By  Michelle Cherian

Edited by Anandita Malhotra, Senior Editor, The Indian Economist

Prime Minister Modi’s Budget was appreciated for many reasons, one among them being the hike in the prices of cigarettes and other tobacco products, as this measure was expected to put an end or at least work towards ending the new system of bondage that exists in the Indian society, the bondage of tobacco addiction. India ranks second after China in tobacco consumption, with the statistic being as notoriously large as 120 million people, and this for one, is not an achievement India needs to maintain.

Excise duty on cigarettes was increased by 22% in 2012-2013 and further an additional 18% in the last fiscal. Falling share prices and a rising illegal trade of cigarettes compelled cigarette manufacturers to file petitions with the finance ministry, asking (which is a euphemism for pleading) for a reduction in the existing duty of ₹669 per thousand cigarettes to ₹200 per thousand cigarettes. This particular development surfaced during the Congress rule last year. However, in the run up to the national elections, such pleas were rendered insignificant and with the Modi Government interested in promoting its motto of ‘out with the old and on with the new’, it did little to put the tobacco manufacturers’ minds at rest; in fact it did just the opposite. Modi’s and Union Health Minister, Harsh Vardhan’s vehement desire to champion the cause of reducing tobacco consumption, led to the duty on cigarettes escalating to an unimaginable and an unthinkable 72%.

Statistics confirm that there is very poor causation between higher cigarette duties and the desirable reduction in consumption. Even, the expected increase in government revenue, falls well below expectations. One might wonder why this happens, given that the demand postulate of economics, claims that a rise in price of a commodity leads to a fall in demand of that commodity, ceteris paribus (all other things remaining constant). Demand does fall, with a noticeable swiftness and ease in case of normal goods than in the case of cigarettes and other tobacco products, because of the inelastic demand for cigarettes. In other words, a change in the price of commodities like tobacco has a very small change in the quantity demanded of the commodity. In the case of tobacco, the possibility of addiction has to be factored in and owing to this factor, a rise in the price of cigarettes does not translate into an immediate fall in consumption as people will continue to try and satisfy their demand by substituting other non-necessity goods for cigarettes. Over time, with better information systems in place, better awareness and more substitutes for cigarettes available, people start shifting away from the consumption of cigarettes.

In India, however, the change in consumption patterns of cigarettes has more to do with the different categories of cigarettes and their different pricing strategies as well as the extremely complex tax structure designed for these products, than with the laws of economics. There exist five different sizes of cigarettes (< 65mm, 65-70mm, 70-75mm, 75-85mm, >85mm) and all these varying sizes have different amounts of duties levied on them. The amount of the duty is directly proportional to the size of the cigarette, implying the highest duty on the longest cigarettes. Thus, manufacturers have started shying away from the production of longer cigarettes and have increased substantially their production of the sub-65mm type to escape the burden of taxation. In addition to the differential taxation system within the cigarettes segment, India also has an inconsistent taxation regime among various tobacco products. Historically, beedis have been charged a lower duty than their counterparts, which explains the dismal market share of 12% in case of cigarettes and a relatively higher 35-40% market share in case of beedis. What this means in demand terms is that when the duty on cigarettes gets hiked, people start moving from the consumption of cigarettes to beedis which is a cheaper alternative, hence the marked difference in the market shares of the two segments (as of 2014). A study of the other interesting features of the taxation of tobacco products in India, bring to light the fact that handmade beedis are taxed lower than machine-made ones (while the tax on handmade beedis is Rs.12 per 1000 sticks, it is Rs. 30 per 1000 sticks for the machine made beedis) and that beedi manufaturers are exempted from paying tax, in case their annual production does not reach the 2-million mark.

Therefore, the outsourcing of the beedi industry to the households resulting in around 98% of the beedis in the market being handmade, and the 2010 International Union against Tuberculosis and Lung Disease report which states that “52 per cent to 70 per cent of all beedis consumed in India have no taxes paid either due to non-compliance or because the manufacturers supposedly produce less than two million beedis per year”, does not come as a surprise.

The consumption of tobacco hardly declines, despite the imposition of sin taxes, because people substitute cigarettes for inexpensive tobacco products which have inconsequential duties or because within the cigarettes segment, they begin consuming the cheaper (and, smaller) kind. Moreover, such enormously high amounts of duties, leads to the unwelcome development of a black market in cigarettes. Such a market thrives in India and has captured about 19% of the total cigarette trade, causing a loss of around ₹6000 crores to the national exchequer. According to ITC Ltd. Chief Executive, Sanjiv Puri, “Legal cigarettes comprise only 12% of tobacco consumed, down from 21% three decades back, but they pay 85 % of tobacco taxes.”

In spite of high taxes, why government revenues have not been rising at the same pace, is a matter of deep concern. The slow but steady siphoning off of revenues by the black market in place and the fact that taxes on cigarettes are not linked to income growth and inflation, have made the government revenues suffer a mighty blow. Though the Laffer curve (which highlights the relationship between tax rate and tax revenue) for tobacco products is still showing a positive slope, the slope is increasing at a diminishing rate and might soon decline.

In order to increase government revenue from sin taxes and possibly reduce consumption of these products, some measures are in order. Firstly, the taxation of tobacco products should be completely revised, establishing consistency among cigarettes and across tobacco products. Secondly, the ad valorem tax on beedis should be replaced by specific taxes so that the tax cannot be diminished by slashing prices and so that the beedi consumption can be brought down effectively. In extension to this, the skewed legislation that allows for the exemption of tax payment, if lesser than two million beedis are produced annually, needs to be scrapped. Thirdly, the taxation on tobacco should be made progressive and be adjusted for inflation so that their real prices rise before the income does, as a result of the inflation.

Every year, more than a million people die due to tobacco-induced cancers in India. According to the National Family Health Survey (2005-2006), tobacco use is more prevalent among men, rural population, illiterates, poor and vulnerable section of the society. Other renowned studies suggest, nearly 23.7% of the deaths among men and 5.7% of the deaths among women, aged 35-69 years are due to tobacco-attributable illnesses. The taxes on tobacco products are introduced with the noble intention of reducing its consumption and by extension, the incidence of cancer, but these measures are not very successful. The estimated total cost of tobacco use in India in 2004, that is, the cost of treating tobacco induced diseases was $1.7 billion, which is 16% more than the total excise tax revenues collected from all tobacco products in the financial year 2003-04; a trend which has unfortunately remained unchanged. Thus, taxes may prevent initiation but they fail to have the desired effect on the seasoned users and hence, are unable to eliminate completely, the threat of cancer.

If we forgo our economic sense for a while then, the disquieting realisation that more than government revenue, tobacco addiction is costing us lives, will be something that we can decide to stomach silently or actively work against. Concerted measures by the Government, consumers and producers are now the need of the hour, otherwise our taxing tobacco troubles will never be a thing of the past.

Michelle is a student of Economics at St.Stephen’s College, Delhi. She is an ardent writer and takes pleasure in writing on various topical issues such as Economics, politics and world affairs. Development Economics is her region of interest and being an idealist as well as a realist, is convinced that through dedication, hard work and foresight, she can help India achieve great highs, economically and otherwise. Her greatest strength is that she believes in herself and she ascribes her achievements to her family and friends.

Posted by The Indian Economist | For the Curious Mind