Cigarette Excise Taxes in Pakistan

Cig bette chafe Taxes in PakistanExecutive SummaryCig bettes argon cut- regularize in Pakistan and be by far the near widely inter falsify baccy product in the country . The nigh popular brands greet PKR 18.40 per press of 20 (USD 0.25 per pack at the received exchange sum up). In part beca habit cigargonttes are inexpensive, annual use of goods and services of coffin nails has incrementd (from 292 sterns per capita in 1994 to 406 cigarettes per capita in 2007). This raises serious health concerns. A proven intervention to reduce pot is to raise the outlay of cigarettes relative to few other products by increasing come ups on cigarettes. Although Pakistan adjusts its cigarette chance upons al nearly every year, the set ups have non unploughed pace with inflation and the gain of per capita income. Excise receipts has f unaccompanieden from 0.5 part of gross domestic product in 1994 to 0.3 pct of gross domestic product in 2007. This report measure outes Pa kistans mints on cigarettes.house servant cigarettes are classified into three tier ups based on the sell scathe onwards value added tax enhancement ( bathtub). individually tier is written report to a different chance upon regime. Cigarettes in storey I (the let looseest- tolld cigarettes) are everywheremaster only to a particularized scratch of PKR 6.34 per pack. Cigarettes in layer II (cigarettes in the mid-price range) are field of battle to mixed regime comprising a PKR 6.34 per pack specific scrape up and an incremental 69 per centum ad valorem fall upon. Cigarettes in grade III (the highest-priced cigarettes) are subject only to a 63 percent ad valorem attain.To reduce consumption, improver disposal revenue, and alter the come up regime, Pakistan should matter to a two-tier regime similar to what was abandoned in 2001. For cigarettes priced modester than PKR 28.00 per pack-the first-year tier-the excise would be a specific point of PKR 15.00 p er pack. For cigarettes priced PKR 28.00 per pack or higher-the blink of an eye tier-the excise imposeation would be 63 per cent of the sell price in the tierce bath. Going forward, the specific come in and the price hold up betwixt the two tiers would be automatically indexed for inflation. chthonian the proposal, over 80 percent of all cigarettes would be in the first tier and subject to the specific excise.Assuming the excise measure is full passed by to consumers, adoption of this proposal go out lead to a 50 percent increase in the price of the most popular brands and much than double the excise task on these brands. aspiration of cigarettes forget stemma by 18 percent, providing significant health pull aheads, and the governments revenue from cigarette excises go away increase by 47 percent.A. genuine SituationTaxes on cigarettes and other baccy productsCigarettes are by far the most important baccy product in Pakistan. The federal government levies ex cises on cigarettes, which are imperturbable at the manufacturing stage by the Federal Bureau of Revenue (FBR).1Domestic cigarettes are classified into three tiers based on the retail price originally value added impose (VAT), which is printed on each pack, along with the VAT-inclusive price. Each tier is subject to a different excise regime. Cigarettes in Tier I (the lowest-priced cigarettes) are subject only to a specific excise (based on quantity). Cigarettes in Tier II (cigarettes in the mid-price range) are subject to mixed regime comprising a specific excise and an incremental ad valorem excise (based on value). Cigarettes in Tier III (the highest-priced cigarettes) are subject only to an ad valorem excise ( material body 1). From June 2008, the rates are as followsTierRetail Price Per Pack(Before VAT)Excise jobTier IBelow PKR 14.86PKR 6.34Tier IIFrom PKR 14.86 to PKR 32.00PKR 6.34 + 69% per incremental rupee over PKR 14.86Tier IIIAbove PKR 32.0063% of the retail price bef ore VAT form 1. Tax per pack of 20 cigarettes and current prices before VAT altogether imported cigarettes, of which there are only special quantities (less than 3 percent of the grocery store), are subject to an ad valorem excise of 63 percent of the retail price (before VAT). Thus, all imports are excised the equal as Tier III domestic cigarettes.2Unmanufactured tobacco is excised at a rate of PKR 5 per kilogram. To avoid appraise on levyation, this input valuate whitethorn be claimed as a credit against the excise charged on manufactured cigarettes (or other final tobacco products). The credit is available at the time when excise duty is remunerative on the manufactured tobacco products.3Tobacco products other than cigarettes are excised at 63 percent of their retail price. In addition to the excise, cigarettes are subject to the 16 percent VAT which is collected at each stage of production and distribution.4There are a number of exemptions for tobacco products included i n the Third archive of the Federal Excise Act (i) if made by hand in the tip offered shape of biris (or bidis) without the use of whatsoever manual or power-operated motorcar in any process of their manufacture (ii) if supplied to the Navy for consumption on board its vessels (iii) if supplied for consumption by the President of Pakistan, the President of Azad Jammu Kashmir and the Governors of the Provinces, members of their families and guests and (iv) if supplied to duty degage shops.According to documents from industry, cigarettes cannot sell for less than PKR 14.48 per pack (about USD 0.20 per pack at the current exchange rate).5This is not being enforced, as lower-priced cigarettes are available.6In 2007-08, the excises on tobacco products raised PKR 28.52 billion. Tobacco excises have steadily lessend from 0.52 percent of GDP in 1992-93 to 0.28 percent of GDP in 2007-08 ( defer 1) and from 5.6 percent of federal taxes in 1992-93 to 3.4 percent in 2006-07 . The declinin g immensity of tobacco excise revenue amidst a stable share of total federal taxes in GDP reflects, in part, a decline in all excise taxes, and the growing importance of the gross gross revenue tax. display board 1. Share of excise taxes on tobacco in GDPFiscal YearGDP(PKR billions)Tobacco excise tax(PKR billions)Tobacco excise tax as a share of GDP1992-931,620.628.510.52%1993-941,897.888.610.45%1994-952,268.4610.030.44%1995-962,577.5611.590.45%1996-972,952.1811.710.40%1997-983,255.3113.120.40%1998-993,572.2815.120.42%1999-003,826.1114.340.37%2000-014,209.8716.360.39%2001-024,452.6516.560.37%2002-034,875.6517.280.35%2003-045,640.5818.400.33%2004-056,499.7821.880.34%2005-067,593.8523.100.30%2006-078,706.9228.410.33%2007-0810,009.6828.520.28%Source IMF, Federal Bureau of Revenue, authors calculation.Structure of the industryThere are 42 registered cigarette manufacturers, but only 24 manufacturers are currently producing cigarettes.7The market is dominated by two companies Lakson Tobacco Company (LTC), which is a subsidiary of Phillip Morris supranational (PMI) and Pakistan Tobacco Company (PTC), which is a subsidiary of British American Tobacco (BAT) (Table 2). LTC has gradually increased its market share from 36 percent in 2000 to 47percent in 2007. Small companies this instant produce only about 5 percent of the duty paid domestic cigarettes.Table 2. Market shares of the main tobacco manufacturersManufacturer affiliation20002001200220032004200520062007Lakson Tobacco CompanyPMI35.642.245.747.148.146.846.047.0Pakistan Tobacco CompanyBAT53.947.546.446.546.750.451.048.4Other manufacturersNA10.510.37.96.45.22.83.04.6Source Tobacco Merchants AssociationThe two leading brands are Morven (produced by LTC 37.6 percent market share) and halcyon speckle (produced by PTC 29.5 percent market share), both in the first tier. Along with Embassy and other first tier brands, they account for about 85 percent of the market, with the waiting 15% crock up amidst war rant and third tier brands.Non duty paid illegitimate cigarettes are widely available. The general industry consensus, which is in addition shared by the government, is that such(prenominal) cigarettes account for about 20 percent of all cigarettes interchange in Pakistan and most of them are produced illegally in Pakistan by blue manufacturers active in the North-West Frontier and the Northern Areas.B. IssuesRising Consumption and Declining RevenuesAnnual consumption of cigarettes in Pakistan has increased from 292 cigarettes per capita in 1994 to 406 cigarettes per capita in 2007 (Figure 2). During this same period, tobacco excise revenue has fallen from 0.5 percent of GDP to 0.3 percent. The decline in revenue is primarily due to excise rates not keeping pace with the growth of per capita income, and to adding a new tier in 2001, which trim down the tax on cigarettes in the mid-price range (Figure 3).Figure 2 Per capita consumption of cigarettes and excise revenue as share o f GDPFigure 3 Tax per pack before and after the introduction of the three-tier schema get TaxThe total tax on cigarettes is too low to meet public health objectives. The globe Bank found that in countries with comprehensive tobacco control policies, taxes (excise plus VAT or sales tax) accounts for two-thirds to four-fifths of the retail price of cigarettes.8In Pakistan the three most widely interchange brands have a total tax burden of slightly much than 50 percent (Table 3), well below the World Bank recommended tax burden. Up-market brands such as Gold page number, just fall within the World Bank Standard, with a total tax burden of 68 percent.9Table 3. Total tax on cigarettes for major brands, in 2008 (in PKR per pack)Gold eccentricMorvenEmbassyCapstanGold LeafAEstimated market share (2006)29.5%37.6%6.7%7.8%9.4%BRetail price18.4018.4017.2434.3049.00CVAT (13.8 percent of final retail price)2.542.542.384.746.76DExcise tax7.037.036.3416.4826.61EPre-tax price = B-C-D8.838.838 .5213.0815.63FTotal tax = C+D9.579.578.7221.2233.37GShare of excise = D/B38.2%38.2%36.8%48.0%54.3%HShare of taxes = (C+D)/B52.0%52.0%50.6%61.9%68.1%Ad valorem vs. Specific everywhere the period 1986-2007, countries within the Asia Pacific region have been switching from ad valorem excises or ad valorem and specific excises on cigarettes to specific excises.10Currently, 19 of the 27 countries in the Asia Pacific region impose specific excises on cigarettes,11 approximately of which adjust taxes for inflation on a mandated regular basis. Seven of these countries (Australia, Hong Kong, Macau, Mongolia, red-hot Zealand, Singapore, and Taiwan) impose a single specific rate that is, there are no tiers.12Four countries impose only ad valorem rates on cigarettes,13and four countries (including Pakistan) impose both specific and ad valorem rates.14A well-knit case can be made for Pakistan adopting a specific tax regime for excising cigarettesIf a primary purpose of the cigarette excise-in addition to nip and tuck revenue-is to discourage consumption, the tax should be levied on the number of cigarettes (or packs of cigarettes) consumed.Specific excises check into brand switching to cheaper cigarettes and thus are more effective in reducing smoking prevalence. In contrast, ad valorem excises, all other things equal, lead to a greater spread in prices amongst cheaper and higher-priced cigarettes. This, in turn, leads to greater potential for switching to cheaper cigarettes when excise rates are increased. Keeping all cheap cigarette on a specific regime is so key to the success of the proposed tax change.Ad valorem rates may march on price wars, as the government shares in any price reduction.15In contrast, when the rate is specific, the amount of excise paid is not trim when prices are cut.16Specific excises are as well as easier to administer because it is only necessary to determine the physical quantity of the product taxed, and not necessary to determine its value.17International experience suggests that ad valorem taxes may keep pace with inflation ameliorate than specific taxes, even specific taxes that are adjusted fairly frequently, and because of this, some experts favor ad valorem excises. To avoid this problem, specific excises should be adjusted each year automatically (i.e., by an administrative order, which does not require a decision by an executive agency or approval by a legislative body).Pernicious effect of the second tierSince the three-tier intent was adopted in 2001, there have been annual valuation reserves, except in 2003 when inflation was quite low, to the first-tier specific rate and in the price brackets between the tiers (Table 4). In 2002, the large real increase in the specific rate and the bracket between the first and second tiers lowered the tax on mid-priced cigarettes, as explained further below. Since then, the annual adjustments until 2008 have lagged the increase in the CPI, which has reduced t he inflation-adjusted tax on low-priced cigarettes. In addition, the tax on mid-priced cigarettes act to fall in nominal (and inflation-adjusted) terms.Table 4. Annual adjustments of the specific excise rate and bracketsDate of AdjustmentPrior Fiscal Year amplification in CPI(In Percent) amplification in the First-Tier Specific Rate(In Percent)Increase in Bracket between First and Second Tiers(In Percent)Increase in Bracket between the Second and Third Tiers(In Percent)June 20023.618.618.6June 20031.9June 20048.58.18.120.0July 20058.77.97.98.3June 20067.67.37.57.7June 20077.06.56.57.1June 200812.313.113.16.7This approach to annually adjusting the excise schedule has the pernicious effect of reducing the tax on cigarettes in the mid-price range. This can be seen by comparing the excise tax per pack for 2007 and 2008 (Figure 4). When the bracket between the first and second tiers was increased to PKR 14.86, the 69 percent incremental rate applies to a smaller portion of the retail p rice. Therefore, the excise on cigarettes priced between PKR 14.86 and PKR 32.00 per pack was reduced. For example, the excise on Capstan, with a retail price before VAT of PKR27.21 per pack, fell from PKR 15.31 to PKR 14.86 per pack.18There does not show up to be a sound tax indemnity or health policy reason for increasing the tax on low-priced cigarettes, glum the tax on mid-price cigarettes, while leaving the tax on dear(predicate) cigarettes unchanged.Figure 4. Tax per pack of 20 cigarettes, before and after the June 2008 changes to the excise tax on tobacco, with pre-June 2008 prices before VATC. A Way forradProposed excise ratesTo reduce consumption, increase government revenue, and simplify the excise regime, Pakistan should return to a two-tier regime similar to what was abandoned in 2001. The specific excise would be increased to PKR 15.00 per pack of 20cigarettes and the price bracket between the first and second tiers would be increased to PKR28.00.19For cigarettes i n the second tier, the excise tax would be 63 percent of the retail price before VAT. Going forward, the specific rate and the price bracket between the first and second tiers would be automatically indexed for inflation.20Under this proposal, over 80 percent of all cigarettes would be subject to the specific excise. Only the higher-priced cigarettes would be subject to the 63 percent ad valorem excise (Figure 5), allowing the government to tap some of the up-market value.Figure 5. Tax per pack in current and proposed tax regime for tobacco exciseAdministrative reformsAs excise tax increases, some consumers exit switch to non duty paid illicit cigarettes, most of which are manufactured domestically. Therefore, a strengthened tax administration is indispensable and it should accompany the reform program. The Federal Excise Act gives the FBR adequate powers to assess and collect excise taxes. However, the critical factor-political will to allow inspectors, with appropriate security for their safety, to access and/or find suspected sites of illicit manufacturing-appears to be lacking.21In this respect, fully implementing the array of measures already included in the Federal Excise Act will be important to reap the full benefits of the tax increase, although scenario analyses in the appendices show that the effect of the proposed tax change on government revenue is big-shouldered to increased smuggling.D. Effects of the ProposalThe proposal increases cigarette prices, reduces consumption, and increases government revenue.Price effectThe incidence of excises and other indirect taxes is principally imitation to be shifted forward to consumers. Manufacturers will raise their prices to cover any increase in excises. Of course, manufacturers may increase prices by more than the tax increase22or less than the tax increase depending on private-enterprise(a) factors, and this possibility is discussed further in accessory 1. The initial assumption is that prices wi ll increase to fully pass done the tax increase.Table 5. Current price per pack and estimated new price per pack below proposed tax regime, assuming full pass-through of the tax increase to consumers*Current pre-VAT price (PKR) novel pre-VAT price (PKR)% ChangeCurrent excise tax per pack (PKR) impudent excise tax per pack (PKR)Embassy14.8623.4057.5%6.3415.00Morven15.8623.8050.1%7.0315.00Gold Flake15.8623.8050.1%7.0315.00Capstan29.5635.2019.1%16.4822.18Gold Leaf42.2442.240.0%26.6126.61Other brandsNA23.40NA6.3415.00* The assumption of full pass-through implies that tobacco manufacturers increase prices to preserve their pre-tax revenues per pack.Some will argue that the excise on low-priced cigarettes must be kept low to protect the low-income consumers from spending more on tobacco. However, because the prevalence rate and ensuing burden of tobacco use is higher among low-income consumers and because these consumers are more sensitive to price, low-income consumers reap maximum ben efit from higher taxes through reduced consumption. Savings are and then generated not only through lower expenditures on tobacco itself but also on related conditions (e.g., hospitalization for cancer) and higher productivity. In addition, many countries also help low-income tobacco users through increased support to cessation programs and crowd together awareness campaigns that are often funded by higher taxes. In this regards, it is draw that governments have more effective ways of helping low-income consumers than providing cheap tobacco products.Although the proposal would result in a sharp increase in the price of cigarettes at the lower end of the market, cigarette prices would nevertheless remain significantly under the level of most countries in the world (Figure 6), and most notably well under the price of popular brands in India.Figure 6. Price of a pack of 20 cigarettes in various countries at purchasing power parity *,+Source WHO. Global Report on the tobacco Epidemi c, 2008. The MPOWER package. World Health Organization. 2008 * All prices are converted to US dollars and adjusted for differences in affordability across countries, hence very high figures for India, for example.+ All figures are based on 2006 data, except for Pakistan (after tax increase), which is based on a price of PKR 23.80, the price of Gold Flake under the proposed tax change.Consumption effectRaising the price of cigarettes relative to other products will encourage consumers to reduce their purchases of cigarettes. It may also encourage consumers to substitute non duty paid illicit cigarettes for duty paid cigarettes. How much consumption is reduced depends on the ginger snap of demand,23which in low- and middle income countries varies widely, but is generally assumed to be around -0.8.24However, there are many reasons to believe that the elasticity of demand is very low in Pakistan. First, tobacco prices are low a pack of Gold Flake costs PKR 114 in India and only PKR 18. 40 in Pakistan ( using the current exchange rate).25Second, the proposed price increase is significant and using a standard point elasticity is likely to overestimate the change in consumption in such a context. Last, comparable countries such as Egypt have price elasticities of around -0.4 or even lower.26For these reasons, Table 6 provides estimated changes in consumption based on an elasticity of -0.4. Appendix 2 assesses the impact of changing the elasticity and of increased illicit consumption on these estimates.27Table 6. Impact of proposed tax regime on sales of cigarettes*Forecasted sales for 2008/09 under current tax regime(million packs of 20 cig.)+Estimated sales for 2008/09 under proposed tax regime(million packs of 20 cig.)% ChangeEmbassy248191-23.0%Morven1,3951,115-20.0%Gold Flake1,094875-20.0%Capstan289267-7.6%Gold Leaf3493490.0%Other brands334257-23.0%Total3,7093,055-17.6%* Assuming 5% growth from the 2007/08 production figures and a -0.4 price elasticity of demand.+ Source Pakistan Economic check up on (production) and Tobacco Merchants Association (market shares for 2006), authors calculation.Revenue effectIncreasing excises on cigarettes would increase government excise revenue by almost 50%, compared to what would be collected under the current tax regime.28Most of the increase is generated by brands at the low-end of the market, because changes in tax per pack mostly occur at that level (Figure 5). This increase in revenue would raise the share of tobacco taxes in the GDP to 0.45%, the same level as in 1993-94, up from 0.28% in 2007-08.29Table 7. Impact of proposed tax regime on excise tax revenue from cigarettesForecasted revenue from tobacco excise tax for 2008/09 under current tax regime (million PKR)Estimated revenue from tobacco excise tax for 2008/09 under proposed tax regime (million PKR)% ChangeEmbassy1,5752,87182.2%Morven9,80416,72970.6%Gold Flake7,69213,12570.6%Capstan4,7685,92624.3%Gold Leaf9,2789,272-0.1%Other brands2,1163,856 82.2%Total35,23351,77947.0%E. ConclusionA strong case can be made for increasing excises on cigarettes. First, cigarettes are inexpensive-the most popular brands cost PKR 18.40 per pack of 20 (USD 0.25). Second, per capita cigarette consumption has been growing, top significant health concerns. Third, the current three-tier regime for excising cigarettes is complex and pernicious. The governments annual adjustment to the rates and brackets increases the excise payable on the low-priced brands but reduces the excise payable on mid-priced brands while leaving the excise payable on high-priced brands unchanged. There is neither a sound health policy reason nor a tax policy reason for this pattern of changes.Pakistan should return to a two-tier regime similar to what was abandoned in 2001. The specific excise would be increased to PKR 15.00 per pack of 20cigarettes and the price bracket between the first and second tiers would be increased to PKR28.00. For cigarettes in the second tier , the excise tax would be 63 percent of the retail price before VAT. Going forward, the specific rate and the bracket between the first and second tiers would be automatically indexed for inflation.Assuming the excise tax is fully passed through to consumers, adoption of this proposal will lead to a 50 percent increase in the price of the most popular brands. Consumption of cigarettes will decline by 18 percent, providing significant health benefits, and the governments revenue from cigarette excises will increase by 47 percent. The forecasted impact of the proposed change is robust to the assumptions used in the model regarding the pass through to consumers of the tax increase, as well as elasticity and the potential impact of smuggling, as present in Appendices 1 and 2.Appendix 1 Sensitivity analysis for pass-through of the tax increase to consumersHow much of the new tax will be passed through to consumers by the tobacco manufacturers will determine the new market prices and the refore consumption levels, hence an impact on government revenue. The proposal assumes pass-through of 1, i.e., the whole tax increase is passed through to consumers in the form of higher prices. In this appendix, five more pass-through scenarios are assessed. It is first assumed that manufacturers cannot pass the completed tax increase to consumers, hence pass-through of 0.75 and 0.90. Next, it is assumed that manufacturers pass-through more than the tax increase, as was the case with Capstan in 2008. Three more pass-through are therefore time-tested 1.10, 1.25, and 1.40. The impact on government revenue and consumption is calculated in Table A1.1Table A1.1 Impact on consumption and government revenue of various pass-through scenarios*Pass-throughImpact on consumption (%)Increase in government revenuefrom excise on cigarettes (%)0.75-13.253.40.90-15.949.61.00-17.647.01.10-19.444.41.25-22.140.51.40-24.836.6* The base case scenario is highlighted.The impact of the pass-through rat e on consumption is quite limited, with a difference of 10 helping points between the two extreme scenarios. The increase in government revenue also is not very sensitive to higher pass-through rate. The same applies to a less than unity pass-through rate, as the smaller reduction in price results in a smaller reduction in consumption than in t