Punitive taxation, extreme tobacco control regulations fuel growth in illegal cigarette trade in India

Excise duty on legal cigarette industry has doubled in the last four years and has impacted the legal industry as well as provided a huge arbitrage opportunity to illegal operators

The combined effect of high and discriminatory central and state level taxation has impacted the legal cigarette industry, sub-optimised government’s revenue collection and provided a huge fillip to the illegal cigarette trade in the country.

The escalating excise duty burden on legal cigarettes has almost doubled in the last four years as a consequence of successive increases in Union Budgets since 2012/13. In addition, cigarettes continue to attract very high rates of VAT and other state level taxes. In addition, extreme regulations such as graphic health warnings provide further encouragement to the illegal cigarette trade in India, as illegal cigarettes do not comply with tobacco control regulation of the government.

According to Euromonitor International, a renowned global research organisation, India is now the fifth largest illegal cigarette market in the world. In fact, the overall market for illegal cigarettes in India (comprising international smuggled and domestically manufactured tax evaded cigarettes) is now estimated at one-fifth of the cigarette industry resulting in a huge revenue loss of more than Rs 7,000 crores to the national exchequer.

The tobacco consumption pattern in India is unique in that only 12 per cent of total tobacco is consumed in the form of legal cigarettes. The balance 88 per cent is consumed in other forms of tobacco consumption and illegal cigarettes. This is unlike western countries, where cigarettes are the dominant form (>90 per cent) of consumption.

The legal cigarette industry in India is in the organised sector, is licensed and is completely compliant with all tobacco control and other regulations while the bulk of tobacco consumed is largely produced in the unorganised sector where compliance and enforcement are extremely difficult. This large unorganised sector, representing two-third of the tobacco industry, pays little tax either due to tax exemptions or evasion. The products from this sector are cheaper, have little statutory oversight and do not comply with regulations.

Legal cigarettes contribute the majority 85 per cent of the revenue from tobacco despite their very small share (just 12 per cent) of total tobacco consumption in the country. The reason for this distorted pattern of revenue collections is that cigarettes are subjected to high and discriminatory rates of taxation, as compared to other tobacco products.

Consequently, over the last three decades, the legal cigarettes’ share of total tobacco consumption in India has declined from 21 per cent in 1981/82 to 12 per cent currently. During the same period the overall tobacco consumption in the country has increased by 42 per cent. This drop in legal cigarettes is reflected in the shift to the illegal cigarette and the unorganised sectors of the industry.

Extremely high tax rates on cigarettes provide a profitable opportunity for tax evasion by illegal trade in both international smuggled and domestic tax evaded cigarettes.

Domestic tax-evaded illegal cigarettes are a significant proportion of illegal trade in the country. Unscrupulous operators, taking advantage of the lacuna in the I(D&R)Act, 1951 have set up manufacturing units without compulsory licensing. Cigarettes from these units are available in the market at Re.1 per stick which is even lower than the tax applicable on such cigarettes.

However, the sharp increases in duty rates has rendered the legal cigarette industry without a counter to these Re.1 illegal products as the cheapest legal cigarette possible is now priced three times the price of these illegal tax evaded cigarettes. This has put the legal cigarette industry at a severe disadvantage while enabling a much higher arbitrage opportunity to the illegal operators.

Illegal cigarettes are readily available at marketplaces, paan shops and hawkers’ stalls across the country. Indeed, cigarette sellers prefer to stock these brands as their low prices ensure higher trade margins. Illegal cigarette trade seriously undermines the social objectives of tobacco control as it not only makes available tobacco products at extremely low prices but also products that are of suspect quality, manufactured under unhygienic conditions.

By not adhering to regulations such as the graphic warnings, illegal cigarettes undermine the tobacco control policies of the government and deliberately create the impression that these products are safer. In the absence of mandated warnings and other statutory requirements on packaging Illegal cigarettes are easily identifiable at selling outlets.

Since contraband cigarettes do not use local tobaccos trade in such products impacts the livelihood of tobacco farmers in the country as demand for domestic tobaccos reduces.

Another dangerous outcome of the increasing illegal trade is that it encourages the entry of organised criminal syndicates, which could have serious consequences for the maintenance of law and order. Internationally, it has been reported that illegal profits from cigarette smuggling have been used to fund criminal activities.

The trade in illegal cigarettes in India is growing rapidly. This clearly demonstrates that extreme regulations and discriminatory taxation policy against cigarettes does not decrease overall tobacco consumption. It simply catalyses the growth of the illegal cigarette trade, and compels people to switch to cheaper illegal cigarettes or low quality, cheaper forms of tobacco consumption.

There is therefore, an urgent need to have a moderated view on tobacco regulation, an equitable and moderate taxation policy and to create resistance and public awareness against illegal cigarette trade and for the government to ensure stricter surveillance and harsher penalties against illegal operators.