To see why Pakistan’s revenues are in such bad shape, take a look at which cigarettes are flying off the shelves.
Local brands are starting to take away market share from rivals marketed by British American Tobacco Plc and Phillip Morris International Inc. The reason is simple: They cost less than the 36-rupee ($0.34) tax imposed on a legitimate pack of cigarettes.
“There is massive tax evasion,” said Haroon Akhtar Khan, a special assistant to Prime Minister Nawaz Sharif on revenue. “We have raided retailers and put up banners at different places, warning sellers of arrests. Now the pressure is going to increase.”
Sharif raised taxes late last year on cigarettes and other consumer goods in a bid to meet revenue targets tied to an International Monetary Fund loan. The central bank said in January that more effective tax enforcement is crucial to lowering the budget deficit to 4.3 percent of gross domestic product this fiscal year, from 5.37 percent in the previous 12 months.
Yet there are signs that isn’t happening: Higher taxes and lax enforcement are fueling a growing black market. Sales of illicit cigarettes cost Pakistan more than 24 billion rupees in taxes in 2014, according to market research company Nielsen.
“Excessive tax increases over the years have led to huge price increases way above the affordability of the consumer, who in turn opts for cheaper alternatives from tax evaders,” said Sekar Menon, regional director for corporate affairs at Philip Morris International, which makes Marlboro. “Unless this issue is addressed to create a level playing field, the long term sustainability of the legitimate tobacco industry may be at risk.”
Philip Morris Pakistan Ltd. has posted losses over the past four years. British American Tobacco’s local unit reported lower volumes last year, citing declining market share due to the illicit trade.
Taxes accounted for about 61 percent of a pack of cigarettes in Pakistan in 2014 even before the latest increases, according to the World Health Organization. This compares with 60 percent in India, 43 percent in the U.S. and 82 percent in Turkey and the UK.
A uniform tax accounting for about 70 percent of the cigarette price could reduce consumption by 7.5 percent and boost Pakistan’s tax revenue by about 27 billion rupees, according to a 2014 report on tobacco taxation funded by Bloomberg Philanthropies and the Bill and Melinda Gates Foundation. Bloomberg Philanthropies is controlled by Michael Bloomberg, the majority shareholder of Bloomberg LP, owner of Bloomberg News.
Applying tax stamps to tobacco products, which provides documentation that taxes have been paid, is an important tool to combat illicit trade, according to a paper published last year by the U.S. Centers for Disease Control and Prevention.
However that’s easier said than done. Pakistan’s tax-to-GDP ratio worsened slightly over the decade through 2012, picking up in 2013 only after Sharif was elected and won a loan from the International Monetary Fund. Less than 1 percent of citizens pay income taxes, according to the government.
“Pakistan can’t regulate medicines, doing it for cigarettes are much more difficult,” said Faisal Bari, associate professor of economics at Lahore University of Management Sciences. “The state lacks the ability to enforce.”
Rafaqat Abbasi, a taxi driver, says he switched to a cheaper cigarette brand about three years ago. If the government cracks down, he’ll opt for chewing tobacco or some other similar stimulant for his daily fix, he said.
“It’s not my headache if they don’t pay tax,” he said. “The government should be worried about it.”