The cigarette that got a tax cut

By Nishan de Mel and Raj Rajakulendran, Verité Research

Somebody got a tax cut. It was not most of us. Between 2021 and 2026, Sri Lanka raised the tax on salaries to company profits, from electricity to gas cylinders, from bread to the bar of soap — all of it on the explicit logic that the country needed more revenue. But over the same period, the tax on a pack of cigarettes was quietly allowed to fall by 7.2 percentage points. 

That missing slice of tax is worth Rs. 17.3 billion a year in 2026 — money the Treasury could have collected by ensuring the rate was kept up to the mark. No new law is required to do this. No household, not even the smokers, need to pay a rupee more. The power, the opportunity and the compelling logic, are sitting on a platter. They have been for the last two years.

We think the Government should act on it. Now.

The reform that skipped one product

Sri Lanka is in an IMF program whose central demand is more revenue. It has raised almost every consumer and producer tax to meet that demand. On cigarettes, it has done the opposite. 

The scale of Sri Lanka’s tax effort since 2021 is real. Personal income tax rates went up. Corporate income tax rates went up. The VAT component in the final price of almost all goods and services – from cooking gas to the bar of soap – rose by 7.8 percentage points. Then it got another 2% tax added to it, called SSCL. Additionally, lots of food items previously exempt from VAT were pulled into the tax net for the first time.

But the taxes on cigarettes moved in the opposite direction. Between 2021 and 2026, the tax share in a pack of Capstan, the cheapest brand of cigarettes, fell by 8.8 percentage points. The share in the most-sold brand, John Player Gold Leaf, fell by 5.6 percentage points. Fuel at the pump to food on the table – we raised the share of taxes on them all. But not on cigarettes. We gave cigarettes a generous tax break (as did Casinos a bit earlier), and we did it quietly. 

Parliament discussed cigarette taxes as if the price increases on cigarettes done by the company were tax increases done by the Government. They were not.

Sri Lanka used to be closer to the mark. In 2018, the weighted-average tax-in-price across cigarette brands stood at 74% — within touching distance of the 75% benchmark set by the World Health Organisation as international best practice. By 2026, it had fallen to 66.8%.

The missing Rupee

Forget the jargon and just count rupees. Out of every twelve rupees a smoker hands over at the shop, how many rupees should the Treasury collect in tax? The World Health Organisation says the right answer is nine — 75%. But today, instead of collecting nine rupees it collects only eight. One rupee in every twelve that used to be public money is now private money.

Sri Lanka used to be closer to the mark. In 2018, the weighted-average share of tax in the price of cigarettes, across all brands, stood at 74% — within touching distance of the 75% benchmark set by the World Health Organisation as international best practice. By 2026, it had reduced to 66.8%.

You have heard the news splashes, at various points, saying the cigarette taxes have been raised. So you wonder, how is it possible that the taxes came down? This is how it is possible. 

When the tax is set as a percentage of price, the rupees collected increase automatically when the price goes up. But much of the tax on cigarettes is through an excise tax that is set as a specific rupee amount and adjusted periodically. As a result, when the company raises prices the rupees collected from excise tax on cigarettes don’t increase automatically – the Government must take action to do it. So yes, the news was right, excise tax was increased; but what it didn’t tell you was this: it was increased much much less than prices were increased by the company to load up its profits. That is why as prices went up, the tax share in the price came down. 

The part worth getting angry about

The smokers got a tax break, but the rest of us? We had to snort up higher taxes on essential goods – Rs. 17.3 billion more this year – to pay for the tax subsidy given to the tobacco industry.

How much is Rs. 17.3 billion? It is 1.2 times what Sri Lanka allocated to the disaster management ministry. It is 1.3 times what it allocated to improve nutrition. It is 2.4 times the estimated cost of paying maternity leave benefits in the private sector. These are programmes the Treasury does not expand, or refuses to fund – like the maternity leave benefits – citing fiscal constraints. The money to expand and pay for critical social support is not missing from the economy. It is sitting on the income statement of Ceylon Tobacco Company, which collected it on a tax subsidy handed to it by the Government.

Here is the part worth sitting with. A Government told its citizens that the crisis required sacrifice and then taxed their incomes, their companies, their electricity and their groceries to prove it. The argument — we must mobilise revenue — was applied to almost everything people buy and earn. It was not applied to the one product for which higher taxes are universally endorsed, on fiscal grounds as well as health ones. The WHO recommends it. The World Bank recommends it. The IMF recommends it, including specifically for fiscal reasons. The tax burden went up almost everywhere. On cigarettes, it went down.

When the Government reduces the effective tax in electricity and fuel (calling it a subsidy) to give consumers a break, there is much discussion about fiscal responsibility. But when the Government gives the cigarette company a whopping tax break? Apparently, that’s OK.

The well-funded fake news industry

An industry that siphons off billions from Government coffers by influencing tax policy is also able to spend on fake news. So there is a great deal of that, and it’s all over, in the air that we breathe, in what we assume as true – without knowing any better. Facts, serious research, global consensus? “That don’t impress me much” (sorry Shania Twain), under the onslaught of this fake news by the industry.

Like it is in the spread of most fake news, there are plenty of ‘guns for hire’ to do it. From the age-old propaganda journalists, to that strange new breed called “social media influencers”. From age-old corrupt bureaucrats, to some new research institutions that play for pay. This is not unique to Sri Lanka, it is a well-studied global phenomenon. But the smart politicians and decision makers in the world know not to be duped.

Fake news comes in three main forms: Government revenue will fall if taxes are raised, because of radically reduced consumption; with more taxes, more revenue will be lost to smuggled substitutes; and higher taxes will cause the industry to collapse and tobacco farmers to suffer.

There are numerous research articles published by Verité Research, and the Institute of Policy Studies in Sri Lanka and additionally by researchers in the finest universities in the world and even multilaterals like the World Bank, UNDP and WHO, that call out the bluff in these arguments and demonstrate how they are contradicted by evidence. 

The economic logic is straightforward. A higher tax on cigarettes does three things at once: it raises revenue to fund important spending, it discourages a product that sends its own bills to the public hospital system, and unlike fuel taxes, it does not raise the prices of essential things like food, electricity and transport. A higher tax on things like fuel raises revenue too — but at a real cost to all prices and economic welfare. 

It is now time to Act. Now.

Sri Lanka was the first Asian country, and the fourth in the world, to ratify the WHO Framework Convention on Tobacco Control, in November 2003. The Article 6 Guidelines to that convention are explicit: tobacco taxes should be raised regularly so they keep pace with inflation and income growth. The IMF’s own technical guidance for member countries prescribes the same. These are not contested positions. They are commitments Sri Lanka has formally signed onto. The data from 2018 to 2026 show they are not being met.

Sri Lanka is collecting more tax than at any point in its recent history. Putting the cigarette tax share back to 75% would add Rs. 17.3 billion to revenue every year — no new tax instrument, no new legislation, and not a rupee more from any household buying essentials, just a reduction in profit for company. There are not many fiscal decisions in Sri Lanka this simple, this well supported, and this fiscally useful. The Government has already chosen to tax almost everything else. It should stop giving a tax subsidy to the cigarette company.