When cigarette taxes go too far

by Tharanga Abeysooriya

Europe is buckling under an onslaught of illicit cigarettes, and losing over 16.7 billion Euros in taxes annually, as the World Health Organization (WHO) sponsored high excise tax strategy on cigarettes as a deterrent unravels faster than ever. 

A recent article published by Washington DC’s, Tax Foundation argues that consumers in Europe and elsewhere are increasingly finding ways around high cigarette prices, whether through illicit purchases or cross-border shopping. More than 10% of cigarettes consumed in the EU last year were illicit, amounting to around 42 billion sticks. Ireland, despite having one of Europe’s highest cigarette tax burdens, still reports a smoking rate of around 17%.

Sri Lanka faces a similar dilemma. Higher taxes on legal cigarettes have not eliminated demand. They may instead be changing where demand is met: through illicit cigarettes or lower-taxed alternatives. That distinction matters. A tax policy can appear effective on paper while pushing consumers outside the legal, taxed market.

The Tax Foundation questions whether taxes should account for at least 75% of the retail price of cigarettes in all circumstances. Its central objection is simple: tax incidence measures a percentage of price, not the real tax burden consumers face, or the revenue governments collect. A 75% tax share on a low-priced product is not the same as a 75% tax share on a high-priced one. Consumers respond to what they pay, not to the percentage embedded in the final price.

The global picture also raises questions about whether such a benchmark is representative. According to the Tax Foundation analysis, only a small minority of countries meet the 75% incidence target, and those that do are concentrated among higher-income economies. A seldom referenced reality is that of the 190+ countries in the world a mere 39 countries conform to the WHO “recommended” tax rate. It is also worth noting that of that 39 countries, 22 are high-income countries and include none from the South Asian region. That matters for countries such as Sri Lanka, where affordability, enforcement capacity, income levels and cheaper alternatives differ markedly from conditions in high-income European markets. A single global benchmark may therefore obscure more than it reveals.

As the Tax Foundation puts it, “the right level of taxation will be profoundly different from one country to the next”. Economic development, enforcement capability and policy objectives all matter. So too does the structure of the market. A retail-price target cannot easily capture those differences.

A target that appears successful on paper, yet encourages consumers to shift towards illicit, untaxed or under-regulated alternatives, deserves closer scrutiny. For Sri Lanka, the lesson is less about the level of taxation than about the need to align tax policy with affordability, enforcement capacity, and consumer behaviour

Sri Lanka’s experience illustrates the problem. Over the past five years, excise taxes on cigarettes have risen by more than 100%. Revenue from the legal cigarette industry, however, has not risen by the same proportion. Higher tax rates do not automatically mean higher revenue if legal sales fall, consumers down-trade, or demand shifts towards illicit and under-taxed alternatives. When tax increases outpace affordability, the legal market can contract while illicit operators gain. Raising rates is not the same thing as increasing receipts.

Retail prices are imperfect guides to tax policy. They reflect not only taxation, but also production costs, distribution, margins, inflation and exchange rates. Consumer responses vary by income group and market. As taxes rise, substitution, avoidance, cross-border shopping and illicit trade can all affect collections. The relationship between higher tax rates and higher revenue is therefore neither linear nor universal. Beyond a certain point, steep increases can create a market for cheaper untaxed products.

Europe offers a cautionary example. Ireland and France have some of the world’s highest cigarette tax burdens. They also face significant illicit trade challenges. According to the Tax Foundation analysis, more than one-third of cigarettes consumed in those countries are not legally purchased domestically. The article also cites evidence that, across the EU, an additional €1 in tax per pack of 20 cigarettes is associated with a roughly 7% increase in smuggling.

None of this means taxation has no role in tobacco policy. It means it must be calibrated. If affordability, enforcement and consumer behaviour are ignored, tax increases may reduce legal sales without reducing overall consumption to the same degree. The result is weaker revenue performance and a larger illicit market.

Sri Lanka’s policymakers should therefore view global recommendations through the lens of domestic conditions. The objective is not to satisfy an international benchmark, but to protect revenue, support public-health objectives and limit the space for illicit trade. Doing so requires closer attention to substitution. If legal cigarettes are taxed heavily while alternatives such as beedi remain lightly taxed and weakly regulated, price-sensitive consumers may shift to cheaper and less controlled products, weakening both revenue and public-health outcomes.

The treatment of beedi exposes a broader inconsistency in the current framework. Despite representing a significant share of tobacco consumption, it remains subject to far lighter taxation and regulatory oversight than legal cigarettes. That creates an uneven market and weakens the effectiveness of tobacco-control policy.

Raising taxes on legal cigarettes while leaving alternative combustible products, such as beedi, comparatively unchecked risks shifting consumption rather than reducing it. If the aim is to reduce tobacco use, protect revenue and strengthen regulatory control, tobacco products should be assessed within a more consistent fiscal and regulatory framework.

The debate is often framed as one between higher taxes and lower taxes. That is too narrow. The more important question is whether taxation is achieving the objectives policymakers intend. A target that appears successful on paper, yet encourages consumers to shift towards illicit, untaxed or under-regulated alternatives, deserves closer scrutiny. For Sri Lanka, the lesson is less about the level of taxation than about the need to align tax policy with affordability, enforcement capacity, and consumer behaviour.