Policy needs economic coherence: a case of Pakistan’s tobacco taxation

Pakistan’s Federal Budget 2026–27 has once again brought the country’s tobacco taxation framework into focus. At a time when the government is under pressure to mobilise revenue, improve documentation, and address illicit trade, the treatment of tobacco and related products presents a mixed policy picture. The budget introduces some enforcement-oriented measures and revises taxation on selected products, but it stops short of a broader restructuring of cigarette rates.

The most visible change is the increase in Federal Excise Duty on e-liquids used in electronic cigarettes, from Rs10,000 to Rs16,500 per kilogram. This indicates that the government recognises the need to bring emerging nicotine products more firmly within the tax net. However, the continued use of a per-kilogram tax base for e-liquids raises an important design question. E-liquids are usually packaged, sold, and consumed in volumetric units. A weight-based tax base may therefore complicate valuation, compliance, and enforcement. From a tax administration perspective, the government may need to review whether the current unit of taxation is suitable for the product it seeks to regulate and tax.

A more significant policy issue is the proposed reduction in Federal Excise Duty on the import of acetate tow from Rs44,000 per kilogram to Rs10,000 per kilogram. Acetate tow is a key input used in cigarette filters. Reducing the duty on this input can lower production costs for cigarette manufacturers at a time when excise rates on cigarettes themselves have not been increased. This creates an apparent inconsistency in the fiscal framework. On the one hand, the government is attempting to strengthen monitoring and enforcement; on the other, it is reducing the tax burden on an important cigarette-related input.

The absence of an increase in cigarette excise rates should be viewed in the broader context of the government’s stated focus on smuggling, illicit trade, documentation, and production monitoring. These are important issues. Pakistan’s tax system has long suffered from leakages, weak enforcement, and gaps between documented and undocumented economic activity. A stronger monitoring regime can improve revenue collection and reduce market distortions. However, enforcement alone cannot substitute for a coherent excise policy, especially when nominal tax rates remain unchanged for an extended period.

Cigarette excise rates have remained unchanged since February 2023. In an inflationary environment, unchanged nominal rates lose their real value over time. This means that even without a formal tax cut, the effective tax burden declines when inflation erodes the real value of specific excise duties. For a revenue-constrained economy, this has direct implications for tax buoyancy and fiscal efficiency. If specific excise rates are not indexed or periodically adjusted, the government risks losing revenue potential simply because the tax system fails to keep pace with prices.

The pre-budget debate also showed that tobacco taxation remains a contested area of fiscal policy. A proposal to introduce a third tier in the cigarette excise structure was reportedly under consideration but was not included in the final budget. Such a tier could have lowered the effective tax burden on cheaper cigarette brands and weakened the existing excise structure. Its non-inclusion is therefore significant. It suggests that while the government did not increase cigarette taxes, it also avoided a structural change that could have diluted the tax base further.

This outcome did not emerge in a policy vacuum. Research institutions and policy stakeholders, including Sustainable Development Policy Institute (SDPI), contributed to the budget debate through evidence-based inputs, roundtables, opinion pieces, stakeholder consultations, and engagement with policymakers. These efforts helped keep tobacco taxation within the broader discussion on revenue mobilisation, enforcement, and public finance. The policy conversation also appears to have shifted attention toward illicit trade and monitoring, which may explain why tax administration measures received more emphasis than rate increases in the current budget.

Going forward, Pakistan needs a more integrated tobacco tax strategy. First, cigarette excise rates should be periodically reviewed to ensure that inflation does not silently reduce their real value. Second, the government should assess whether relief on inputs such as acetate tow is consistent with its wider revenue and excise policy objectives. Third, the taxation of e-liquids should be technically refined so that the unit of taxation matches market practice and improves enforceability.

There is also scope to examine environmental taxation in the tobacco sector. Tobacco cultivation, curing, manufacturing, and waste generation carry measurable environmental costs. A carbon levy or environmental surcharge on tobacco products could be explored as part of future fiscal policy, provided it is supported by credible data on deforestation, fuel use, emissions, and waste.

The Federal Budget 2026–27 shows that tobacco taxation remains an important but unresolved area of Pakistan’s fiscal policy. At the same time, the government has reduced duty on a major cigarette input, raising questions about policy coherence.

For Pakistan, the issue is not simply whether tobacco taxes should be higher or lower. The real question is whether the tax system is economically consistent, administratively enforceable, and capable of protecting revenue in real terms. A stronger tobacco tax framework should combine effective monitoring, inflation-sensitive excise policy, rational treatment of inputs, and consideration of environmental costs.