Fighting stick with stick

With the annual budget announcement round the corner, different stakeholders including importers, small, medium and large scale manufacturers, the political government and the state’s tax collection machinery are striving to establish their point and get their interests watched in the upcoming policies. The retention of the existing tax regimes for different sectors or revision in them are among the main topics of discussions and lobbying exercises going on nowadays.

The cigarette manufacturing industry which is dominated by two giants – the Pakistan Tobacco Company (PTC) and Philip Morris Pakistan Limited (PMPL) – and has 98 percent of the legitimate market share is among the most active industries. Its plea is that the government must not withdraw the tax concessions granted to the industry a year ago on the grounds that it had discouraged illicit trade by significantly bridging the gap in prices of smuggled, non-custom paid and counterfeit cigarettes and those legitimately produced and sold.

On the other hand, the anti-tobacco campaigners, independent research organisations, the Ministry of National Health Services (MNHS) etc, reject this claim and stress that the production of cigarettes has increased drastically due to tax concessions, and the revenue target set by the Federal Board of Revenue (FBR) is far from achieved. More production, they claim, means more consumption, both by the existing users and those attracted to smoking for the first time due to the lowering of cigarette prices. Against this backdrop, the demand to remove tax concessions is getting stronger by the day. The demand has international support as well because reduction in taxes on tobacco industry is in contradiction to the international commitments Pakistan has made under the WHO’s Framework Convention on Tobacco Control (FCTC).

To have a better understanding of the issue, one needs to look at the existing tax structure for the cigarette industry. It is based on a tier-based system that applies the same amount of tax on cigarettes falling within a particular price range and not as a percentage of the price of the product. Earlier, there were two tiers but a third was introduced last year to bring down taxes on comparatively low-priced cigarettes.

Under the two-tier system, there was a Federal Excise Duty (FED) of Rs74.10 on a 20-cigarette pack with a retail price of more than Rs88 and Rs32.08 for a pack with a price up to Rs88. But now, under the third tier formula, the FED is Rs 74.8 for a pack of more than Rs90, Rs33.4 for a pack more than Rs58.5 and Rs 16 for a pack that costs under Rs58.5.

The large-scale cigarette manufacturing companies benefitted from this concession and brought down the prices of their products slightly to make them fall in the third tier. For example, a pack of Rs 60 is subjected to FED worth Rs33.4, but by lowering the price to Rs58, it is shifted to the third tier where the FED rate is Rs16. By simply moving a product to the third tier the FED is reduced by more than half. Reportedly, these companies were aware of this revision in the formula well ahead of the announcement and that is why they ordered to clear their stocks of low-priced brands as early as possible. The letter issued by one of these companies to this effect is available as proof.

A look at the trend following the introduction of the third tier shows that contrary to the prediction of the FBR and industry, only the production and turnover of companies increased but the FED paid by them declined or did not increase in the required proportion. This suggests an increase in cigarette consumption or number of smokers, or both. As a report of the Islamabad-based Sustainable Development Policy Institute (SDPI) puts it, during the third quarter (post the introduction of the third tier) the gross turnover of the PTC increased by six percent, but the FED paid by the company declined by two per cent in quarterly comparison.

Similarly, the PMPL witnessed a growth of 41 percent in its gross turnover in quarterly comparison, but its FED payments rose by only 17 percent. And an even more alarming fact is that on a year-to-year basis, as per the data of the Pakistan Bureau of Statistics (PBS), the production of cigarettes increased by 131.53 percent, growing from 2.2 billion cigarette sticks in January 2017 to 5.2 billion in January 2018.

Even if the justification that low taxes discourage illicit trade is believed to be true, the figures above appear to be highly misleading because the cigarette companies put the share of illicit trade to be around 38 percent. The companies claim that the production has increased due to the shifting of consumers to the legitimate market, but cannot explain why it has gone up by a whopping 131 percent, especially when a survey by Pakistan National Heart Association (PANAH) has put the estimate of illicit trade to be around nine percent only.

Then there are apprehensions that an artificial dip in terms of the FED and sales tax collection in 2016-17 was made the premise to introduce the third tier. Before this, collection was on the rise and stood at Rs106 billion in 2014-15 and Rs114 billion in 2015-16. Was there no illicit trade of cigarettes during these years and the legitimate market was disturbed only in 2016-17 is the question. Besides, it was in May 2017 that the FBR raided a warehouse of the PMPL in Mandra, Rawalpindi, and recovered a cache of non-duty paid cigarettes. This news was carried by the national press and strengthened the impression that multinational companies (MNCs) also contribute to the illicit trade of cigarettes and demand tax favours on the basis of engineered figures.

In view of this analysis, there is a need for measures that can help reduce the prevalence of smoking, without much affecting the revenue collection figure and ending the dichotomies in policies. At the moment, if on one hand the FBR is addicted to tobacco-related revenues to protect the local industry, then on the other, the health ministry proposes measures to curb smoking and suggests increasing taxes on cigarettes. It is strange that the ministry is vehemently opposing the third tier but the FBR is resisting doing away with it despite pressures from different quarters. Last year, the ministry had even proposed to raise the tax on the second tier but was stunned by the introduction of the third tier.

Therefore, it is suggested that the government returns to the old two-tier system and launches an extensive crackdown on illicit trade, which will reduce the incidence of smoking and also increase revenues. One must remember that it was the same two-tier system that helped the FBR achieve revenue worth Rs114 billion in 2015-16. As majority of smokers used to buy cigarette brands falling within the second tier, the revenue fell as they moved to the third tier – carrying a low FED imposition figure.

Furthermore, there is no doubt that illicit trade should be brought down, but through better enforcement and not through reduction in prices of cigarettes, that too through unwarranted tax concessions. The FBR has appointed its officers inside small-scale local factories to ensure there is no tax evasion and every cigarette pack is tracked. The need here is to make this step effective by countering corruption and inefficiency among these officers and subjecting MNCs to similar scrutiny as well.

The writer is a staffer at The News.

Email: shahzada.irfan@gmail.com