Tobacco FED: battle of narratives

Come budget season, different industries become active to secure favorable tax treatment from the government. The tobacco industry is no different. While it is inappropriate to comment on what goes on behind the scenes, the publicly available information contained in the respective Directors’ Reviews of the top tobacco companies show that they have been quite vocal about how cigarettes sold by “duty-non-paid” (DNP) or “non-tax paid illicit” manufacturers threaten the formal industry and tax revenues.

As per market leader Pakistan Tobacco Company (PSX: PAKT), the DNP sector has reached a market share of 37.6 percent, with an estimated tax loss of Rs70 billion. PAKT claims that DNP brands are selling at average price of Rs38 per pack, even lower than the minimum tax (excise duty and sales tax) of Rs42.12 per pack. As for second-ranked cigarette-maker Phillip Morris Pakistan (PSX: PMPK), the market-share of non-tax paid illicit sector has reached 40 percent. The industry’s concern is that increasing federal excise duty (FED) makes formal sector price-uncompetitive and illicit cigarettes cheaper for users.

However, surveys conducted by a few other organizations have claimed that the market share of illicit tobacco trade is much lower than that. As per the 2020 STOP survey (an EU-funded collaboration between several local and international universities and Pakistan’s Ministry of National Health Services), only 16 percent of cigarette packs being sold in Pakistan qualify as “illicit”. Another past study, conducted by Pakistan National Heart Association, had claimed that illicit cigarettes had a market share of 9 percent.

The bone of contention between the industry and the non-profit organizations remains the scale of “illicit” tobacco trade. A credible and definitive answer to that question is important because it can determine the course of tobacco taxation policy in years to come. But the FBR chooses to stay mum on the subject, having failed to roll out a track-and-trace system that could isolate the source and scale of the problem. Meanwhile, the claims of the formal industry are being echoed by a couple of media advocacy platforms, whose objective of stopping tax evasion is noble but their origin is unknown at best.

One of them, named “Stop Illegal Trade,” has been active on social media, making arguments supportive of formal industry’s stance. Recall that last year during the budget season, this entity had taken out newspaper advertisement claiming that illegal cigarettes were causing an annual “loss” of Rs44 billion to the treasury. This year, this forum has claimed that the annual tax loss due to the illicit sector has reached Rs77 billion. The source or rationale for those claims is not provided, only a number.

It defies logic as to how in one single year the purported tax-loss figure has exacerbated by a whopping 75 percent, without anyone in the government or the private sector raising a great hue and cry about it. Even the market shares of illicit or DNP sector, as reported by the top two players, have not seen that much increase in the last 12 months. But the Rs77 billion figure is still doing the rounds, bolstered also this year by the celebrity-laden messaging of a much more active advocacy platform called “Behtr Pakistan”.

Meanwhile, the academia in the country has also started raising its voice on the matter. For instance, the Pakistan Institute of Development Economics (PIDE) recently released a report titled “Switch, Reduce, or Quit: How Do Smokers Respond to Tobacco Tax Increases in Pakistan?” in which authors have argued that the main factor that explains uptake of smoking, especially among the youth, is “affordability”. Their analysis suggests that cigarette prices in Pakistan are much lower than what smokers are willing to pay, and therefore, space exists to raise tobacco taxes by a significant degree to bring down consumption.

This argument that making cigarettes unaffordable can lead to widespread behavior of “quitting” among smokers has been around for some time. Will the government pay heed this time? Last budget, the government had listened to the formal players and didn't raise FED. That treatment’s “positive” effect has been acknowledged by PAKT in its recent report, even as PMPK continues to blame illicit sector growth on FED hikes introduced back in September 2018 and June 2019. However, both players have had an impressive run in recent quarters. While the prospect of an FED hike for FY22 seems unlikely, who will force the tax machinery to do its job, unearth the scale of tobacco tax evasion, and plug the leak?