Legal cigarettes comprise a mere 10% of overall tobacco consumption in India with the balance 90% constituted by other tobacco product forms such as bidis, chewing tobacco, khaini, etc., and by illegal cigarettes.
However, despite its small share of tobacco consumption (10%), the Government collects 86% of tobacco related tax revenue from Legal Cigarettes alone as per the data available for 2016-17. The reason for this distorted pattern of collections is that Cigarettes are subjected to high and discriminatory rates of taxation compared with other tobacco products. In fact, as per data available up to 2016-17, on a per Kg basis of tobacco consumption, taxes on Cigarettes are 55 times higher than on other tobacco products as against about 28 times higher in 2005-06.
Such discriminatory treatment of the legal cigarettes encourages consumers to shift to cheaper, revenue 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 2016-17 while the overall tobacco consumption in the country has increased by 33%, 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 since 2012-13, 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 1/4th of the Industry currently.
Based on the current tax rates on cigarettes, it is estimated that the Government loses Rs. 13,000 crores per annum on account of illegal cigarette trade.
A more recent 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 pushe business to the underground, clandestine trade in illegal cigarettes.
The Goods and Services Tax (GST), conceptualized as a simple and Revenue Neutral tax, has further increased the tax burden on legal cigarettes.
Cigarettes, on which increasing excise duty, VAT and other State level taxes were being levied previously, the highest GST rate of 28% is now being levied in addition to GST Compensation Cess and National Calamity Contingency Duty (NCCD). Moreover, the GST Council at its meeting on 17th July 2017 effected a steep increase in the compensation cess rates on Cigarettes. The incidence of tax on cigarettes post the increase in compensation cess rates is not in keeping with the fundamental GST principle of Revenue Neutrality.
This additional tax burden will exacerbate the pressure on the legal cigarette volumes which have shrunk by around 25% in 2017-18 from a level of 110 billion sticks in 2011-12.
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 and revenue inefficient non-cigarette tobacco product forms, which are largely in the unorganized sector and to illegal cigarettes.
The growth of these revenue inefficient, 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.
It is therefore, imperative for the Policy Makers to contain the movement of tobacco consumption to cheaper revenue-inefficient tobacco products and to illegal cigarettes through policy intervention.