Taxes on tobacco are considered to be the most effective way of boosting government revenues and bringing down its demand. In Pakistan, locally produced cigarettes are subject to levy of Federal Excise Duty (FED). In 2013, as a major paradigm shift, the government changed the criteria for levy of FED on cigarettes from hybrid/mixed duty structure to the specific tier-based structure. At the time of the introduction of this new regime, the cigarettes were classified under two tiers on the basis of retail price per thousand cigarettes. The regime was further amended in 2017 with the insertion of another tier making it a three-tier structure from the two-tier system. Within each tier, FED is levied on a fixed basis, irrespective of the price of the cigarettes; effectively, resulting in a higher percentage of taxes being imposed on low-cost cigarettes within the tier. The prevailing system of taxation is regressive in nature and lasting three-fold negative impacts. Firstly, it places an extra burden of duty on less costly brands in comparison with high value brands. FED, on different brands falling within a tier, is required to be levied and collected at the same amount, irrespective of the sale price of these brands. This practice may result in less collection of FED on brands selling at higher rates within a tier and putting extra burden on less costly brands. This practice is even susceptible to criticism on account of unfairness. It also fails to account for the disparity between the purchasing power of lower and higher income groups. Secondly, the duty changes erratically among tiers making the system unreasonable, irrational, and vulnerable to abuse. Change in a tier by increase or decrease in price may substantially increase or decrease the amount of applicable duty without having any co-relation with the price and exposes another weakness of the tiered system, allowing industry participants to exploit it for profit maximization at the cost of the lower collection of FED. Last but not the least, even though, any downward movement from Tier-1 to Tier-2 is prohibited, however, it does not stop industry participants from using ploys to manipulate the results. A Tier-1 or Tier-2 product may be rebranded and introduced as a Tier-2 or Tier-3 product, thereby, reducing the charge of FED thereon and ultimately dwindling the FED collection. In comparison, other countries follow various structures to levy duties on cigarettes and these normally include i) Fixed/Specific ie based on quantity ii) Ad valorem: based on value and iii) Hybrid/mixed taxes: both specific and ad valorem. The key challenge for the legislature is the choice of excise structure in order to levy duties and fixing their rates, or to strike an appropriate balance between the ‘Specific’ and ‘Ad valorem’ excise structures, so that higher revenues are generated while also achieving public health objectives.‘Specific’ duties are generally used to discourage people to avoid the use of potentially harmful products like tobacco, alcohol etc. in order to make it more difficult for users to afford the purchase of such products, especially those at the lower end of the economic scale. At the same time, governments implement these duties on the assumption that there would still be enough consumption of the products to generate desired revenues. As per the report of the ‘Global and regional overview of cigarette prices and taxation, World Health Organisation’, published in 2013 several countries were using ‘Specific’ structure. List of said countries majorly includes developed countries like USA, Canada, Australia, Norway, Switzerland, New Zealand and these are more focused on implementing the ‘Specific’ structure to secure greater control over the usage of cigarettes while achieving the desired level of revenue. On the other hand, countries generally with lower incomes were using the ‘Ad valorem’ excise duty structure and focused on the collection of excise duties by applying the ‘Ad Valorem’ structure, thereby collecting higher revenues, while limiting the use of tobacco products by charging higher ‘Ad Valorem’ rates. Further, in lower income countries, inflation is a critical phenomenon, which ought to be kept in mind while designing any tax policy. Under the ‘Ad Valorem’ structure, the value of excise duty is preserved with the price increase considering tobacco product prices are pegged to annual inflationary increases. In other words, an ‘Ad Valorem’ structure maintains tax revenue under high inflation. On the contrary, under the ‘Specific’ structure, duties need to be adjusted with changes in the Consumer Price Index, to keep pace with inflation. This is necessary as the real value of the excise will be eroded unless it is adjusted in line with inflationary trends. Further, a ‘Specific’ Tiered based duty structure also provides incentives for price manipulations, to the extent that manufacturers can alter their pricing or production behaviour to avoid higher duties. The key challenge for the legislature is the choice of excise structure in order to levy duties and fixing their rates, or to strike an appropriate balance between the ‘Specific’ and ‘Ad valorem’ excise structures, so that higher revenues are generated while also achieving public health objectives The duty structure of Pakistan, being a developing country, is not aligned with the duty structure of those of other developing countries. Pakistan may consider adopting an ad valorem duty structure to maintain and gradually increase its FED collection instead of ‘Specific’ duty structure followed by developed countries like USA, Canada and Australia etc. Further, the consumption of cigarettes can also be controlled with substantially higher ad valorem rates, rather than setting a single rate for a whole class of brands (eg brand prices ranging from Rs 91 to Rs 140). There could be many disadvantages with the fixed/specific duty structure especially in the economic scenario of Pakistan; however, in the case of an ad valorem structure (i.e. duty as a percentage of price), the increase in collection of FED may be secured gradually while catering to the factors like; harmonised level of duties when price increases; curbing price manipulation and keeping pace with inflation. The writer is FCA, LLB and Partner Ernst & Young, Pakistan. He can be reached at muhammad.Awais@pk.ey.com Published in Daily Times, May 23rd 2018.