FED: Evasion, Fiscal Federalism & Policy Failure
Dr. Ikramul Haq
Pakistan aptly fits in the concept of a “soft state”—famously articulated by the Nobel Laureate, Swedish sociologist. Gunnar Myrdal, in his 1968 three-volume work, ‘Asian Drama: An Inquiry into the Poverty of Nations’. It is a broad-based assessment of the degree to which the state, and its machinery, is equipped to deal with its responsibilities of governance. The more soft a state is, the greater the likelihood that there is an unholy nexus between the law-makers, the law-keepers, and the law-breakers. In a nutshell, this is the case of illicit trade in cigarettes in Pakistan destroying health of millions, especially the youth but governments are interested only in revenues and not even health tax as discussed above!—Budget 2021: Illicit trade, June 12, 2020
If income tax has been reduced to a withholding-driven extraction mechanism and sales tax has turned into a narrow, high-rate and distortionary levy, federal excise duty (FED) exposes yet another layer of incoherence in Pakistan’s tax policy. The official record for fiscal year (FY) 2024-25 shows that FED grew sharply, but the pattern of that growth is too uneven and too policy-driven to be celebrated without scrutiny.
The Revenue Division Year Book 2025 reports net FED collection of Rs. 766.6 billion for FY 2024-25, up from Rs. 577.4 billion in FY 2023-24, a rise of 32.8 percent. Its share in overall FBR collection rose from 6.2 percent to 6.5 percent. The FBR Year Book 2024-25 gives the same broad picture but breaks the tax more clearly into domestic FED of Rs. 624.4 billion and import-stage FED of Rs. 142.3 billion, showing an 81:19 composition. At first sight, such growth appears impressive. On closer examination, however, it reflects selective rate hikes, sector-specific interventions and statistical concentration rather than a coherent excise policy.
Revenue Division Year Book identifies cigarettes as the single largest FED spinner at Rs. 225.5 billion in FY 2024-25, accounting for 29.4 percent of all FED, though this was down from 40.7 percent in the previous year. Cement came next at Rs. 154.1 billion, followed by inland air travel, travel by air, beverage concentrates and aerated waters. The same yearbook records that cigarette FED fell by Rs. 9.6 billion, or 4.1 percent, even as total FED rose strongly.
FBR Year Book, however, presents the cigarette story in a more revealing way. In its domestic FED table, cigarettes are shown at only Rs. 121.2 billion in FY 2024-25 against Rs. 234.2 billion in FY 2023-24, a collapse of 48.3 percent, while cement surged to Rs. 154.1 billion and became the largest domestic FED source.
The FBR text explicitly attributes the decline in cigarette FED to higher prices caused by tax hikes, lower legal sales, down-trading from premium to economy brands, and greater reliance on smuggled or untaxed products. This is one of the rare cases where the official publication itself admits that higher taxation has coincided with a shift away from the duty-paid segment.
That admission is critical because it vindicates what has been argued for years in earlier work on illicit cigarette trade. In a 2020 series, it was pointed out that the wrong tier structure and abrupt tax engineering had widened the gap between duty-paid cigarettes and illicit cigarettes, thereby encouraging down-trading and revenue loss.
The first article cited an Auditor General-linked estimate that the third-tier structure caused a revenue loss of Rs. 33 billion in just one year after brands shifted into the lower slab. The second article argued that consumption had remained broadly stable, while legal revenue fell because the market migrated toward non-duty-paid cigarettes. Those warnings were not ideological; they were empirical.
The latest official data now point in the same direction. A tax that is supposed to curb smoking and raise revenue has instead presided over a shrinking formal market share for legal manufacturers and a widening space for illicit production and smuggling.
The problem is no longer anecdotal. FBR itself stated in November 2025 that illicit cigarette manufacture and trade were causing annual revenue losses of roughly Rs. 250 billion to Rs. 300 billion. PRIME Institute also revealed in a study that illicit cigarettes trade accounts for 56% of the market, up from 30% in 2023, leading to an annual loss of more than Rs300 billion in tax revenue.
More recently, the Minister of State for Finance said FBR’s own calculations showed a loss of nearly Rs. 200 billion a year from illicit cigarette trade, while independent estimates placed the loss even higher. In other words, the state is simultaneously acknowledging a huge excise base and admitting that a massive portion of that base is leaking away.
This is why clandestine manufacturing of cigarettes remains the central test case for FED policy. A predictable and enforceable excise system should narrow the price differential between legal and illegal products while ensuring compliance across the manufacturing chain. Pakistan has done the opposite far too often. It has relied on abrupt rate hikes, complicated tiering, weak track-and-trace enforcement and insufficient control over non-duty-paid production centres.
The result is a perverse equilibrium: the state raises rates to recover revenue, the illicit segment grows because the legal–illegal price gap widens, legal sales fall, and the revenue target is missed or met only partially through squeezing documented sectors elsewhere. The tax is then blamed for being too low, when the real problem is incoherent design and weak enforcement.
The yearbooks also show how distorted the import-side FED has become. The FBR Year Book records import-stage FED at Rs. 142.3 billion in FY 2024-25, up 289 percent from Rs. 36.6 billion in FY 2023-24. Yet this surge was not due to a broad expansion of excise coverage; it was overwhelmingly driven by one item—man-made staple fibres—at Rs. 97.5 billion, equal to 68.5 percent of all import FED. The yearbook explains that this jump followed the Finance Act 2024 imposition of FED on acetate tow at a fixed rate of Rs. 44,000 per kg.
It also notes that Chapter 56 items rose for the same reason, because acetate tow is used in both cigarette and textile industries. At the same time, import-stage tobacco and manufactured tobacco substitutes contributed only Rs. 665 million, or 0.5 percent of import FED. This composition is too skewed to be regarded as normal excise design. It is a policy spike, not a stable tax base.
This takes the argument beyond cigarettes alone. Federal excise duty in Pakistan is no longer being used with conceptual discipline. Cement, sugar, air travel, beverages, motor cars, fertilizers and selected industrial inputs are all pulled into the excise net for different reasons, some fiscal and some regulatory, without a clear theory of incidence or a transparent federalism logic. That lack of coherence becomes constitutionally serious when one turns to electricity, oil and gas.
Article 161 of the Constitution provides that the net proceeds of the federal duty of excise on electricity, natural gas, and oil levied at bus-bars of a hydro-electric station and well-head respectively, shall not form part of the Federal Consolidated Fund and shall be paid to the province in which the well-head or is situated. Article 160, by contrast, governs the divisible pool taxes under the National Finance Commission (NFC) framework. The distinction is fundamental: if excise is properly levied at bus-bars of a hydro-electric station and well-head as envisaged under Article 161, the producing provinces receive the net proceeds directly, rather than as part of a later divisible-pool allocation.
This is where federal tax policy has persistently failed Sindh, Khyber Pakhtunkhwa and Balochistan. Instead of building a constitutionally coherent excise regime on electricity, oil and natural gas, the federation has preferred other instruments, especially sales tax and petroleum levy, because they are administratively easier and fiscally more beneficial for the centre.
Recent work on petroleum levy and fiscal federalism in these columns has already shown how reliance on petroleum levy and zero-rating of GST on petroleum products centralises revenue and deprives provinces of their due share. The same logic applies here in another form: if constitutional space exists for FED on electricity, oil and gas with direct provincial entitlement, failure to operationalise it systematically weakens fiscal federalism and keeps producing provinces dependent on federal transfers rather than on their own constitutionally earmarked receipts.
A report from 2015 had already noted that FBR itself accepted, before the Senate Standing Committee, that federal excise duty could be levied on local crude oil and that Article 161(1)(b) would require the net proceeds to be paid to the province where the well-head is situated. Yet the centre opposed the move on the ground that it would raise petroleum prices and would then have to be mirrored at import stage for uniformity. That argument may explain political reluctance, but it also confirms the constitutional point: the power exists, the provincial entitlement exists, and the choice not to use it has distributional consequences.
The broader conclusion is that FED in Pakistan suffers from three simultaneous failures. First, it is unstable as a revenue instrument, because large parts of it depend on abrupt policy changes and narrow sectoral concentration.
Second, it is ineffective as a regulatory instrument, because in sectors like cigarettes it has not curbed illicit supply and has arguably widened the legal–illegal divide. Third, it is inconsistent with sound fiscal federalism, because constitutionally available excise heads linked to electricity, oil and gas have not been developed in a way that secures producing provinces their due share under Article 161, while the federation has increasingly preferred centralising instruments outside the divisible framework.
That is why FED should no longer be treated as the smallest and therefore least important federal tax. It is, in fact, one of the clearest windows into Pakistan’s deeper fiscal disorder. The enforcement against counterfeit cigarette collapses, the import-side acetate-tow anomaly and the long neglect of constitutionally grounded excise on electricity, oil and gas together show a state still improvising where it should be legislating with principle. The final part of this series is going to move from tax heads to the taxation structure itself: exposing the crisis of credibility, the failure of data integrity and the urgent need for structural reform.
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Dr. Ikramul Haq, Advocate Supreme Court, Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE), holds an LLD in tax laws. He was full-time journalist from 1979 to 1984 with Viewpoint and Dawn. He also served Civil Services of Pakistan from 1984 to 1996.