Smoking is injurious to health, and its higher consumption increases the health expenditure on a macro scale. That is why all over the world, higher taxes are imposed on tobacco sales to discourage its consumption. The basic premise about increasing excise duty is similar in Pakistan. However, the incentive is to jack up tax revenues – especially after recent increase of up to 150 percent in excise duty, to attain the elusive overall tax revenue targets. The problem is that in the presence of high and increasingly illicit market, the dual objective to attain higher taxes and lowering consumption are both are likely to be missed.

At the start of the fiscal year, the excise duty tax collection from tobacco sales was budgeted at Rs160 billion, and later was increased to Rs200 billion. After the excise duty increase in February 2023 that target increased by another Rs260 billion. However, with the recent decline in sales of fully tax paid cigarettes sales, the government may not be able to fetch even Rs200 billion. The Laffer curve comes in play, and the situation becomes worse, with no meaningful crackdown on elicit tobacco sales.

The excise duty on TIER 1 cigarettes (20 per pack) increased by Rs130 to Rs330 (154 percent increase) and on TIER 2 has increased from Rs41 to Rs101 (146 percent increase), and the minimum retail price threshold has increased from Rs41 to Rs101.

Industry sources claim that a sudden shift occurred in demand trends thereafter, whereby illicit tobacco sales have increased tremendously whilst sharp decline has taken place for those companies and brand that pay full taxes. The volumes of legitimate companies are down by around 60 percent in March as compared to sales in January 2023 while for illicit brands these have increased by around 70 percent. The overall market is down by almost 15 percent. Thus, there is an overall decline in sales; but the decline in taxation collection is likely to be much higher.

There are three types of illicit cigarettes. One is termed as duty not paid. These are locally manufactured, but under declared production allows firms to evade duties and taxes. And they do sell below the minimum price threshold. Their share is estimated at 33 percent. The second are counterfeit of original brands or brands resembling original. Their market share is miniscule.

And the third type is of smuggled brands that usually comes from Afghanistan to Pakistan. They simply evade duties and taxes and their market share has risen suddenly in the aftermath of taxation imposition. Sources say that the market is flooded with smuggled cigarettes with 70 plus new brands being introduced in the market.

Now that is a double whammy. One, the government is not receiving taxes on these smuggled cigarettes, and these have replaced sales of those who pay full taxes. Moreover, since these are smuggled (informally imported), there is greater pressure on the balance of payment, as payment of these informal imports (hawala) nets off against informal remittances (hundi). And overall, formal remittances have worsened the current account balance. Moreover, this is going to hamper the efforts on FATF front.

There must be a mechanism to reduce the penetration of illicit cigarettes sales. One way is to lower taxes to make the formal sector competitive. However, in that way, the objective to discourage consumption is compromised. Hence, a better way is to curb the sales of illicit tobacco.

The first step required is to have a robust track and trace system. This must be followed by enforcement, which can make a substantive difference. In order to ensure enforcement, there must be political will. In South East Asia, Pakistan stands at second position in terms of illicit cigarette trade. Moreover, as a result of recent excise hike, it is likely to surpass Malaysia and take the number one spot.

Right now, out of total 52 tobacco companies, only two multi-national companies (Pakistan Tobacco Company, Philip Morris (Pakistan)Limited) have track and trace implemented while rest of all have stay orders against its implementation. The two complied companies pay 98 percent+ taxes with 60 percent market share. The other step is to control smuggling. Without doing these two, the government revenues are going to decline along with dip in sales of two multinational companies, and overall cigarette consumption shall remain high.