First impressions can be misleading. After the budget was announced, news media and some brokerage firms came out with “negative” outlook for the tobacco industry. After all, the three-tier FED regime had been abolished and FED raised on the two remaining tiers. But a closer look reveals that the tobacco industry has been successful in averting the worst that could have happened.
In a comeback for tobacco lobbyists, the health levy is off the books for now. After the federal cabinet gave its approval to a “health tax” – Rs10 per cigarette pack – in late May, it was a foregone conclusion that the budget would include this levy. Lo and behold, the budget documents make no mention of that. A FED (5% of retail price), however, was imposed on sugary beverages.
This column had previously estimated that at least Rs30 billion could be hauled through the health levy on cigarettes. (For more on the background to the health tax, read “Tobaccos: at a loss?” published May 31, 2019). Question now is: has the treasury forgone those billions? No, it hasn’t!
The taxman has reportedly assured the cabinet that reverting to a two-tier FED regime would net the treasury Rs33 billion in FY20 – taking total tobacco taxes above Rs140 billion next fiscal. This move, of abolishing the three-tier system, might do more than help the government recover its “missing” billions from the industry. It will also please health advocates, who had pinned great hopes on the Khan government to curb cigarette consumption by raising taxes.
It looks like the government acted rationally. It took something from the industry – the three-tier FED regime – to quickly raise revenues and polish its tobacco control credentials. And it gave the industry something in return by not going ahead with the health tax. But this is not where the story ends.
The two tiers have been designed such that it may not significantly raise the “effective FED” paid on cigarette sales. That rate has averaged 44 percent of gross turnover under the three-tier system in last two years, lower than 50 percent of gross turnover when the two-tier system was last in place until 2016. The reason why effective FED rate may not rise, and thus help the firms retain more or same of their gross turnover, is that the retail-price thresholds for imposing FED on the two tiers have been significantly increased but the corresponding FEDs have not seen the same increase (see the table). Let’s take each tier one by one.
In Tier-1, the minimum retail price has been increased by 32 percent but the fixed FED has been increased by only 15 percent. This tier sells high-end brands – here, smokers tend to have lower demand price elasticity, meaning they thus absorb the price hike that will follow. So a 15 percent FED hike, which in real terms would be about a 3 percent increase, won’t likely dent sales of top-tier brands.
For Tier-2, in which the current tiers 2 and 3 will soon be merged, the retail-price threshold has been increased to Rs119.2 per pack, while keeping FED at Rs33/pack. For a medium-end brand currently selling in tier-2, the FED is effectively reduced by 10 percent. As for low-end brands, the companies will see their net turnover ratio decline as FED is raised by 32 percent in the new tier 2 which these brands will soon fall in. But the gains from top and middle brands may more than compensate.
In the end, the tobacco industry has reason to feel happy. The health tax is out of sight. The negative effects of the two-tier system have been largely neutralized. And the effective FED rate might not rise. Meanwhile, health advocates won’t mind incremental improvements in tobacco taxation regime. But only the coming year will tell the impact on smoking incidence and public revenues.
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