Legal cigarettes comprise a mere 9% of overall tobacco consumption in India with the remaining 91% consumption is in the form of 29 cheaper tobacco products such as bidis, chewing tobacco, khaini etc. and illegal cigarettes.
However, despite its small share of tobacco consumption (9%), the Government collects a very high proportion of tobacco related tax revenue from Legal Cigarettes alone. The reason for this distorted pattern of revenue collections is that cigarettes are subjected to high and inequitable taxation, as compared to other tobacco products, which are largely produced in the unorganised sector and are prone to tax evasion.
Such high and inequitable taxation on legal cigarettes encourages consumers to shift to cheaper tobacco products. Consequently, over the last three decades, the legal cigarette share of total tobacco consumption in India has declined from 21% in 1981-82 to 9% in 2021-22 while the overall tobacco consumption in the country has increased by 50%, during this period.
Extremely high tax rates on Cigarettes provide a profitable opportunity for tax evasion. Consequently, illegal trade in cigarettes in India has grown steadily over time. Due to the particularly steep increases between 2012 and 2020, there has been a perceptible spurt in the growth of illegal cigarettes with its resulting impact on the Legal Cigarette Industry. Illegal cigarettes (comprising International smuggled and domestic tax-evaded Cigarettes) are growing and accounts for 1/3rd of the legal Industry currently.
It is estimated that the Government loses Rs.18,500 crores per annum on account of illegal cigarette trade.
A Study by FICCI titled “Need for Policy Reforms to Combat Illicit Markets – Case study on Tobacco Industry” notes that high taxes on cigarettes is the primary driver of illicit trade in the country. High taxes offer a huge arbitrage opportunity to illegal operators and push business to the underground, clandestine trade in illegal cigarettes.
The Goods and Services Tax (GST) has further increased the tax burden on legal cigarettes. The GST tax regime, introduced in July 2017, increased the GST Compensation Cess rates by a weighted average of about 13% over the pre-GST tax rates. The tax burden on cigarettes (cumulative growth in rates of tax on cigarettes, after cognizing for the increase in rates of GST Compensation Cess) almost trebled between 2012 and 2020.
The highest GST rate of 28% is levied on cigarettes in addition to the GST Compensation Cess, Basic Exise Duty (BED) and National Calamity Contingent Duty (NCCD).
This additional tax burden exacerbated the pressure on the legal cigarette volumes which shrunk by around 28% in 2020-21 from a level of 109 billion sticks in 2012-13.
While anti-tobacco activists may claim the decline in Legal Cigarette volumes as a success of tobacco control measures, the reality is that punitive taxation on Legal Cigarettes has only forced consumers to shift to cheaper non-cigarette tobacco product forms, which are largely in the unorganized sector and to illegal cigarettes.
The growth of these cheaper tobacco products and illegal Cigarettes has not only deprived the Government of a huge revenue opportunity but also defeated the avowed objective of tobacco control directed at reducing overall tobacco consumption.
Moreover, the growth of illegal cigarettes has also reduced the demand for domestic tobaccos causing acute distress to Indian tobacco farmers. Since contraband products do not use locally grown tobaccos, illegal trade severely impacts the earnings and livelihood of the farmers.
The Government has adopted a pragmatic taxation policy in the past two years, providing stability in tax rates on Cigarettes. This policy of tax stability has been successful as it has reversed the growth momentum of illicit cigarettes, helped legal industry recover small volumes from illicit trade and brought positive growth to Government tax revenues.