Introduced in May 2017 to counter alleged trade of illicit cigarettes, the three-tier tobacco FED regime has been controversial since the start. (Read ‘Illicit cigarettes: a smokescreen?’ published April 13, 2018). The tobacco industry, however, welcomed its inception on grounds that it would help fight ‘illicit’ trade and they eventually turned around their fortunes. (Read ‘Big tobacco wins, again,’ published May 2, 2018).

Meanwhile, the federal governments, both current and former, apparently had the revenue objective ensconced in mind. (Read ‘Cigarettes: the middle ground,’ published September 25, 2018). Never mind the cigarette production hitting through the roof in FY18, accompanying a tax loss of over Rs30 billion amid cigarettes becoming cheaper by over 20 percent in real terms!

Now spilling into the public view, this long-running tussle between the ‘revenue objective’ and the ‘health objective’ vis-à-vis tobacco taxation has lacked empirical evidence on either side. But that may be changing. Two studies released last week at the 34th Annual General Meeting of the Pakistan Institute of Development Economics, Islamabad (PIDE) make a compelling case to revisit the multi-tier FED regime. (The Institute for Health Research & Policy at the University of Illinois, Chicago, funded both studies).

The first study, ‘Economics of Tobacco Taxation and Consumption in Pakistan’ – authored by scholars at the PIDE – used tax simulations to conclude that a two-tiered FED regime with increased tax rates could result in better health outcomes without compromising tax revenue. The suggestion is to convert the current three-tier system into a two-tier system by raising the FED on the third tier (currently Rs25 per pack) to the level of tier-II (Rs36.8 per pack) while keeping tier-I FED unchanged at Rs90 per pack.

Simplifying the findings, reverting to a two-tier tax system with higher FED as suggested above will raise the average cigarette pack price to Rs77 per pack (up Rs10); reduce smoking prevalence among current and future smokers by 2.6 million individuals; and avert almost one million premature deaths as a result. Those health outcomes are more than double what can be achieved from existing three-tiered system. Meanwhile, the move will also yield notably higher additional FED collection (Rs13.5 bn) and marginally higher total tax revenues (Rs104.2 bn) compared to the existing FED regime.

Notably, the PIDE study also suggests following a “net revenue” approach whereby the taxation regime should take into account whether revenues raised from tobacco products will be sufficient to counter the “disease burden created by tobacco consumption”. Alas, no such study exists that can substantiate the “health costs” of tobacco consumption. PIDE is apparently planning to conduct a study on those lines in the coming year.

Coincidentally, the federal government is also reportedly interested in raising cigarette prices by levying Rs10 ‘sin tax’ per pack. (Read ‘Sin tax has fiscal virtues,’ published December 12, 2018). There is consistency between PIDE’s recommendation (of Rs10 hike in average pack price for better health outcomes) and the proposed sin-tax that would raise weighted-average pack price by Rs10. But the two proposals are not linked. Perhaps federal health ministry should study these findings to bolster its case in the federal cabinet when the matter comes up next.

The idea of raising FED, however, has not been popular with tobacco majors, who often warn that economy will suffer due to reduced output and people losing jobs up and down the tobacco value chain. That’s part of what Dr. Roberto Iglesias, a high official from the World Health Organisation who was speaking at the conference, described as SCARE tactics deployed by tobacco companies when confronted with higher tax on tobacco, especially in developing countries. (SCARE: Higher taxes induce smuggling; lead to court challenges; are anti-poor; reduce revenue; and lower employment).

Some of that SCARE-mongering is debunked by the second study, ‘Macroeconomic Impacts of Tobacco Use in Pakistan’, which was authored by researchers at the Social Policy and Development Center (SPDC). The study, which found that cigarette industry had 1 percent share in industrial production (FY18) and a 0.3 percent share in industrial employment (FY15), makes the case that the economy will be slightly better off if higher taxes force consumers to switch their expenditure towards food items.

In simple words, the SPDC study found that if the government levied a higher FED such that it reduced consumer spending on cigarettes by Rs1 billion and redirected that saving towards consuming food items, it would have the net effect of boosting i) national output by Rs2.4 billion, ii) national income by Rs0.54 billion, and iii) employment by creating over 7,000 jobs. Slightly lower but still positive net effects on national outcome, income and employment were observed if those tobacco savings were redirected in equal parts towards food and education. Hardly a doomsday scenario of having fewer smokers!

The two studies make a strong case for simplified and higher taxation on tobacco products – the first study on account of such a system’s better health outcomes and the second one on account of its benign economic impact.

The idea is not to kill the tobacco industry, which has both direct and indirect levers of influence in policymaking, but to take policy decisions that are in the longer-term interest of the economy.

FBR and its bosses at the finance ministry were instrumental in introducing the three-tiered system in 2017 without undertaking independent assessments of the pros and cons.

Now their successors should take time out to evaluate these empirical findings and come up with an explanation for the fiscal laziness that continues on this account. Instead of making this market even more competitive for the formal players, they need to fight illicit trade through a whole-of-the-government approach that is backed by political will and technological measures that have already been identified.