Tobacco taxation is widely considered as a powerful policy instrument, especially as a part of a comprehensive tobacco control strategy that includes clean indoor air policies, restrictions on marketing, etc. Effective and optimal tobacco taxation is not only used to reduce the prevalence of tobacco consumption but also to generate revenues for offsetting adverse health implications. The level of taxes on tobacco in the country is well below the WHO-recommended level of 70 percent and cigarette prices are among the lowest in the world. The average tax rate on cigarettes is around 52 percent.
Despite this realization, recent reforms in tobacco taxation have been unable to fully achieve these dual objectives in Pakistan. The higher tobacco taxation generally avoided due to the perceived macroeconomic contribution of the tobacco industry. It is argued that the tobacco industry is not only making a significant contribution to large-scale manufacturing but is also creating direct and indirect employment in the country. High rates of tobacco taxes, therefore, would adversely affect the economy. It is also argued that cigarettes industry is one of the major contributors of the excise duty and any decline in the production will simultaneously cause the decline in the magnitude of excise duties and will cause a decline in a tax-to-GDP ratio which is already alarmingly low. On these considerations, in 2017, FBR introduced a three-tier structure of excise duty to encourage the production of low-priced cigarettes. However, a deeper analytical investigation into macroeconomic linkages showed an opposite picture.
Pakistan is placed among the top ten raw tobacco producers in the world and was ranked 9th in 2016.5 Despite being one of the largest tobacco growing countries, tobacco is not a major crop in Pakistan. It accounts for only less than half (0.42) per cent of the total value of agricultural produce, 0.25 percent of the total area under cultivation and only 0.03 percent of agricultural employment (8,200 persons).
Similar to agriculture, the cigarette industry is also not a major contributor to the manufacturing sector and GDP. Its share in total industrial output is 1.1 percent. On top of that, the share of the cigarette industry in industrial employment is less than a half percent only (0.3 percent). Cigarettes industry is a capital-intensive industry and heavily relied on imported inputs. Finally, the industry, instead of earning foreign exchange by capitalizing the agriculture production, causes a drain on foreign exchange as a net importer.
Theoretically, this meagre contribution of the cigarettes industry may be an understatement as any sector of the economy serves three purposes. Firstly, it uses the input of other sectors of the economy in production process referred to as "backward linkages". Secondly, it contributes to the economy through production by using factors of production ie. labour and capital referred to as "value-added". Finally, it provides input to other sectors for the further value addition - "forward linkages".
The cigarette industry has backward linkages with all three-broad categorization of economic sectors ie. agriculture, industrial sector and services. Interestingly, the largest contributor to the production of the cigarette industry is not the agriculture sector. This is a reflection of the reliance of the cigarette industry on imported inputs like filters and chemicals. The agriculture sector as a whole contributes a meagre 5 percent of the total value of final production.
Other industrial inputs including paper and packaging materials, utilities like electricity, gas and water contribute more than 7 percent of the final value of cigarettes production. The biggest component of the added value of the cigarette industry is the operating surplus and cost of capital, indicating the high profitability of the industry.
To get a fuller picture a recent study of the Social Policy and Development Centre (SPDC) estimated the ripple effects of cigarette industry on the economy on the basis of multipliers, which indicate how much output, income and employment the cigarette industry is generating. And how much that generated output, income and employment are causing to generate further economic activities by consuming the goods and services produced by other sectors. The study concluded that despite adding all possible direct and indirect ripple effects, the contribution of cigarette industry turns out to be small.
For instance, the estimates of output multiplier (2.9) indicates that a decrease of Rs 1.0 billion in the final demand for cigarettes, will decrease the output of the economy by Rs 2.9 billion, which is a relatively small impact compared to the output multipliers of food and education which are estimated to 5.4 and 4.0 respectively.
Impact on income and employment are even smaller. A reduction of Rs 1.0 billion in final demand for cigarettes will lead the income level to decline by Rs 0.385 billion while the total employment loss to the economy would be only 121 persons. Thus, the impact of the cigarette industry is medium in terms of output but small in terms of loss of income and loss of employment. Further, the impact of this sector is limited to only a few sectors since the cigarette industry does not have a large number of inter-linkages within the economy.
Although a reduction in tobacco consumption may lead to small short-term losses to the economy, there are significant gains in the medium to long-term. SPDC estimates show that a 10 percent increase in price will lead to an 11 percent reduction in cigarette consumption, translating into annual savings of Rs 16 billion by individuals. Reduction in cigarette consumption would allow individuals to spend their savings on other commodities. For example, spending this amount on food items would lead to a net increase of Rs 40 billion annual output of the economy.
This research reveals that direct and ripple effects on income and employment of other goods and services are far higher than those of the cigarette industry. Thus, the research provides a strong macroeconomic case for increasing tax rates to their optimal level. Apart from macroeconomic gains, higher taxes will help for achieving the dual objectives of reducing the prevalence of tobacco use and increasing revenues which can be used for promoting public health.
(The writer is the Principal Economist at SPDC. The views expressed in this article are not necessarily those of the newspaper)