until the PTI government brought it to a reasonable level in September this year.
In FY14, the FED for lowest tier was 38.5 percent of that tier’s threshold retail price. This ‘effective FED’ rate was 40 percent in FY15, 39.5 percent in FY16, and 38.4 percent in FY17. With a three-tier system arriving for FY18, the FED rate on the lowest (third) tier came to be 27.3 percent. It was raised in FY19 by PML-N government to 29 percent in April 2018. The PTI government revised it up to 42.7 percent in the mini budget.
Another report released at the PIDE conference – titled ‘Macroeconomic Impacts of Tobacco Use in Pakistan’, by the Social Policy and Development Center (SPDC) – gets a little more specific. It noted that for the low-priced brand of Morven Gold, effective FED rate had declined from 50 percent in 2014 to less than 30 percent in 2017. Meanwhile, duty for medium-range brand Capstan went up from 67 percent in 2014 to 72 percent in 2017 while it remained the same for K2 at 70 percent. For Gold Leaf, the high-priced brand, the duty declined from 58 percent in 2014 to 54.5 percent in 2017.
Running analysis on data from roughly past two decades, the SPDC study shows that the sector’s effective excise duty had come down to 41.4 percent in FY18 – down from 53.1 percent in FY17, 52.5 percent in FY16, 51.1 percent in FY15 and 51.6 percent in FY14. This state of affairs is leading to bad outcomes.
The report shows that thanks to the three-tier system, per capita tobacco consumption (294 cigarettes in FY18) had surged 68.6 percent year-on-year, a result of nominal prices of cigarettes dropping 21.7 percent. This is in sharp contrast to the gains made by the country earlier in the decade – between 2010-17, there was a nearly ten percent average annual growth in nominal prices, with a proportionally larger but relatively restrained 16 percent average annual growth in per capita tobacco consumption.
The SPDC study puts the tax loss in FY18 on account of tier 3 introduction at almost Rs45 billion. In FY17, the FED per stick sold came out at Rs1.932; whereas in FY18, the same metric had declined to Rs1.174 per stick. Had the previous FED regime continued in FY18, 65 percent more FED revenues could have been raised against the actual FED collection of Rs69.3 billion that year!
One understands that the government is in a catch-22 situation. If it raised the FED too much, it might encourage illicit trade of duty-non-paid cigarettes. And if it reduced the duties or kept them at same level, it could encourage more smoking in society. The way out – using technological measures to track and trace cigarettes across the tobacco value chain – is known. But political will continues to be in short order. Meanwhile, health outcomes are suffering even as tobacco tax revenues decline in proportion to sales.
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