Legal cigarettes comprise a mere 10% of overall tobacco consumption in India with the remaining 90% consumption is in the form of 29 tax-inefficient tobacco products such as bidis, chewing tobacco, khaini etc. and illegal cigarettes.
However, despite its small share of tobacco consumption (10%), 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 tax-inefficient 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 10% in 2023-24 while the overall tobacco consumption in the country has increased by 49%, 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.23,000 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) 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.
Under GST 2.0 reforms, announced in September 2025, the highest GST rate of 40% is levied on the Retail Sales Price (RSP) of cigarettes.
Subsequently, the Government imposed a steep high Excise duty rates leviable on Cigarettes with effect from 1st February, 2026, replacing the GST Compensation Cess, previously levied on Cigarettes and other tobacco products. The new Excise duty rates are excessively high and as per the Jefferies Report “The Big Tax Shock” (January 2026), due to the GST @40% on (RSP), the effective tax hike comes to around 70%.
The huge increase in tax burden due to the high excise duties and the 40% GST on RSP will result in very high price increases, increased arbitrage and provide an enormous impetus to the already large illicit cigarette market in the country.
Historical data indicates that periods of high and discriminatory tax increases lead to sub-optimal tax revenue, while periods of tax stability result in strong buoyancy. Moreover, years of high taxation have led to steep increases in illicit cigarette trade.
The high excise tax increase will further boost illegal trade adversely impacting farmers livelihood, Government revenues and promoting anti-social activity.
Implementing a balanced and rational taxation policy is essential to safeguard the livelihoods across the entire value chain, including the legal industry, and to prevent further growth in illicit trade. Such measures are crucial for sustainable economic and social stability.