Revisit the tax treatment of tobacco products

Source– The post is based on the article “Revisit the tax treatment of tobacco products” published in The Hindu on 30th January 2023.

Syllabus: GS3- Indian economy and mobilisation of resources

Relevance– Taxation of products that generates negative externalities

News– The article explains issues with taxation structure on tobacco products

In 2017, the economic burden and health-care expenses due to tobacco amounted to ₹2,340 billion, or 1.4% of GDP. But, India’s average annual tobacco tax revenue stands at only ₹537.5 billion.

Tobacco use is also the cause for nearly 3,500 deaths in India every day. It impacts human capital and GDP growth in a negative way.

What are features of current taxation structure that are hindering efforts in regulating consumption of tobacco products?

One issue is the overuse of ad valorem taxes, which are not effective in reducing consumption. The GST system in India relies more on ad valorem taxes than the pre-GST system, which primarily used specific excise taxes.

In India, the share of central excise duty in total tobacco taxes decreased substantially from pre-GST to post-GST. It decreased for cigarettes from 54% to 8%, for bidis from17% to 1%.

A large part of the compensation cess as well as the National Calamity Contingent Duty currently applied on tobacco products is specific. If specific taxes are not revised regularly to adjust for the inflation, they lose their value.

There is a large discrepancy in taxation between tobacco products. Despite cigarettes accounting for only 15% of tobacco users, they generate 80% or more of tobacco taxes. Bidis and smokeless tobacco have low taxes.

Bidis are the only tobacco products without a compensation cess under GST.

The current six-tiered tax structure for cigarettes is complex. It creates opportunities for cigarette companies to avoid taxes legally by manipulating cigarette lengths and filters for similarly named brands.

The GST rates on certain smokeless tobacco ingredients such as tobacco leaves, tendu leaves, betel leaves, areca nuts have either zero or 5%-18% GST.

Smokeless tobacco products in India are taxed ineffectively due to their small retail pack size which keeps the price low.

GST currently exempts small businesses with less than ₹40 lakh annual turnover. Many smokeless tobacco and bidi manufacturers operate in the informal sector, which reduces the tax base on these products.

What is the way forward for effective taxation on tobacco products?

Inflation indexing should be made mandatory for any specific tax rates applied on tobacco products.

Taxes should be made more consistent across all tobacco products. The main principle behind tobacco taxation should be in protecting public health.

The tiered taxation system on cigarettes should be eliminated or reduced to two tiers, which can then be phased out over time to have a single tier.

It is important that all products that are exclusively used for tobacco making are brought under the uniform 28% GST slab.

The mandatory standardised packing should be implemented for smokeless tobacco pouches. This will also make it easier to implement graphic health warnings on the packaging.

The GST related exemptions should not be extended to businesses that produce or distribute tobacco products. Conditions should be imposed on these exemptions so that tobacco businesses do not benefit from them.