Regressive policies reverse revenue potential

By Ajith Perera 

Last week the Ceylon Tobacco Company made public its results for 2017, which showed Government earnings from the company rise to Rs. 117.3 billion from Rs. 98.3 billion in 2016, buffered by the imposition of Value Added Tax. 

Whilst we rejoice at the enhanced revenue to the State at a time of need, a closer look at the figures also spelt the possible beginning of the end of this golden run. The 2017 numbers present the first conclusive look at the behaviour of the Sri Lankan smoker since the unprecedented price hike of 43% in October 2016, plus the imposition of 15% VAT. With volumes falling 18% over the year, it appears that Sri Lanka is well on track with reducing smoker rates but stable incomes. However, in reality we are faced with more challenges than solutions. 

With the excessive price increase in October 2016, we may have tipped the scale to a far extreme whereby regulations become prohibitive and counterproductive, as opposed to working towards the betterment of State and society. 

On the revenue front, 2017 saw year-on-year Government excise revenue growth from CTC slide to just 1.8% as opposed to the annual average of 20%. With Sri Lanka’s real rate of inflation well over 12%, volumes are likely to be further impacted this year, which will result in a dip in excise revenue and overall state earnings from tobacco. 

An unofficial estimate employing inflation, consumer spend and earnings points to a further dip of CTC volumes by over 12% this year, which will further disrupt earnings. The situation is compounded by the growing prevalence of smuggled illicit cigarettes in the country which has grown by over 250% over the past year. The exorbitant price of legal cigarettes coupled with lax penalties have transformed Sri Lanka into a land of opportunity to smugglers, with smokers seeking out cheaper illicit products and the Government losing out close to Rs. 20 billion in revenue as a result. Impractical pricing regimes have proven unproductive across every sector, impacting revenue and livelihoods whilst giving rise to lawlessness – which then translates to further cost. 

This was also identified by the Central Bank of Sri Lanka in its 2016 Annual Report, which states: “The price of cigarettes rose between 45.0 and 100.0 per cent, depending on the brand, in 2016. The last increase in November 2016 was as a result of the application of a 15.0 per cent VAT on tobacco products. It should be noted that higher cigarette prices may lead to an increased demand for smuggled cigarettes or cheaper substitutes such as beedi that cause severe health hazards. In fact, during the first two months of 2017, Sri Lanka Customs has seized over 10 million illicit cigarettes entering Sri Lanka, in comparison to around four million illicit cigarettes seized by Sri Lanka Customs in 2016.”

CTC’s filing states that if not for the excessive price hike of October 2016, the Government would have earned Rs. 135 billion in taxes last year as opposed to Rs. 117.3 billion. This difference of Rs. 18 billion is significant. 

For instance, in 2016 Sri Lanka’s Central Bank reports that the Government spent Rs. 186.1 billion on health expenditure, up from Rs. 177.8 billion in 2015. That’s double the additional cost the Government has incurred during a year on the entire health sector in the country. 

The State loses an estimated Rs. 17 billion from the illicit cigarette industry, if we succeeded in converting that segment to the legal base Sri Lankan smokers would be effectively coughing up the entire annual Government spend on health. 

CTC’s filing to the Colombo Stock Exchange affirmed: “The gap between the price of legal and illicit products available in the market coupled together with the current macroeconomic factors impacting consumer spending power have pushed smokers towards such cheaper alternatives, defeating the Government’s public health objectives.”

Pricing mechanisms

In Sri Lanka, in its tobacco and alcohol sector in particular, price reversals are unheard of for the want of pacifying extreme social and religious wants. However, it is possible to implement pricing mechanisms in line with prevalent economic, inflationary and other cost of living indicators. This would not only safeguard due revenue from smokers to the Government, it will also control the spiraling growth of illicit cigarettes. The Government is in dire need of revenue, and it is imperative it takes every lawful and practical measure to maintain the steady flow of funds. 

In addition, the Government must take measures to control and regulate the informal beedi sector. Fledgling statistics point to a meagre cottage industry but ground estimates reveal an industry as large as four billion sticks a year providing little or no revenue to the Government. 

A beedi stick is retailed at Rs. 5 a stick with no tax component, whilst the cheapest legal cigarette is sold at Rs. 20 per stick. The introduction of a mere Rs. 5 as tax on beedi will yield Rs. 20 billion in revenue to the Government. The State is well aware of these realities as reflected in the Central Bank report. 

“The tobacco products subsector recorded a decline of 3.2 per cent during 2016. This was primarily due to lower consumer demand arising from higher cigarette prices caused by the increase in excise duties during the latter part of 2015 and further price increases during 2016. Although import duty was increased on the importation of Tendu leaves as a measure to curb the production of beedi, the beedi producers in Sri Lanka rely on local substitutes for Tendu leaves. This indicates that stringent measures should be adopted to curtail the spread of unauthorised and illicit tobacco products in the country.”

Governments need to walk the talk and address these long-term real issues that it is well aware of rather than playing to a gallery of a vested few. It needs to consider the bigger picture and the future direction and progress of the country in the modern milieu. 

For social and economic expansion, the State needs to strengthen existing revenue streams and ensure law and order. Policymakers must learn to be steadfast and practical; to reverse the tide to appease the minds of a vested few will win them little favour or votes on judgment day. 

(The writer is a retired Administration, Shipping and Maritime Security Consultant in Sri Lanka and the Middle East)