A parallel economy depriving the state of billions

On May 26, 2020 Last updated Oct 4, 2021

Counterfeit cigarettes are to be burnt to generate electricity at an incineration power plant in Xuchang city, central Chinas Henan province, 13 March 2015. The Tobacco Monopoly Bureau of Xuchang county, Henan province reportedly delivered a total of 447 cartons of counterfeit cigarettes to an incineration power plant to generate electricity on March 13. According to China News, the fake cigarettes, including some 50 different brands, were seized during 2014. Workers at the incineration power plant were seen offloading cartons from several trucks and preparing them to be burned. The fake cigarettes were eventually burned at the power plant, generating over 10,000 kWh of electricity.

By Zahid Hussain Khan

A parallel economy is one that runs opposite to a formal or official economy. In a parallel economy, the goods and services produced are not brought under the tax net hence the government tends to be the loser at the end of the day.

Imagine this, there are a sum total of 10 automobile manufacturers in a country who pay Rs300bn in taxes. However, one comes to know that these are not the only automobile manufacturers in the country. There are 20 more but neither are they documented nor are their goods being taxed. Hence, while these manufacturers may earn in the billions for doing business in the country, the government and the masses, at the end of the day, are the losers are they are bereft of billions in taxes.

Hence, one may ask, wherein lies the solution? What must a government do (or equally important, not do) in such a situation? Take the example of Pakistan. The country’s already battered economy is currently reeling from the COVID-19 outbreak that has shuttered shopping malls, small and large businesses and dealt a blow to the employment of thousands across the country.

Prime Minister Imran Khan, in a bid to mitigate the loss felt by the country’s huge lower-middle class, has set up a Coronavirus Relief Fund. Though the fund, as per government estimates, has amassed Rs4bn rupees, a larger amount of money can be deposited in the national kitty in such trying times. By bringing illegal businesses under the tax net.

Take, for instance, the cigarette manufacturers in Pakistan. According to news reports, cigarette manufacturers in Pakistan contribute a whopping R115bn rupees in taxes, out of which Rs113.5bn are paid by two multinational companies.

The market share of these multinational cigarette manufacturing companies, who are law-abiding entities that pay their share of the annual taxes for doing business in Pakistan, currently stands at roughly 60%.

On the other hand, there are several local cigarette manufacturing brands that have captured an astounding 40% of the market share. However, in the 2019-2020 tax year, they contributed only Rs1.5bn in taxes. Which roughly accounts for 2% of the taxes from the tobacco industry. The FBR and other relevant authorities have estimated that by not bringing these local cigarette manufacturers under the tax net, the government is losing out on an estimated Rs45bn per year.

If the government wants to improve the tax revenue from the tobacco industry, the Ministry of National Health Services, Regulations and Coordination with the help of the FBR will have to take appropriate measures to check daily consumption of approximately 64 million illicit cigarettes in Pakistan, reflecting serious violations of health laws/rules and regulations by the ‘illicit’ industry.

These illicit cigarette manufacturers are not only evading taxes and as a result, depriving the country from billions of rupees in revenue, but are also violating other regulations put in place by the government of Pakistan.

For example, the government of Pakistan has set a minimum price of a packet containing 20 cigarettes and that is Rs62.76. No cigarette brand is allowed to sell a packet of cigarettes below this minimum selling price. However, seven illicit cigarette manufacturing brands are selling their products in the price range of Rs20-50 per packet.

Furthermore these illicit manufacturers violate other health laws such as advertising, targeting youth, monetary incentives and lucky draws etc. all of which are prohibited under the law of Pakistan. Hence, it is of the utmost importance that the government initiate a crackdown against such elements that are brazenly flouting laws in Pakistan and depriving the country of billions of rupees in tax money.

On the other hand, let’s talk a little about what the government should not do. With the economy in shambles and the government looking to collect additional revenue, it would be unfair and unfortunate if the authorities decide to levy additional taxes on law-abiding cigarette manufacturers who have been paying taxes in the billions to the government. This will not be beneficial for business and also, for the government as well. Here is how.

For one, levying more taxes on business enterprises that are already playing by the rules would seem more like a punishment than an encouragement. It makes no sense. Secondly, if the government were to levy more taxes on these legal entities operating within the ambit of the law, the demand for cigarette smoking will not decrease, contrary to public and the government’s opinion.

In a market where you have comparatively cheaper cigarettes as substitutes, the consumers will shift to the local, illicit brands because those cigarettes cost low. Hence, this will not achieve the government’s aim of reducing smoking in the country. Rather, it would shift consumers to those brands that are already not paying any taxes to the government.

Hence, it is high time that the government bring these illicit cigarette manufacturers under the tax net so that Pakistan can benefit from billions in taxes at a time when its economy and its people need it the most.