Excessive taxation on tobacco productsresulting in black market boom in Pakistan

ISLAMABAD: The government’s move to slap an exorbitant new tax on tobacco products in the minibudget is driving cigarette sales into the black market, causing more harm than good to both the exchequer and the industry.

Industry sources say Pakistani cigarette manufacturers’ sales have nosedived across the country in the wake of the minibudget, in which the government imposed a new federal excise duty on tobacco products as well as raising the sales tax rate by a percentage point.

Manufacturers’ data shows retails sales plummeting by more than 50 percent in some parts of the country. But there is no evidence to suggest smokers are quitting in droves. Instead, they are switching to smuggled cigarettes, counterfeit cigarettes or low-quality cigarettes manufactured locally by clandestine tax dodging plants.

Cumulatively, the new taxes caused retail prices of Pakistani cigarettes to soar by up to 200 percent – but the impact is limited to the formal sector. By definition outside the tax net, the grey sector – comprising the trade in smuggled cigarettes and the informal tobacco industry – is immune to this price hike.

Sales lost to the formal, taxpaying industry are therefore migrating to the shady grey market constituted by these manufacturers – and to smuggled or counterfeit cigarettes, pressing home the point that the economic managers’ policy, aimed at raising more tax revenue, has backfired, inflicting damage on the industry as well as the exchequer.

A section of the media reported last week the International Monetary Fund (IMF) has taken up the matter with the government, expressing its concerns over the huge amounts of tax dodging involved.

An executive with one of the major Pakistani tobacco manufacturers said the Fund staff cannot possibly have access to the data and insights required to fully grasp the magnitude of harm the grey market can do to industry.

Oblivious to how the tobacco black market in our country works, they limit their estimates to the impact of smuggled cigarettes. However, counterfeit cigarettes and local brands manufactured outside the tax net are an even bigger problem in Pakistan.

It does not help that some of the illicit factories making local brands in the informal market without any attention to quality are owned by influential and well-connected figures, whose networks of patronage protect them from any attempts by the tax authorities to bring them to book.

These factories operating outside the purview of taxation or regulation are a major component of the illicit tobacco market. Sworn to the pirate code of “take whatever you can, never give back”, they are only concerned with maximizing their profits and have perfected strategies and tactics to resist any attempt by the Federal Board of Revenue (FBR) or other law enforcement agencies to bring them to book.

What is more, they have access to inside knowledge and frequently adapt their strategies to suit the changing environment. For instance, they were initially operating in certain parts of Khyber-Pakhtunkhwa (KP) province but have since diversified their locations to other parts of the country and beyond to Azad Jammu & Kashmir.

Some such players have mounted machinery on trucks, becoming industries on wheels that can vanish at a minute’s notice and start operating at some other, safer place. Some illicit factories are known to have relocated to the areas of Azad Jammu & Kashmir (AJK) adjacent to major population centers of Punjab.

Some in the formal cigarette industry say the FBR is not serious in taking any meaningful action against illicit cigarette manufacturers. In fact, they accuse FBR functionaries of facilitating illicit cigarette trade by not increasing the retail price threshold as per past precedents to keep minimum legal price low to facilitate availability of cheap cigarettes.

Pakistan’s formal tobacco industry is a major revenue contributor for the exchequer. In addition, the industry is in the forefront of corporate social responsibility spending for community welfare and social development initiatives.

The industry has cried itself hoarse that the exorbitant new taxes have rendered it uncompetitive in the face of illicit players. They say the market share lost to the tax evaded sector could be inflicting irreparable damage on the industry.

Revenue lost to the industry represents a proportionate amount of loss in tax collection. Also, money spent on smuggled cigarettes inevitably results in smugglers siphoning off precious foreign exchange through Hundi and Hawala channels, exacerbating the pressure on the rupee’s exchange value.

The grey market already commands around 37 percent of the tobacco market share. With the recent price hike fueled by exorbitant taxes, there are fears the share of the illicit market could rise as high as 70 percent of the domestic market within the year. Observers and industry insiders say the latest spate of taxation threatens the very sustainability of the formal tobacco industry.

One economist said the drastic drop in cigarette sales already in evidence could trigger plant shutdowns and eventually, flight of the industry – not exactly development in line with the objectives the government’s economic team is pursuing.

Will the government undertake a course correction on its policy? There is no word from the officialdom as of now, but if they do decide to act, they may want to do it sooner rather than later, before the damage becomes irreparable.