A thriving illicit trade of more than 40 billion cigarettes a year is undermining Pakistan’s tax policy objectives
Pakistan’s cigarette market has become a case study in how good-faith tax policy can yield unintended/negative results.
Despite repeated increases in excise duties – most dramatically in the 2022–23 financial year – the country now hosts the world’s largest illicit cigarette market. More than 40 billion cigarettes avoid domestic taxation each year, more than half of all cigarettes consumed.
Policymakers have long assumed that aggressive tax rises will reduce consumption and bolster revenues. Instead, total consumption has remained remarkably stable at around 80 billion cigarettes annually.
What has changed is the composition of the market: legal, tax‑paid cigarettes have steadily lost ground to cheaper illicit products that evade domestic taxes, costing Pakistan’s exchequer significant lost tax revenues.
The economics behind this shift are clear. Over the past decade, more than 80% of changes in the retail price of cigarettes have been driven by excise duty hikes.
Real‑terms price increases are strongly correlated with growth in the illicit market. When tax‑paid cigarettes become less affordable, consumers do not stop smoking; they trade down into untaxed and unregulated alternatives.
The 200% nominal excise increase introduced between April 2022 and February 2023 illustrates the point starkly. Legal cigarette sales fell from roughly 55 billion sticks in FY 2021‑22 to just 36 billion two years later.
Yet, excise revenues rose by only 8% above inflation over the same period, despite the average real excise per cigarette increasing by more than 60%. A dramatic rise in tax rates yielded almost no additional fiscal benefit. In fact, cigarette tax revenues were higher 10-15 years ago when tax rates were considerably lower than they are today.
Between FY 2010‑11 and FY 2014‑15, cigarette tax rates were a third lower than they are today in real terms, annual duty‑paid sales averaged around 64 billion sticks, and Pakistan collected around Rs 250 billion a year in cigarette taxes (in real terms).
In the three fiscal years following the FY 2022‑23 tax shock, annual revenues in real terms fell to roughly Rs210 billion, while legal volumes dropped to just 38 billion. Higher tax rates have, therefore, delivered lower revenue and a weaker legal sector (in real terms).
Structural factors on the supply side have amplified the problem. According to WHO data, the manufacturer’s share of the retail cigarette price in Pakistan is among the lowest globally; 146th out of all countries assessed and only about 20% of the global average.
This leaves compliant manufacturers with razor‑thin margins, making it difficult to cover operating costs and compete with firms that evade taxes entirely. This creates a powerful incentive for domestic producers to shift cigarette production off the books.
Pakistan’s geography does not help. Its porous land borders facilitate both domestic tax evasion and the inflow of smuggled cigarettes. Enforcement agencies have made clear progress over the past two years, but the scale of the illicit market means that even expanded efforts have, so far, only arrested further growth.
Other policy tools have fared less well. Pakistan’s track‑and‑trace system, introduced to curb evasion, has struggled with enforcement gaps and high compliance costs. Large illicit manufacturers have simply avoided participation, while lawful operators face additional financial and administrative burdens. As a result, the system has yet to achieve its core purpose.
Pakistan’s experience offers a broader lesson for emerging markets: tax policy cannot be designed in isolation from enforcement capacity, market structure or consumer behaviour. Tobacco excise can be an important source of revenue, but only when calibrated to local conditions.
A sustainable approach would be to combine moderate, predictable excise increases with stronger regulatory oversight and targeted enforcement.
With excise on cigarettes staying stable for the last three years and the Government’s concentrated effort on enforcement in FY 2025-26, the Government can expect an estimated increase of Rs30 billion in tax collection during this fiscal year.
A pertinent point to mention is the cost of Track‑and‑trace technology that should not be increased, and the system must apply uniformly to all manufacturers. Without this, policymakers risk entrenching the very dynamics they aim to eliminate. If excise stability continues coupled with rigorous enforcement and stability in tax stamp cost, it can prevent further rise in illicit trade.
Pakistan’s large illicit cigarette market is not inevitable. It is the product of policy choices. A shift towards stability, predictability and effective enforcement would give the government a better chance of restoring both revenue and regulatory credibility.