BACKGROUND: Tobacco taxation is a key policy tool to reduce consumption globally. In Pakistan, policymakers have not fully tapped the potential of cigarette taxation due to tax collection inefficiencies. The Federal Board of Revenue relied on manufacturers' self-declaration of production until 2022, when they began implementing a track and trace system. Without an effective system, there is an opportunity for under-reporting production to evade taxes. This study quantifies under-reporting of cigarette production and assesses tax evasion by the manufacturing industry.
METHODS: To calculate under-reported cigarette production, a three-step methodology was used. First, a database was constructed from the financial statements of three companies listed on the Pakistan Stock Exchange with over 88% of the market share. The data was supplemented by other secondary sources to include price indices and other macroeconomic variables. Second, a theoretically consistent production function was estimated using this database. Third, annual production values were computed and converted into cigarette stick numbers. Subsequently, the magnitude of under-reported cigarettes was determined by the difference between reported and estimated production.
RESULTS: The estimates suggest that the three listed firms under-reported the production of more than 12.8 billion cigarette sticks from 2018-19 to 2020-21, translating to an average of 8.1% under-reporting, which resulted in an estimated tax evasion of PKR29.5 billion during the three years.
CONCLUSIONS: The analysis provides evidence of a significant level of under-reporting of cigarette production by the firms in the absence of a track and trace system, which has caused a substantive revenue loss to the national exchequer. Moreover, a mix of reported and under-reported production permits the industry more flexibility in pricing so that they can charge less if they choose to attract or retain customers. While the analysis is limited to Pakistan, its implications can be used to highlight the significance of track and trace in other countries.