A study by Ficci Cascade (Committee Against Smuggling and Counterfeiting Activities Destroying the Economy) has revealed the magnitude of illicit trade to be far beyond the common perception. For seven products - alcoholic beverages, auto components, computer hardware, FMCG packaged foods, FMCG personal goods, mobile phones and tobacco products - the supply of unaccounted and untaxed goods increased by 44.4 per cent between 2012 and 2014. As a result, genuine producers collectively suffered a loss of Rs 32,412 crore, while the government's loss in tax revenue went up by Rs 13,049 crore.The maximum loss was that of the tobacco sector - a staggering Rs 9,139 crore in 2014. The expert committee estimates that the share of the grey market in tobacco products grew from 15.7 per cent to 20.2 per cent in these two years.
What incentivises rapid growth in grey markets is high tax rates, a point that policy-makers miss. Additionally, consumers suffer when supplied with spurious and substandard goods manufactured in unhygienic conditions. So far, the government has not been able to strike the right balance between tax revenue targets and the consumer interest. The roll-out of the goods and services tax (GST) offers an opportunity to rectify tax anomalies and set right the imbalance.
Take tobacco as an example. In the 1950s, tobacco products (including cigarettes) in India used to be subjected to central levy in the form of excise duty, state levy in the form of sales tax and other levies like octroi. A taxation enquiry commission headed by Dr John Mathai - independent India's second finance minister - suggested the need for coordination between the central, state and local bodies for taxes. Subsequently, at the National Development Council meeting held in December 1956, the Centre and the states mutually resolved to replace sales tax with additional excise duty (AED) on tobacco products, to be collected by the Centre and distributed by the states. Accordingly, the AED Act was enacted and became effective from April 1958. The practice of levying AED continued until March 2006.
Until February 1987, cigarettes were taxed under an ad valorem excise structure. This turned out to be flawed and, recognising the inherent problems with this structure, a length-based, specific-duty structure was introduced in 1987. This new structure catered to India's wide income distribution through multiple length slabs, providing consumers with alternative price options based on their ability to spend, and eliminated valuation disputes and litigation.
The Luxury Tax Act was instituted in Maharashtra in 1987, imposing luxury tax on various kinds of tobacco products including cigarettes, cigars, cheroots, snuff, pan masala and gutka. The tax was later adopted by several other states. A mindset had developed that cigarettes, cigars, etc, are luxury products, which today has been well established as a misconception. In 2005, following an order of the Supreme Court, tobacco products were removed from the list of luxury goods.
While finalising GST rates, the government has a rare opportunity to create a level playing field. It is clearly a game changer and provides a historic opportunity for removing distortions and infirmities in tobacco taxation and facilitating the broader national tobacco control policies. Policymakers have to think out of the box and not follow the beaten track. Such opportunities are rare and should not be missed.
While tobacco consumption in India went up from 406 million kg in 1981-82 to 562 million kg in 2014-15, the consumption of cigarettes declined from 21 per cent to 11 per cent of overall tobacco. Of this, about 68 per cent remains untaxed due to evasion and the narrow tax base. Cigarettes constitute only 11 per cent of the tobacco industry, but 85 per cent of tobacco taxes. The current practice in effect means that there is no tax on tobacco, as only the smallest segment - cigarettes - is taxed. This is against tobacco taxation goals, and the health agenda of the government. Due to high taxes, consumption has shifted to cheaper illegitimate products, causing loss of revenue to the government and posing a greater health risk to consumers. This is contrary to two key government priorities - protect tax revenue and protect citizens' health.
A World Health Organisation study shows that cigarette taxes as a percentage of per capita GDP are very high in India. In fact, taxes in India are 14 times higher than in the US, seven times higher than in China and five times higher than in Australia. As a result of the contraband trade, India has become the fourth largest market for illicit cigarettes in the world.
There is another danger from cigarette smuggling - it is used to finance terrorist activities. "Terrorist financing through cigarette smuggling is huge," says Louise Shelly, a transnational crime expert at George Mason University, and an adviser to the World Economic Forum on illicit trade. It is estimated that one in every three cigarettes exported worldwide is sold on the black market. The seizure figures obtained by Ficci Cascade from official sources reveal a huge rise in smuggling of cigarettes in the last two years. The menace of cigarette smuggling has its roots in high rates of taxation.
A key priority for GST should be to bring the current 68 per cent of untaxed tobacco under the tax net. Even if 50 per cent of this is realised, it will yield new tax revenue of over Rs 16,000 crore. Additionally, tax arbitrage opportunities must be eliminated to combat illicit trade and the revenue neutrality of tobacco taxes should be maintained. The resulting equitable taxation structure on tobacco will certainly ensure sustainable revenue buoyancy as we move ahead. Further, since tobacco and tobacco products will be taxed under Central Excise in addition to GST, the incidence of Excise Duty plus GST has to be revenue-neutral. Also, the GST levy on all tobacco products should be at a standard rate applicable to the general category of goods, and there has to be continued availability of Cenvat Credit of the central excise duty paid on intermediate tobacco products.
Policy-makers in the past have considered cigarettes a luxury item. It is unfair to single out cigarettes, since tobacco in any form is harmful. There must be uniformity in tobacco taxation to achieve the objective of controlling the menace of tobacco consumption in India. Taking any other view would not be in the wider public interest, and will be inconsistent with the stated objective of widening the tax base.
The writer is former chairman, Central Board of Excise and Customs, and advisor, Ficci Cascade
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
