As Pakistan prepares to unveil its federal budget for FY 2025–26, the government is facing a dual fiscal imperative: bolstering national defence amid regional security challenges and addressing an ever-worsening burden of Non-Communicable Diseases (NCDs) versus broader economic gains by incentivising formal industries. Slapping taxes on formal industries leads to price escalations and an inadvertent reliance of consumers on informal substitutes, resulting in no taxes collected, a boost to cheap and counterfeit products, and public health risks due to dependence on low-quality substitutes. To meet the country’s enhanced fiscal demands, policymakers are hard-pressed to increase the Federal Excise Duty (FED) on formal industries, with tobacco, dairy, sugary drinks, juices, and other processed food segments being the usual suspects. However, the outcomes may remain far from optimal and short-sighted.
In recent weeks, renewed tensions with India have escalated the urgency to enhance Pakistan’s defence preparedness. The government has signalled a significant increase in the defence budget to bolster deterrence and maintain operational readiness. As discussions in Islamabad intensify, insiders confirm that a sizable bump in the defence budget is being prioritised for apparent reasons. This, however, comes at a time when the country faces a persistent revenue shortfall and growing macroeconomic constraints. “Given the current regional instability, increasing the defence budget is non-negotiable,” a senior official at the Ministry of Defence noted. “Our armed forces need the resources to defend the country effectively, particularly under rising threats.”
The tightly monitored IMF program has made it amply clear that fiscal discipline, revenue generation, and subsidy rationalisation are prerequisites for releasing the next tranche of funding. The government is demonstrating a seriousness about corrective measures, with the Prime Minister committing to fast-track institutional reforms alongside macroeconomic stabilisation, and the Finance Ministry and FBR on board in creating a more enabling environment conducive to Foreign Direct Investment (FDI). As part of the IMF’s Extended Fund Facility program, Pakistan has no choice but to broaden its tax base through progressive taxation. Increasing excise duties—especially on non-essential consumer products presents the most obvious, quick and equity-enhancing tool to collect funds for increased strategic spending without violating deficit ceilings.
Unlike regressive general sales taxes, excise duties on tobacco, dairy, processed food, and beverages can be narrowly targeted, making them appear ideal without increasing the cost of essentials such as grains, pulses, and fuel. Discussions of a rise from the current 20% to 30% for aerated beverages and from 20% to 40% for high-caffeine drinks, juices, and processed food items are already circulating, with a proposed trajectory of 50% by 2028. Supporters of this proposal argue that such a move will serve the dual purpose of swiftly generating substantial tax revenues and addressing Pakistan’s non-communicable disease (NCD) burden. However, historical data indicate that measures such as these led to a greater reliance on substitutes offered by informal segments, including unhygienic gawala (milkman)– supplied milk, counterfeit and harmful beverages with higher sugar content, smuggled and low-quality cigarettes, and spurious juices and syrups. The beverage industry currently contributes over Rs 175 billion in taxes annually (FED, GST, income tax, super tax) – one of the highest taxed sectors.
Let us take the example of cigarettes. According to ACT Alliance Pakistan, a civil society group founded in 2016 to address illegal economic activities, including tax evasion and smuggling, the legal cigarette market is seeing a sharp decline in sales, with a price elasticity of demand for cigarettes at -1.4. This indicates that significant price increases, due to an already over-taxed industry, led to reduced legal purchases and a shift by consumers toward counterfeit, smuggled, and untaxed cigarettes. For the first time in the country’s history, illegal cigarette sales exceeded legal ones, now making up 56% of the total market share. Frequent tax hikes on legitimate brands, combined with the track-and-trace system’s failure to meet its revenue goals, have prompted consumers to seek out untaxed options. This has led formal cigarette manufacturers to contemplate shifting their investments to more lucrative and investor-friendly markets.
This year, the Ministry of Health has recommended a 20% flat excise duty (FED) on industrial dairy products and up to 50% on confectionery, beverages, snacks, and other ultra-processed foods. The World Bank and local organisations, such as the Pakistan National Heart Association, have endorsed this tax proposal, citing international evidence that shows a significant reduction in the consumption of beverages and processed food following price increases. In May 2024, a multi-party group of parliamentarians publicly supported a significant increase in the Federal Excise Duty (FED) on processed foods and sugary drinks. “We are losing lives and spending billions because of preventable diseases,” said Dr. Nisar Cheema, a former Member of the National Assembly. “The time for half-measures is over. We need to tax these products at 50%, as recommended by international experts.” Dr. Cheema remarked. “The excise duty should not only reflect economic needs but also social responsibility.”
What the proposals from the Ministry of Health fail to factor in is the prevalence of informal substitutes and the ready availability of even worse options, similar to the cigarette segment, to consumers in Pakistan. These informal products do not contribute to the national economy through taxes, unlike the formal manufacturers and retailers. Industry associations warn of job losses, possible divestment, reduced business activity, and loss of tax revenue in the medium to longer term if the Fed raises interest rates beyond sustainable thresholds. The beverage industry estimates that the unprecedented hike in the Fed’s rate from 13% to 20% in 2023 resulted in a double-digit volume decline over two consecutive years (2023–2025) and a return to 2018 volume levels (from 825 MUCs to 689 MUCs). This resulted in just 60% plant capacity utilisation, despite having strong infrastructure and a history of growth, and an investment of USD 300 million placed on hold since March 2023. Industry projects that lowering FED to 15% will unlock PKR 38 billion in additional tax revenue in FYs 2025-2027 compared to even continuing with the current 20%. These formal players are also increasingly shifting focus to healthier substitutes, such as cigarette manufacturers offering low-nicotine options and beverage brands promoting light and zero options with lesser sugar content and reduced calories. Informal sugary drinks and juices have neither the count of their sugar content nor any quality checks, and make zero contribution to the national exchequer.
For Pakistan, the need to meet IMF requirements, respond to escalating regional tensions through greater spending on defence, and confront the health emergency posed by NCDs are critical and all point to one policy lever with outsized potential: excise taxation on formal industries. To strike the optimal balance, it may be a good idea for the policy-makers to look at the informal sectors such as the local mithai walas (sweetmeat makers), gawalas (milkmen), and the numerous factories and illegal units making counterfeit, harmful, and sub-par beverages and juices, and successfully evading taxes. Of course, this means taking a more prudent view of fiscal policies that do not deter growth but bring informal segments into the tax net, thereby tightening the noose around informal manufacturing segments and bringing heretofore untaxed segments into the tax net. As the federal budget nears finalization, all eyes are on whether Pakistan rises to the occasion—and implement some long-overdue reforms or once against opts to reap short-term dividends to the detriment of sectors already contributing to the economy. The choice for Pakistan remains between killing the golden egg-laying goose for a quick reward or nurturing it and reaping dividends in the long term.
