Cigarette taxation as a policy tool to raise revenue and even control smoking is back. Investors certainly think so, with ITC Ltd’s shares falling by 12% early on Tuesday, and down 15% from Friday’s close. Its shares trade closer to their 16 March levels, the day the Goods and Services Tax (GST) Council decided that the cess on demerit goods such as cigarettes would be capped. The share has gained since 17 March.
Are the caps on or off? That is unclear but safer to assume they are off. The reasons for the higher cess also send confusing signals. On television, the finance minister was heard saying that an anomaly in the calculations led to a lower tax burden post-GST. Cigarette companies could either cut prices or retain them and let profits increase. Since they had chosen to do the latter, the government decided to increase the cess.
The press statement sends a different message. It says that a “lower tax incidence” may be welcome for other goods but is unacceptable in goods such as cigarettes.
This is very strange. If companies did not pass lower taxes the anti-profiteering rules should kick in. The government should have notified the Authority and entrusted the case to it. In other words, companies can be forced to cut prices.
But is the government also saying that may be undesirable from a health viewpoint? Are the effects of smoking on health coming to the fore again, to be tackled by various measures including taxation? The past few years have seen this government go a little easy on cigarettes on the taxation front, ostensibly due to concerns that curbing cigarette consumption can affect livelihoods of tobacco farmers.
Because a lower tax per cigarette stick does not mean lower tax revenues. ITC estimates that a fifth of the cigarette market is served by illegal cigarettes (those that don’t pay tax). If legal cigarettes become cheaper, their consumption will increase as the price gap narrows and tax revenues will increase too.
That may not show India in good light, however, in international circles as a country that lowered taxes on cigarettes and unwittingly encourage consumption. India is one of the signatories to the World Health Organisation’s Framework Convention on Tobacco Control. Its health minister was recently awarded by the WHO as well for tobacco control measures.
The smoke surrounding this development is more irksome than the tax increase itself. Between 16 March and 30 June, how come nobody in the government realised that the tax on cigarettes had reduced? This, when even analysts who don’t have access to data the government must have, knew it. Has the government made mistakes in other products too? The cascading effect of indirect taxes was no hidden anomaly. In fact, GST sought to remedy this very defect.
Coming back to ITC’s forlorn investors, all analysts (and this writer) had said that GST had gifted ITC Ltd certainty in taxation. Rates were capped and increasing them would be difficult as the GST Council had that mandate now. That is wrong. Nowhere has the government said the current rates are capped. The GST Council was easily convinced of the need to increase taxes. If tax collections under GST are below expectations, can the tax on cigarettes be hiked again? Why not?
Also, the cess was a compensation to make up the shortfall in tax revenues of individual states. States can claim compensation for five years. After that, the cess should go. After Monday’s tax hike, that is a foolish hope to harbour. High cigarette taxes are here to stay and investors in ITC and other cigarette companies should take notice.