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Most of the manufacturers of non-duty paid cigarettes are operating in KPK province where supply chains from low enforcement jurisdictions of Federally Administered Tribal Areas (FATA) and Azad Kashmir facilitate their operations through backup production facilities. Research on illicit trade conducted by the industry revealed Monday that the manufacturers, mostly located in KPK Province, have ensured uninterrupted production of non-duty paid cigarettes.

Their convincing fašade includes printing the latest health warning but fictitious prices printed onto packs. This resulted in tax evasion of billions, copyright infringements, and on-going illegal consumer promotion schemes. In the absence of effective enforcement mechanism, high prices provide an incentive to engage in the illicit tobacco trade. In addition, the threat of increased illicit cigarettes weakens the government's ability to use cigarette tax hikes as a tobacco control policy tool as proved by the inability to move the needle in terms of reducing smoking incidence in Pakistan. The only impact these measures have had is a 10% drop in sales volume for the duty paid cigarette industry that historically has been a very stable and reliable revenue generating stream for the Government.

According to research, nearly one out of every four cigarettes sold in Pakistan is illicit; manufactured, most likely, in a local production facility that evades duties and taxes. This duty evasion allows widespread availability of very low priced products. As non-duty paid cigarettes are sold at less than half of the price of their duty paid counterparts, resultantly the illicit segment has reached a staggering market share of nearly 25% in Pakistan.

The cheapest duty paid cigarette brand is now priced at Rs 50, while the price of its illicit substitute starts from Rs 12 or Rs 15 as no duties are paid on these products. Easy availability of such cheaper alternatives allows the consumer to keep smoking at an affordable cost and maybe even over indulgence by increasing consumption. According to recently issued data by KPMG in 2015, cigarettes have become 30% more expensive in Pakistan, relative to income growth, for consumers in 2014 as compared to 2008. In the above context, when the government attempts to reduce smoking incidence through frequent and steep tax increases it is met with three responses. First, the legitimate industry is bound to increase price due to tax rate increase on duty paid cigarettes. Secondly, the huge non-duty paid segment evades all applicable duties and taxes and gets away with it due to lax enforcement. Hence it does not have to increase its prices in line with taxes. Thirdly, the consumer is left with no choice, but to down trade to illicit products to conserve his limited income.

Resultantly, the government suffers loss on two counts. Firstly, the government suffers revenue loss of around Rs 20 billion per annum. The revenue loss in the last 5 years was equivalent to more than US $1 billion in lost taxes. Illicit substitutes thus undermine both objectives of the government by driving consumers to switch from duty paid products to illicit products.

In comparison to global standards, the total tax incidence in Pakistan is 62.5% of the retail price on weighted price basis of the duty paid brands. This is not only higher than the global average but also increase the significant growth of illicit trade in Pakistan. Nearly 25% of the cigarette market is paying less than 1% of the total taxes collected annually by the overall industry. With every price increase the Government imposes on the duty paid segment, it only increases the burden on the legitimate players who are already paying more than Rs 100 billion in taxes this year alone.

Copyright Business Recorder, 2015

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