GST regime should tax cigarettes more

An ideal standard rate for the Goods and Services Tax (GST) is still being hotly debated in policy circles. However, it is important to know whether this standard rate will be applied to all goods and services, including demerit goods such as cigarettes.

The economic costs attributed to tobacco related diseases amounted to ₹1,045 billion in 2011, according to a report by the ministry of health. Nearly a million deaths per year are also attributed to tobacco use in India.

The committee on possible tax rates under GST headed by the Chief Economic Advisor Arvind Subramanian had proposed a structure of rates under GST in its report in December 2015. It suggested a standard GST rate for most goods and services (16.9-18.9 per cent), a low rate (12 per cent) for certain necessary commodities, and a higher rate (40 per cent) for sin/demerit products.

While there is enough consensus that demerit goods like cigarettes need to be taxed high, there is hardly any consensus on how high that should be.

In order to understand this, it is important to demystify a seemingly high demerit rate of 40 per cent. The proposed 40 per cent is a statutory rate which is calculated before this rate is included in the final retail price.

Once applied, and calculated as a percentage of final retail price, the inclusive rate becomes only 28.6 per cent, that is, a seemingly high rate of 40 per cent GST is merely a 28.6 per cent inclusive rate or tax burden.

Article 6 of the World Health Organization (WHO) Framework Convention of Tobacco Control, which 180 countries have ratified, including India, recommends parties to implement “tax policies and, where appropriate, price policies, on tobacco products so as to contribute to the health objectives aimed at reducing tobacco consumption”. It thereby, acknowledges that tobacco taxes are an effective instrument to reduce tobacco use.

The WHO technical manual on tobacco tax administration recommends that tobacco excise taxes account for at least 70 per cent of the retail price. It is clear that the proposed 40 per cent GST is not even near half that rate.

India, currently has a complex system of indirect taxation on cigarettes. The excise tax on cigarettes is applied based on the length of cigarettes as well as the presence of a filter tip, leading to six excise tax slabs at present.

In FY 2015-16 the average excise from all slabs was ₹22.9 per pack of 10 cigarettes. The statutory VAT rates on sales, on the other hand, varies from a low of 13.5 per cent in Assam to 45 per cent in States like UP and Rajasthan with the average rate being approximately 30 per cent, which translates to an inclusive rate of 23.1 per cent.

The average retail price of a pack of 10 cigarettes in the year 2016 is ₹70.6 according to data from Euromonitor. Hence, the excise burden is approximately 32.3 per cent and the total tax burden is 55.4 per cent in the FY 2015-16.

Cigarettes being a highly demerit product, it is important that its post-GST tax burden remains at least as much as it is today, if not more. If GST were to be implemented today at a rate of 40 per cent for cigarettes, there needs to be at least an additional ₹1902 of excise tax per 1,000 sticks in order to maintain the current tax burden and tax revenue from cigarettes intact.

The calculation is simple: 88.1 billion cigarettes were sold in 2015, with an average retail prices of ₹ 70.6 per pack and a total tax burden of 55.4 per cent, generating a total excise tax revenue of ₹ 202 billion and VAT revenue of ₹144 billion, totalling ₹346 billion in FY 2015-16.

If the GST is 40 per cent, for the same final retail price and quantity of consumption, it would generate a GST revenue of ₹178.6 billion requiring an additional excise of ₹1902 per 1,000 sticks to maintain the total tax revenue intact. Given that there is annual inflation, and the GST is expected to be rolled out only by the FY 2017-18, the required excise taxes to maintain an inflation adjusted revenue from the current levels, would be ₹2,257 per 1,000 sticks on top of a 40 per cent GST. This would only replace the current tax burden of 55 per cent.

Tax rates on cigarettes shouldn’t be any lower than this when the GST is rolled out. Else, it poses huge risks to public health while digging a hole on the tax revenue from cigarettes which contributes more than 80 per cent of the excise revenue from all tobacco in India.

Since GST is an opportunity to overhaul the indirect tax system, it is also important to use this opportunity to eliminate the different slabs and impose a uniform specific excise tax rate on all cigarettes, regardless of their length or other characteristics. This is because, previous experience shows this complex tax structure works to the advantage of cigarette manufactures by facilitating legal manipulation of the system while preserving their customer base in the event of a tax increase.

When the GST Council meets to recommend a rate its overwhelming objective may be to find a revenue neutral rate that is applied to all goods and services, without compromising the fiscal position of either the central or the State governments. Hence, it is important to keep in mind that cigarettes being a major source of indirect tax revenue, a high demerit GST rate coupled with a uniform excise higher than the existing average excise rates should be applied to cigarettes. This will ease the pressure on the standard GST rate that may be applied to essential goods and services, besides actively discouraging cigarette consumption.

The writer is an assistant professor of economics, IIT-Jodhpur