KARACHI: Pakistan should adopt a simpler structure of taxation and strengthen administrative efforts against smuggling and illicit domestic production of cigarette, said Serhan Cevik, a Senior Economist at International Monetary Fund (IMF).
Pakistan is a major tobacco-producing country with historically high smoking prevalence rates. About 40 percent of the male population and 9 percent of the female population smoke regularly, consume over 82 billion cigarettes on an annual basis.
“Tax policy and administration should take into account cigarette market conditions across the price spectrum and challenges in addressing illicit trade. The structure of cigarette taxes is critical in determining the relative prices of different tobacco products and brands across the price spectrum and thereby influencing the behavior of consumers within a country” Cevik recommends in a working paper, prepared for IMF.
While tax policy can help reduce negative externalities associated with tobacco consumption, the taxation model needs to avoid providing incentives to switch down to cheaper cigarette brands in response to tax related and other price increases, the paper adds.
Furthermore, consumers’ price sensitivity and brand switching behavior and manufacturers’ pricing strategy, including brand repositioning, differential tax shifting and cross-brand price subsidy, can have potential consequences of tax revenue collection at an aggregate level. “To this end, Pakistan should adopt a simpler structure of taxation without tiers to have a greater influence on the relative prices of different tobacco products across the price bands and strengthen administrative efforts against smuggling and illicit domestic production of cigarette”.
A one-rupee increase in cigarette taxes is found to lead to an increase of only Rs 0.8 in retail cigarette prices, on average. In other words, cigarette taxes in Pakistan are under shifted by tobacco manufacturers to the prices paid by consumers. The working paper estimates the magnitude and speed of tax pass-through across tobacco products at different price points in Pakistan by using a novel dataset of monthly observations on cigarette prices in 50 cities during the period 2004-2015.
The pass-through of cigarette taxes to retail prices is found to occur within two months, but is mostly incomplete in magnitude. On average, a one-rupee tax increase is estimated to lead to an increase of only Rs 0.8 in retail cigarette prices.
Celvic said, ‘This is driven by the fact that tobacco manufacturers absorb a significant part of the tax increase. For the premium brand, however, I observe a pass through, indicating possibilities of different demand elasticizes across product tiers’. These findings are likely to be attributable to competitive market pressures, especially at the budget end of the price spectrum, possibly stemming from changing consumption patterns with greater awareness of health risks as well as the impact of illicit domestic production.
While the share of excise taxes have declined from about 30 percent of total tax revenue in 1990 to 5.5 percent in 2016, the tobacco sector still accounts for 4 percent of sales tax and excises collected at the federal level, and the share of tobacco excises stands at 56 percent of total excise taxes (up from 36 percent in 2010).