The year 2018 was a turnaround year for the two major tobacco multinationals operating in the formal fold. That’s the year when the controversial introduction of a three-tier tobacco FED regime, introduced in mid-2017 to fight illicit cigarette trade, showed its true colors (see the illustration for comparison of tobacco FED over the last five years). 2018 saw cigarette production attain its peak, resulting in recouped tobacco profits, even as effective excise duty rate went down and per capita cigarette consumption rose.

While the tobacco duopoly registered double-digit gains in gross turnover, the respective net profits were proportionally more (see the illustration). While that could be attributable to factors including better operating performance, what explains the fact that growth in net turnover was significantly more than gross turnover? At work is the lower effective FED per pack, thanks to the third tier, where bulk of cigarette sales is made.

In the September 2018 mini budget, the PTI government followed the middle ground: it kept the three-tier system but raised the FED on the lowest tier to bring it up to a reasonable level. A lot depends on what the next budget will bring for the industry. There are expectations that the third-tier will remain in place but with enhanced FED on it.

But it will be hard to keep the multi-tier tobacco FED regime alive, given some latest studies that suggest net benefits of a simplified and enhanced FED regime for cigarettes. (Read ‘A case against multi-tier tobacco tax regime,’ published December 17, 2018, for more on those findings).

One of the studies, by PIDE Islamabad, study noted that returning to the two-tier system would make cigarettes expensive on average without hurting tax revenues and would reduce smoking incidence and premature deaths by a significant number. The other major study, by SPDC Karachi, noted that higher FED on cigarettes would boost instead of suppress national output, income and employment.

One is not sure when and how the proposed sin tax on tobacco – reportedly a Rs10 charge on every cigarette pack sold – will go into effect. The move is expected to garner treasury some Rs30 billion rupees, based on FY18 cigarette production levels. Tobacco company officials have come out against this tax, arguing that it will further widen the price gap between formal-sector cigarette packs and the locally-produced duty-non-paid (DNP) brands.

At its core, the problem is how to tackle illicit trade, especially of the DNP kind. There is significant disagreement among the stakeholders over the scale of illicit trade, but nobody denies its existence. The previous government, thinking the best way to tackle DNP trade was to make formal sector more price-competitive, effectively slashed the FED rate to help the formal players in the value-for-money segment, where DNP brands sell the cheapest. Meanwhile, “enforcement” remained the elephant in the room.

The current government has more or less continued with that approach. Attribute it to political vested interests or FBR’s lack of capacity, the outcome is of thriving illicit trade. Despite the introduction of the third tier, the illicit cigarettes control up to a third of the whole market, concedes a prominent tobacco executive. It appears as though the formal market has achieved a cozy co-existence with the illicit market post multi-tier re-introduction couple of years ago.

But there is no way around effective enforcement against DNP brands through administrative crackdowns and practicable measures like tax stamps posted on individual cigarette packs. The industry and the government both are currently relieved, enjoying growing revenue streams. But in a couple of years when illicit trade encroaches more of the formal-sector territory, the FBR and the duopoly will be back to square one, yet again making the case for a fiscal relief for the formal tobacco industry. The buck stops with the government to nab illicit trade for good, regardless of political consequences.