Legal cigarettes comprise a mere 8% of overall tobacco consumption in India with the remaining 92% 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 (8%), 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 8% in 2020-21 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 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.
It is estimated that the Government loses more than Rs. 15,000 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. The new 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. Incidence of taxes on cigarettes after accounting for the GST Cess increase has more than trebled since 2012-13. 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).
The Union Budget for 2020-21 increased NCCD rates on Cigarettes across all length segments ranging from Rs. 200 per thousand sticks (earlier Rs. 90) on the lowest length segment to Rs 735 per thousand sticks (earlier Rs. 235) on the highest segment.
This additional tax burden has exacerbated the pressure on the legal cigarette volumes which have shrunk by around 28% in 2020-21 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 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.
It is therefore, imperative for the Policy Makers to contain the movement of tobacco consumption to cheaper tobacco products and to illegal cigarettes through policy intervention.