Sri Lanka loses an estimated Rs. 17.3 billion in cigarette tax revenue each year, enough to fund the annual budget of the 1990 Suwa Seriya ambulance service almost four times over or the Mahapola scholarship scheme twice over.
Sri Lanka’s cigarette tax share lingers below the World Health Organization’s (WHO) recommended benchmark and tax revisions have been inconsistent. Verité Research estimates that bringing cigarette taxes in line with this international benchmark could generate billions of rupees in additional revenue annually.
In an interview with The Sunday Morning Business, Verité Research Lead Economist Raj Prabu Rajakulendran discussed the economic costs of delayed tax revisions, shortcomings in Sri Lanka’s cigarette tax structure, and the policy changes needed to improve revenue collection and tobacco control outcomes.
Following are excerpts:
Sri Lanka has not revised cigarette taxes as frequently as recommended in recent years. What has been the economic cost of these delays from a Government revenue perspective? When cigarette taxes are not adjusted in line with inflation and income growth, how does this affect cigarette affordability over time?
With cigarette taxation, there are two issues to consider. One is whether the tax is too low. The WHO recommends that cigarettes should be taxed at 75% of the retail price. If the tax share is below that level, then taxes are too low.
The second issue is whether the price is too low. Even if a cigarette is taxed at 80%, if the price is very low, the tax collected remains minimal. Revenue can fall short when either of these two factors is not addressed.
In Sri Lanka’s current context, we are failing to meet the recommended tax share across all cigarette categories. On price, the longest cigarette category is relatively close to where it should be, but the shorter cigarette categories remain underpriced and undertaxed.
If only the tax share is fixed at the minimum, while keeping current price levels unchanged, the Government could collect an additional Rs. 17.3 billion annually. If both the tax share and price issues are addressed, the estimate rises to around Rs. 30 billion a year. The economic cost of failing to adjust taxes correctly is that price increases benefit the tobacco company rather than contributing to Government revenue.
Does Sri Lanka’s current cigarette tax structure meet international best practices, or are there specific shortcomings that need to be addressed? How important is having a transparent and formula-based approach to cigarette taxation rather than ad hoc tax revisions?
The WHO’s recommended best practice is to have a single tax rate applied to all cigarettes, which is then adjusted annually to nominal GDP growth.
Sri Lanka currently follows a tiered tax structure based on cigarette length, where different lengths are taxed at different rates. This has created incentives for the market to move from longer, higher-tax cigarettes to shorter, lower-tax cigarettes. As a result, the tax structure is not delivering the intended health or revenue outcomes.
Moving to a single indexed rate is also where the larger revenue is: restoring the tax share alone yields around Rs. 17.3 billion a year, whereas reforming the structure as well takes it above Rs. 30 billion.
The issue is not simply whether taxes are revised regularly but whether the tax structure is rational. If one cigarette is half the length of another, the tax should broadly reflect that proportion. Sri Lanka’s tax structure does not do that, as shorter cigarettes are taxed at disproportionately lower rates.
That is also why the adjustment has to be formula-based rather than ad hoc. A fixed annual rule holds the tax share steady while discretionary revisions let it drift, which is exactly what has happened.
Verité Research’s Cigarette Tax Leakage Tracker puts the loss at Rs. 547 every second right now. Can you break down exactly how that number is calculated? As of 15 July, the tracker showed Sri Lanka has lost Rs. 9.2 billion in cigarette tax revenue this year alone. How significant is that loss?
The dashboard tracks the estimated Rs. 17.3 billion in annual revenue leakage if Sri Lanka does not bring cigarette taxes up to the 75% benchmark at current price levels. The per-second figure is simply that annual amount broken down over time.
To put that figure into context, Rs. 17.3 billion is about 1.2 times the budget for disaster management, 1.3 times what the Government allocates to nutrition programmes, and 2.4 times the estimated cost of private sector maternity leave benefits.
Sri Lanka’s tax-in-price hit 74% in 2018, close to the WHO’s 75% benchmark. By 2025 it had fallen to 67%, even as Value-Added Tax (VAT) increased from 8% to 18% and a Social Security Contribution Levy was added. What happened in between?
Between 2018 and 2025, cigarette taxes increased by an average of around 11% annually. However, cigarette prices increased by approximately 13% annually over the same period. Since prices increased faster than taxes, the tax share fell.
Successive governments increased taxes during this period, including two 20% excise duty increases in 2023 – one effective 1 January and the other effective 1 July – and a further revision gazetted in January 2025. VAT and other taxes were also increased as part of broader fiscal reforms. However, the increase in cigarette taxes did not keep pace with price increases.
Did this tax structure also change what smokers were buying?
It changed it substantially. Between 2018 and 2024, consumers moved towards shorter, lower-taxed cigarettes. In 2018, the market share of the longest cigarette category stood at around 85%. By 2024, it had fallen to 43%.
That is not smokers changing their taste. That is the tax structure incentivising them to switch. If market shares had remained unchanged and smokers had not shifted towards lower-tax cigarette categories, Sri Lanka could have collected approximately Rs. 40 billion more in taxes.
Tobacco taxation is sometimes linked to concerns about illicit trade. To what extent is illicit trade being used to justify delays in tax revisions, and what does the evidence show? Do you think higher taxes could lead to people bringing in higher quantities of illegal brands or versions which evade taxes altogether?
Some substitution may happen at the margin. That is true of any tax and it would be dishonest to claim otherwise. The question is how large it is and whether it outweighs the revenue at stake.
The argument that higher taxes automatically lead to illicit trade has been challenged by global and local evidence. Studies by institutions such as the World Bank, as well as statements by Sri Lanka’s National Authority on Tobacco and Alcohol, have noted that concerns about illicit trade are frequently and systematically overstated. Even countries with relatively low tobacco taxes experience illicit markets.
It also matters where the estimates come from. The illicit-volume figures most often quoted in Sri Lanka are drawn from private research cited in the tobacco company’s own annual reporting, and the company benefits directly whenever a tax revision is postponed.
Illicit trade is primarily a governance and enforcement problem. Tackling it requires stronger Customs enforcement, better tracking mechanisms, and implementation of the Protocol to Eliminate Illicit Trade in Tobacco Products, which Sri Lanka acceded to in February 2016. Tax policy and illicit trade are not competing choices. Smuggling can and should be curbed while simultaneously an adequate share of tax revenue is collected.
Your proposal increases the excise tax on cigarettes up to 60 mm from Rs. 19.35 to Rs. 22.90, and on 60-67 mm cigarettes from Rs. 50.15 to Rs. 60.11. What are the specifics behind these numbers, and would they bring the tax share back to 75%?
These are minimum adjustments, calculated at today’s prices. If prices increase further, the tax has to increase again. The shorter cigarette categories remain significantly underpriced and undertaxed relative to their length. The method is not complicated: work out what tax rate delivers a 75% tax share at existing prices and gazette it. That is what the proposed adjustments to the tax rates are.
Some argue cigarette taxes in Sri Lanka are already too high, and that’s why the Government is short on revenue. How would you respond to that argument?
That argument depends on the benchmark being used. If the WHO benchmark is applied, Sri Lanka’s cigarette taxes are not too high. In fact, the country’s tax share is currently at its lowest level in around 16 years.
The recommendations being made are based on international best practices and on commitments Sri Lanka has already given. As a party to the WHO Framework Convention on Tobacco Control (FCTC), it has undertaken to maintain appropriate tax levels on tobacco. Thus, these recommendations are not out of the ordinary, nor are they an attempt to squeeze the middle class – and in any case it is the company, not the Government, that sets retail prices.
At a time when the Government is looking for revenue, collecting taxes that are already justified under international benchmarks is a reasonable approach.
Sri Lanka ratified the WHO FCTC in 2003, which calls for regular tax hikes tied to inflation and income growth. What has kept successive governments from sticking to that commitment?
Historically, cigarette tax adjustments in Sri Lanka have been sporadic, and there is still no consistent, regular, or rational adjustment mechanism. This is not for want of proposals.
The 2019 Budget proposed adjusting cigarette taxes annually in line with nominal GDP growth, and automatic excise tax adjustments were also included in the current International Monetary Fund (IMF) programme. However, neither proposal was implemented.
Thus, what is needed is a legal mechanism that removes discretion from the minister of finance and introduces automatic annual tax adjustments as part of the law. Countries such as Australia already follow this approach.
If cigarette taxes are not revised consistently over the next few years, what are the likely implications for Government revenue and tobacco control outcomes?
The Rs. 17.3 billion estimate assumes nothing gets worse. Based on present trends, it will.
If prices remain unchanged while incomes increase, cigarettes become more affordable and consumption can increase over time, which increases the revenue the Government forgoes. Alternatively, if cigarette prices increase without corresponding tax revisions, a larger share of revenue shifts to the tobacco company rather than the Government.
Either way the Government loses, and the loss compounds with every year the adjustment is postponed. This is not a difficult problem to solve. It needs a rule that adjusts the tax automatically, so that collecting it no longer depends on someone deciding to act.
The answer is not another one-off tax increase announced only when the revenue loss becomes impossible to ignore. Parliament should establish a transparent statutory formula that adjusts cigarette taxes annually in line with inflation and income growth and should oversee its implementation.
Good tax policy should not be periodically rescued from neglect. Sri Lanka is searching for revenue while allowing an established source of revenue to erode each year. That is not fiscal prudence but fiscal irony. Cigarettes are priced, adjusted, and sold every day. There is no reason their taxes should move only when the Government remembers.