Taxation

The tobacco consumption pattern in India is unique in that only 11% of total tobacco is consumed in the form of Legal Cigarettes. The balance 89% is consumed in other forms such as chewing tobacco, zarda, bidi and illegal cigarettes. This is unlike the rest of the world where tobacco consumption is synonymous with cigarettes which account for as much as 90% of total consumption.

Cigarettes bear the brunt of Tobacco Taxation in India

Despite a mere 11% share of consumption, Government collects 87% of its total tobacco revenue from legal cigarettes. The reason for this distorted pattern of revenue collections is that cigarettes are subjected to high and discriminatory rates of taxation, as compared to other tobacco products.

Source: Ministry of Finance, Govt. of India and Industry estimates

On a per kg basis, cigarettes are taxed at Rs. 4159 per kg vis-à-vis Rs. 81 per kg for other tobacco products making tax incidence on cigarettes 51 times higher than other 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 11% currently.

Tobacco Consumption (Million Kgs.)

Year Legal Cigarettes Other Tobacco forms* Total*
1981 – 82 86 320 406
2014 – 15 62 500 562
Difference -24 +180 +156

Source: USDA; Tobacco Board Industry estimates
*Includes illegal cigarettes

Moreover, given the availability of cheap substitutes, there is a great deal of interchangeability and dual usage between consumers of cigarettes, bidis and other tobacco products.

While the legal cigarette industry in India is in the organized sector, has statutory oversight and is completely compliant with all regulations the bulk of tobacco consumed is largely produced in the unorganized sector which does not have compliance or enforcementThis large unorganized sector (estimated at  68% of overall tobacco consumption) pays little tax either due to tax exemptions or evasion. Consequently, while on the one hand revenue collections are being sub-optimized, more importantly, overall tobacco consumption is also increasing.

State taxes are aggravating the tax burden on Cigarettes

States levy VAT on Cigarettes at rates that are much higher than the rates on other tobacco products. Moreover, there is significant revenue leakage from non-cigarette tobacco products on account of rampant tax evasion. According to a study published in the Indian Journal of Cancer, Oct.-Dec. 2012, about 90% of all non-smoking tobacco products are tax evaded.

The weighted average incidence of State taxes (VAT, entry tax etc) on Cigarettes is currently at around 24%.

Cigarette taxes in India are the highest in the world

As a percentage of per capita GDP, Cigarette taxes (Excise Duty & State Taxes) in India, of the most popular price category, are amongst the highest in the world. As is apparent from the chart below, cigarette taxes in India (as a percentage of per capita GDP) are almost 14 times higher than in the USA; 9 times higher than Japan; almost 7 times more than China; 6 times higher than Germany; 5 times more than in Australia & 3 times more than in Malaysia & Pakistan and 2 times higher than in UK and Thailand. Consequently, cigarette prices in India, relative to per capita GDP, are also amongst the highest in the world.

Cigarette taxes as % of per Capita GDP; Tobacco taxes as percentage of per capita GDP

Tax includes Excise duty, VAT/State taxes
Source: ‘WHO Report on the Global Tobacco Epidemic, 2015-Raising Taxes on Tobacco’

The chart above clearly indicates that high taxes make cigarettes extremely unaffordable in India compared to other countries in the world. Moreover, it is preventing the Government from realizing the full revenue potential from tobacco.

As per the ‘WHO Report on the Global Tobacco Epidemic, 2015 – Raising Taxes on Tobacco’ released in July 2015, affordability of cigarettes in India was amongst the lowest. Affordability measured as a proportion of GDP per capita required to purchase 100 packs of 20 cigarettes of most sold brand, was as high as 10.82 for India compared to other countries as depicted below:

Cigarettes affordability in India/World; World Cigarettes affordability; Purchasing power of cigarettes

Source: ‘WHO Report on the Global Tobacco Epidemic, 2015 – Raising Taxes on Tobacco’

The combined effect of high and discriminatory Central and State level taxation has impacted the legal cigarette industry, sub-optimized Government’s revenue collection and provided a huge fillip to the illegal cigarette trade in the country. The escalating excise duty burden on Legal Cigarettes has more than doubled in the last five years as a consequence of successive increases in Union Budgets since 2012-13.

Proposed GST Regime Provides an Opportunity to Remove Distortion in Tobacco Taxation

The anomalies caused due to distortions in the current tobacco taxation policy should be addressed under the GST regime by widening the tobacco tax base and bringing all tobacco products in the tax net. This could be achieved by levying GST at the first point of transaction itself. This would be at the points where raw tobacco is procured by manufacturers and tobacco traders for example Tobacco Board auctions for FCV tobacco, State APMC yards where non-FCV tobacco is sold and Tendu Leaf auction points. Removal of distortions in tobacco taxation in the GST regime will provide a level playing field to FCV tobacco farmers, bring about parity across all tobacco products and help expand the tobacco tax base and increase tobacco revenues exponentially.

Further, under the proposed GST regime all Tobacco Products should be taxed at a uniform rate of GST plus Central Excise Duty (CED) with overall incidence remaining Revenue Neutral. Additionally, the proposed Cess on cigarettes, if felt necessary, should also be Revenue Neutral and it should be levied on a “Specific” basis proportionate to current excise duty.

In fact, recognizing the problems related to the Ad-valorem levy of excise, a length based, Specific duty structure was introduced in 1987. This duty structure caters to India’s wide income distribution through multiple length slabs, providing consumers with alternative price points based on their ability to spend and facilitating up trading to higher revenue yielding products with growing per capita incomes.

Specific duty structure has ensured simple and transparent administration, and a litigation-free environment with no valuation disputes. At the same time, it has ensured efficiency of revenue collections whereby, even on a smaller volume base, revenue collections have grown more than 18 times. Notably, the Specific duty structure for a highly taxed product like cigarettes has been recommended by various taxation experts including those by Dr. Vijay Kelkar, Dr.Chelliah, and in studies by WHO, World Bank/IMF and the Ministry of Health & Family Welfare’s Report on Tobacco Control in India (2004).