Unravelling cigarette tax revenue mystery

The first half of fiscal year 2025 has painted a perplexing picture of Pakistan’s cigarette industry.

The latest data on cigarette production and tax collection in Pakistan reveals that production is soaring compared to the same period last year, yet tax revenues are mysteriously declining. To further complicate the narrative, a curious anomaly in December 2024 data adds another layer to the puzzle. Let’s dissect these two conundrums and see if we can make sense of the smoke and mirrors.

The numbers reveal a surprising narrative. According to the Pakistan Bureau of Statistics, between July and November of FY25, the cigarette industry produced 15.4 billion sticks. This marks a substantial 30.8% increase compared to the same period last year, when production was 11.8 billion sticks.

While this surge in production raises concerns about potential adverse health implications for the population, one might also expect it to result in a significant revenue boost for the Federal Board of Revenue (FBR). After all, higher production should logically lead to increased tax revenues.

However, the reality is quite the opposite. Revenue collection from both Federal Excise Duty (FED) and Sales Tax have actually declined, by 7.8% and a concerning 27.4%, respectively (Table 1). This paradox raises an important question: how can production soar while tax revenues plummet?

To unravel this first puzzle, we need to examine Pakistan’s distinctive two-tier tax system for cigarettes. This system differentiates between ‘economy’ brands, taxed at a lower rate (PKR 101 per pack of 20), and ‘premium’ brands, with a higher rate (PKR 330 per pack of 20). According to estimates based on the effective tax rate, during the last fiscal year, economy brands held a dominant 82% market share, while premium brands accounted for the remaining 18%.

However, the current data suggests a dramatic shift. A 7.8% decline in FED revenue alongside a 31% increase in production indicates a significant change in market composition. To reconcile these figures, the share of premium brands would have had to plummet to a mere 2.3%, with economy brands capturing a massive 97.7% of the market.

This raises three possibilities: stockpiling and release, brand switching, and brand reclassification.

Stockpiling and release: It is possible that manufacturers stockpiled premium brands last year and released them into the market in the first five months of FY25. This would imply higher production of economy brands and lower production of premium brands during this period.

Brand switching: There could have been a significant shift from consumers, moving from premium to economy brands due to economic pressures or changing preferences.

However, a study by Social Policy and Development Centre (SPDC) indicates that smokers shifted to low-priced brands after a substantial tax and price increase in February 2023. Thereafter, tax has not increased while market prices have risen marginally. Therefore, a significant or large-scale brand switching is very unlikely.

Brand reclassification: During this fiscal year, after the budget announcement, a noted tobacco company reduced the price of its premium brand to shift it to the category of economy brands. This move may have impacted the market share of both premium and economy brands. While this reclassification affects the shares, it is unlikely to explain such massive changes.

In other words, even considering all these factors, a 2.3% market share for premium brands appears exceptionally low and raises red flags. This warrants further investigation and explanation from tax authorities.

Just as we began deciphering the dynamics of the first puzzle, December 2024 presents a perplexing reversal of trends. Production took a sharp downturn, plummeting from 3 billion sticks in December 2023 to 2.2 billion sticks in December 2024, a significant decline of 26.1%. However, in a stark contrast to the production trend, FED collection surged by 27%, rising from PKR 16.5 billion to PKR 21 billion.

This unexpected surge in FED revenue, despite the decline in production, suggests a substantial shift in market composition towards premium brands. Our calculations indicate that to achieve this level of FED collection, the market share of premium brands would have had to increase to a considerable 38%.

While a sudden and dramatic shift in consumer preference towards premium brands in December 2024 seems improbable, the data presents a compelling contradiction. This anomaly is further compounded by the simultaneous decline of 18% in sales tax collection, which typically mirrors production trends.

The December 2024 data present an unexplainable scenario that defies conventional economic explanations. It raises questions about potential data anomalies, reporting inconsistencies, or perhaps even deliberate manipulation. Further investigation is crucial to unravel this enigma and ensure the integrity of the reported figures.

These two puzzles highlight the need for a deeper dive into Pakistan’s cigarette tax system.

• The current system appears to be encouraging production shifts and potentially facilitating revenue manipulation rather than achieving its intended goals. A comprehensive assessment is needed to determine whether a single-tier tax structure, with a uniform tax rate for all cigarette brands, would be more effective in achieving revenue targets and promoting public health objectives.

• The unexplainable discrepancy in FED and sales tax numbers in December 2024 raises concerns about data accuracy and potential loopholes in the FBR reporting system. A thorough investigation is crucial to ensure the integrity of the data and identify any vulnerabilities that could be exploited.

• Robust and reliable data is essential for informed policymaking and effective research. The government should invest in improving data collection methods, ensuring accuracy, and promoting transparency.

By addressing these issues, Pakistan can move towards a more transparent and efficient cigarette tax system. This will not only enhance revenue collection but also contribute to sound economic policy and improved public health outcomes.

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                    Table 1:  Production and Tax Collection on Cigarettes
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          Production (billion sticks)           FED (billion PKR)           Sales Tax (billion PKR)
              FY24    FY25   Growth           FY24      FY25    Growth       FY24    FY25    Growth
Jul. -Nov.    11.8    15.4    31%             88.9      81.9    -8%          22.7    16.5      -27%
December       3.0     2.2   -26%             16.5      21.0    27%           3.9     3.2      -18%
Jul. Dec.     14.8    17.6    19%            105.4     102.9    -2%          26.6    19.7      -26%
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Source: Production from QIM, Pakistan Burau of Statistics, GoP, Tax 
collection from FBR Biannual Review (Jul-Dec) 2024-25
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